UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q/A
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter Ended Commission File Number
March 31, 1995 1-8233
USF&G CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-1220567
(State of incorporation) (IRS employer identification no.)
100 Light Street, Baltimore, Maryland 21202
(Address of principal executive offices and zip code)
(410) 547-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve (12) months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes x No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common Stock, Par Value $2.50; 106,596,322 shares outstanding as of April
30, 1995.
Page 1 of 29
U S F & G C o r p o r a t i o n
Contents
PART I. Financial Information
Item 1. Financial Statements:
Condensed Consolidated Statement of Financial Position 3
Condensed Consolidated Statement of Operations 4
Condensed Consolidated Statement of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6
Report of Independent Auditors 12
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 13
PART II. Other Information
Item 6. Exhibits and Reports on Form 8-K 25
Exhibit 3- Articles of Incorporation 25
Exhibit 11- Computation of Earnings Per Share 26
Exhibit 12- Computation of Ratio of Consolidated Earnings
to Fixed Charges and Preferred Stock Dividends 27
Exhibit 15- Letter Regarding Unaudited Interim Financial
Information 28
Signature 29
U S F & G C o r p o r a t i o n
Condensed Consolidated Statement of Financial Position (Unaudited)
At March 31 At December 31
(dollars in millions except per share data) 1995* 1994*
Assets
Investments:
Fixed maturities:
Held to maturity, at amortized cost (market, 1995, $4,422; 1994, $4,284) $ 4,640 $ 4,659
Available for sale, at market (cost, 1995, $4,348; 1994, $4,265) 4,275 4,081
Common stocks, at market (cost, 1995, $44; 1994, $53) 40 46
Preferred stocks, at market (cost, 1995, $27; 1994, $26) 27 26
Short-term investments 343 450
Mortgage loans 349 349
Real estate 637 662
Other invested assets 405 288
Total investments 10,716 10,561
Cash 83 69
Accounts, notes, and other receivables 655 741
Reinsurance receivables 651 554
Servicing carrier receivables 701 706
Deferred policy acquisition costs 485 504
Other assets 842 845
Total assets $14,133 $13,980
Liabilities
Unpaid losses, loss expenses, and policy benefits $ 9,859 $ 9,962
Unearned premiums 983 968
Corporate debt 602 586
Real estate and other debt 43 42
Other liabilities 1,089 981
Total liabilities 12,576 12,539
Shareholders' Equity
Preferred stock, par value $50.00 (12,000,000 shares authorized;
shares issued, 1995, 5,299,910; 1994, 6,627,896) 265 331
Common stock, par value $2.50 (240,000,000 shares authorized;
shares issued, 1995, 110,402,995; 1994, 104,810,794) 276 262
Paid-in capital 1,156 1,104
Net unrealized gains (losses) on investments and foreign currency (67) (147)
Minimum pension liability (63) (63)
Retained earnings (deficit) (10) (46)
Total shareholders' equity 1,557 1,441
Total liabilities and shareholders' equity $14,133 $13,980
See Notes to Condensed Consolidated Financial Statements.
* Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial
Corporation. See Note 10.
U S F & G C o r p o r a t i o n
Condensed Consolidated Statement of Operations (Unaudited)
Three Months Ended March 31
(dollars in millions except per share data) 1995* 1994*
Revenues
Premiums earned $ 617 $ 587
Net investment income 185 184
Other 12 9
Revenues before realized gains 814 780
Net realized gains on investments 4 5
Total revenues 818 785
Expenses
Losses, loss expenses, and policy benefits 518 522
Underwriting, acquisition, and operating expenses 247 231
Interest expense 10 9
Facilities exit costs (income) (6) -
Total expenses 769 762
Income from operations before income taxes 49 23
Provision for income taxes (benefit) - -
Net income $ 49 $ 23
Preferred stock dividend requirements 8 12
Net income available to common stock $ 41 $ 11
Primary Earnings Per Common Share $ .39 $ .11
Fully Diluted Earnings Per Common Share $ .36 $ .11
Weighted average common shares outstanding (000s):
Primary 107,155 93,295
Fully diluted 129,429 93,295
Dividends declared per common share $ .05 $ .05
See Notes to Condensed Consolidated Financial Statements.
* Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial
Corporation. See Note 10.
U S F & G C o r p o r a t i o n
Condensed Consolidated Statement of Cash Flows (Unaudited)
Three Months Ended March 31
(in millions) 1995* 1994*
Operating Activities
Direct premiums collected $ 519 $ 483
Net investment income collected 172 181
Direct losses, loss expenses and policy benefits paid (445) (434)
Net reinsurance activity 68 16
Underwriting and operating expenses paid (243) (219)
Interest paid (11) (9)
Income taxes paid - (1)
Other items, net (7) (4)
Net cash provided from operating activities 53 13
Investing Activities
Net (purchases) sales and maturities of short-term investments 107 (29)
Purchases of fixed maturities held to maturity - (197)
Sales of fixed maturities held to maturity - 13
Maturities/repayments of fixed maturities held to maturity 29 159
Purchases of fixed maturities available for sale (182) (79)
Sales of fixed maturities available for sale 23 27
Repayments of fixed maturities available for sale 75 183
Purchases of equities and other investments (11) (113)
Sales, maturities, or repayments of equities and other investments 65 150
Purchases of property and equipment (8) (7)
Disposals of property and equipment - 3
Net cash provided from investing activities 98 110
Financing Activities
Deposits for universal life and investment contracts 77 50
Withdrawals of universal life and investment contracts (202) (153)
Net borrowings of short-term debt - 2
Long-term borrowings 1 122
Repayments of long-term borrowings - (124)
Issuances of common and preferred stock - 26
Cash dividends paid to shareholders (13) (16)
Net cash used in financing activities (137) (93)
Increase (decrease) in cash 14 30
Cash at beginning of period 69 18
Cash at end of period $ 83 $ 48
See Notes to Condensed Consolidated Financial Statements.
* Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial
Corporation. See Note 10.
U S F & G C o r p o r a t i o n
Notes to Condensed Consolidated Financial Statements
Note 1 Basis of Accounting
The condensed consolidated financial statements are prepared in accordance with
generally accepted accounting principles ("GAAP"). These statements include the
accounts of USF&G Corporation and its subsidiaries ("USF&G"). Intercompany
transactions are eliminated in consolidation. Certain 1994 amounts have been
reclassified to conform to the 1995 presentation. (See also Note 10 regarding
restatements for mergers consummated in the second quarter of 1995.) The
interim financial statements in this report should be read in conjunction with
the consolidated financial statements and notes thereto in USF&G's 1994 Annual
Report to Shareholders (Restated). In the opinion of management, the
accompanying unaudited condensed consolidated financial statements contain the
necessary adjustments, all of which are of a normal recurring nature for interim
period reporting purposes, for a fair presentation of results for the interim
periods.
Note 2 Review of Independent Auditors
USF&G's independent auditors, Ernst & Young LLP, have performed a review of the
condensed consolidated financial statements in this Form 10-Q/A as to the three
month periods ended March 31, 1995 and 1994. Their limited review in accordance
with standards established by the American Institute of Certified Public
Accountants did not constitute an audit. Accordingly, they do not express an
opinion on this information.
Note 3 Earnings Per Common Share
Primary earnings per common share are based on income, after deduction of
preferred stock dividends, and the weighted average number of common shares
outstanding during the periods. Common stock equivalents were not included as
they were insignificant. Fully diluted earnings per common share assume the
conversion of all securities whose contingent issuance would have a dilutive
effect on earnings. Refer to the computation in Exhibit 11.
Note 4 Ratio of Consolidated Earnings to Fixed Charges
For purposes of computing the ratio of consolidated earnings to fixed charges
and preferred stock dividends, earnings consist of income before considering
income taxes and fixed charges. Fixed charges consist of interest and that
portion of rentals that is deemed to be an appropriate interest factor. Refer
to the computation in Exhibit 12.
Note 5 Supplemental Cash Flow Information
The Condensed Consolidated Statement of Cash Flows is presented using the
"direct method," which reports major classes of cash receipts and cash payments.
A reconciliation of net income to net cash provided from operating activities is
as follows:
Three Months Ended March 31
(in millions) 1995 1994
Operating Activities
Net income $ 49 $ 23
Adjustments to reconcile net income to net
cash provided from operating activities:
Realized gains on investments (4) (5)
Facilities exit costs (income) (6) -
Change in insurance liabilities 31 45
Change in deferred policy acquisition costs 19 (20)
Change in receivables (12) (56)
Change in other liabilities (17) (30)
Change in other assets (6) 40
Other items, net (1) 16
Net cash provided from operating activities $ 53 $ 13
Note 6 Unrealized Gains (Losses) on Investments
At March 31, 1995, gross unrealized losses pertaining to equity securities
totaled $7 million. In addition, gross unrealized gains and gross unrealized
losses on limited partnerships and other investments totaled $13 million and $6
million, respectively. At March 31, 1995, there were gross unrealized gains of
$25 million and gross unrealized losses of $98 million pertaining to fixed
maturities available for sale. There were also $6 million of gross unrealized
gains relating to a deferred policy acquisition cost ("DPAC") adjustment. This
DPAC adjustment was made to reflect assumptions about the effect of potential
asset sales of fixed maturities available for sale on future DPAC amortization.
The change in net unrealized gains (losses) on investments and foreign currency
amounted to a gain of $80 million during the three months ended March 31, 1995,
compared with a loss of $164 million during the three months ended March 31,
1994.
Note 7 Proceeds From Sales of Fixed Maturity Investments
There were no sales of fixed maturities held to maturity during the three months
ended March 31, 1995. During the three month period ended March 31, 1994,
proceeds from sales of fixed maturities held to maturity were $13 million. Such
sales involved four different issuers and were based on evidence of significant
deterioration of the issuers' creditworthiness. Gross gains and gross losses of
$1 million were realized on those sales. Proceeds from sales of fixed
maturities available for sale were $23 million for the three months ended March
31, 1995, compared with $27 million for the same period in 1994. Gross gains
and gross losses of less than $1 million were realized on such sales in 1995 and
1994.
Note 8 Facilities Exit Costs
During 1994, USF&G committed to a plan to consolidate its home office operations
in Baltimore, Maryland at its Mount Washington facility. Facilities exit costs
of $183 million were recorded in the fourth quarter of 1994, representing the
present value of the rent and other operating expenses to be incurred under the
lease on the Corporation's principal office building ("the Tower") from the time
USF&G vacates the building through the expiration of the lease in 2009.
Facilities exit costs recorded in 1994 did not consider any potential future
sublease income, as such income was neither probable nor reasonably estimable at
that time. To the extent that additional or extended subleases are subsequently
negotiated, the present value of income to be received over the term of those
subleases is recognizable in the period such income becomes probable and
reasonably estimable. Net income for the three months ended March 31, 1995
includes $6 million of sublease income recognized as a result of USF&G's
renegotiation in the first quarter of 1995 of a sublease with a tenant. The new
sublease covers two floors of the Tower already occupied by the tenant and
extends that occupancy through July 2009.
Note 9 Legal Contingencies
USF&G's insurance subsidiaries are routinely engaged in litigation in the normal
course of their business, including defending claims for punitive damages. As a
liability insurer, they defend third-party claims brought against their
insureds. As an insurer, they defend themselves against coverage claims.
Additional information regarding contingencies that may arise from insurance
regulatory matters and regulatory litigation matters may be found in the
Regulation section of Management's Discussion and Analysis of Financial
Condition and Results of Operations, as well as in USF&G's 1994 Annual Report to
Shareholders (Restated).
In the opinion of management, such litigation is not expected to have a material
adverse effect on USF&G's consolidated financial position, although it is
possible that the results of operations in a particular quarter or annual period
would be materially affected by an unfavorable outcome.
9.1. North Carolina workers' compensation litigation
On November 24, 1993, N.C. Steel, Inc. and six other North Carolina employers
filed a class action in the General Court of Justice, Superior Court Division,
Wake County, North Carolina against the National Council on Compensation
Insurance ("NCCI"), North Carolina Rate Bureau, USF&G and eleven other insurance
companies which served as servicing carriers for the North Carolina involuntary
workers' compensation market. On January 20, 1994, the plaintiffs filed an
amended complaint seeking to certify a class of all employers who purchased
workers' compensation insurance in the State of North Carolina after November
24, 1989. The amended complaint, which is captioned N.C. Steel, Inc., et al., v.
National Council on Compensation Insurance, et al., alleges that the defendants
conspired to suppress competition with respect to the North Carolina voluntary
and involuntary workers' compensation business, thereby artificially inflating
the rates in such markets and the fees payable to the insurers. The complaint
also alleges that the carriers agreed to improperly deny qualified companies
from acting as servicing carriers, improperly encourage agents to place
employers in the assigned risk pool, and improperly promote inefficient claims
handling. USF&G has acted as a servicing carrier in North Carolina since 1990.
The plaintiffs are pursuing their claims under various legal theories, including
violations of the North Carolina antitrust laws, unlawful conspiracy, breach of
fiduciary duty, breach of implied covenant of good faith and fair dealing,
unfair competition, constructive fraud, and unfair and deceptive trade
practices. The plaintiffs seek unspecified compensatory damages, punitive
damages for the alleged constructive fraud and treble damages under the North
Carolina antitrust laws. On February 14, 1995, the trial court granted the
defendant's motion to dismiss the complaint. The plaintiffs have appealed the
trial court's dismissal of the case. USF&G believes that it has meritorious
defenses and has determined to defend the action vigorously.
9.2. Texas workers' compensation litigation
On April 18, 1994, Mi-De-Pizza, Inc. and ten other Texas insureds filed an
amended class action in the District Court of Dallas County, Texas against the
NCCI and all insurance companies and certain insurance brokers that wrote
workers' compensation insurance in Texas during the period 1987 to 1991. The
case, which was subsequently consolidated with another case to which USF&G was
not a party and is now captioned Weatherford Roofing Company, et al., v.
Employers National Insurance Company, et al., alleges that the defendants
utilized rates and forms that had the effect of charging premium rates in excess
of the rates approved by law. The plaintiffs are pursuing recovery of these
alleged excess charges under various legal theories, including breach of
contract, fraud, civil conspiracy and violation of the Texas Insurance Code and
the Texas Business and Commerce Code. USF&G believes that it has meritorious
defenses and has determined to defend the action vigorously.
9.3. South Carolina workers' compensation litigation
On August 22, 1994, the Attorney General of the State of South Carolina filed
suit in the County of Greenville, South Carolina on behalf of South Carolina
employers that have allegedly been damaged as a result of alleged unfair and
deceptive trade practices. Specifically, the Attorney General alleges that the
NCCI, the National Workers' Compensation Reinsurance Pool, USF&G and seven other
insurance companies which served as servicing carriers for the South Carolina
involuntary workers' compensation market, conspired to fix servicing carrier
fees at unreasonably high and noncompetitive levels in violation of the South
Carolina Uniform Trade Practices Act, allegedly causing inflated deficits in the
involuntary market and an excessive expansion of the residual market.
The Attorney General alleges that the conspiracy occurred for an unspecified
period of time prior to January 1994. The Attorney General has indicated that he
intends to pursue recovery on behalf of all South Carolina employers who have
suffered an ascertainable loss as a result of such alleged conduct, civil
penalties of $5,000 for each willful violation, and temporary and permanent
injunctive relief. USF&G believes that it has meritorious defenses and has
determined to defend the action vigorously.
9.4. Alabama Workers' Compensation Litigation
On September 14, 1994, three Alabama employers filed a class action captioned
Four Way Plant Farm, Inc., et al., v. National Council on Compensation
Insurance, et al., in the Circuit Court of Bullock County, Alabama on behalf of
all Alabama employers that have allegedly been damaged as a result of an alleged
conspiracy by the NCCI, the National Workers' Compensation Reinsurance Pool,
USF&G and numerous other insurance companies which served as servicing carriers
for the Alabama involuntary workers' compensation market, to fix servicing
carrier fees at unreasonably high and noncompetitive levels in violation of
Alabama law. Plaintiffs allege that the conspiracy occurred during the period
January 1, 1985 to January 1, 1994, and caused inflated deficits in the
involuntary market and an alleged excessive expansion of the workers'
compensation residual market. The plaintiffs seek unspecified damages on behalf
of each member of the proposed class action. USF&G believes that it has
meritorious defenses and has determined to defend the action vigorously.
9.5. Proposition 103
In November 1988, voters in the State of California passed Proposition 103,
which required insurers doing business in California to rollback most
property/casualty premium prices in effect between November 1988 and November
1989 to November 1987 levels, less an additional 20 percent discount, unless an
insurer could establish that such rate levels threatened its solvency. In May
1989, the California Supreme Court ruled that an insurer does not have to face
insolvency in order to qualify for an exemption from the rollback requirements
and is entitled to a "fair and reasonable return."
The California Insurance Department's authority to establish regulations setting
forth a basis for determining what constitutes a "fair and reasonable return"
has been the subject of significant controversy. In August 1994, the California
Supreme Court issued its opinion in 20th Century Insurance Company v.
Garamendi, affirming the California Insurance Department's authority to
establish a broad industry-wide formula for implementing Proposition 103. The
20th Century Insurance Company subsequently settled the matter with the
California Insurance Department, and on February 22, 1995, the United States
Supreme Court denied the writ of certiorari filed by the other litigants in the
proceedings.
It is not clear how the current regulations adopted by the California Insurance
Department will apply to USF&G, and there are many issues which remain
unsettled. The range of liability to USF&G could be from less than $10 million
up to approximately $31 million, including interest. The ultimate outcome of
this issue is not expected to have a material adverse effect on USF&G's results
of operations or financial position since any such liability is not expected to
materially exceed amounts already reserved.
9.6. Maine "Fresh Start" litigation
In 1987, the State of Maine adopted workers' compensation reform legislation
which was intended to rectify historic rate inadequacies and encourage insurance
companies to reenter the Maine voluntary workers' compensation market. This
legislation, which was popularly known as "Fresh Start," required the Maine
Superintendent of Insurance to annually determine whether the premiums collected
for policies written in the involuntary market and related investment income
were adequate on a policy-year basis. The Superintendent was required to assess
a surcharge on policies written in later policy years if it was determined that
rates were inadequate. Assessments were to be borne by workers' compensation
policyholders, except that for policy years beginning in 1989 the Superintendent
could require insurance carriers to absorb up to 50 percent of any deficits if
the Superintendent found that insurance carriers failed to make good faith
efforts to expand the voluntary market and depopulate the residual market.
Insurance carriers which served as servicing carriers for the involuntary market
would be obligated to pay 90 percent of the insurance industry's share. The
Maine Fresh Start statute requires the Superintendent to annually estimate each
year's deficit for seven years before making a final determination with respect
to that year.
In March 1993, the Superintendent affirmed a prior Decision and Order (known as
the "1992 Fresh Start Order") in which he found, among other things, that there
were deficits for the 1988, 1989 and 1990 policy years, and that insurance
carriers had not made a good faith effort to expand the voluntary market and
consequently were required to bear 50 percent of any deficits relating to the
1989 and 1990 policy years. The Superintendent further found that a portion of
these deficits were attributable to servicing carrier inefficiencies and poor
investment practices and ordered that these costs be absorbed by insurance
carriers. Also, in May 1993, the Superintendent found that insurance carriers
would be liable for 50 percent of any deficits relating to the 1991 policy year
(the "1993 Fresh Start Order"), but indicated that he would make no further
determinations regarding the portions of any deficits attributable to alleged
servicing carrier inefficiencies and poor investment practices until his
authority to make such determinations was clarified in the various suits
involving prior Fresh Start orders.
USF&G was a servicing carrier for the Maine residual market in 1988 through
1991. USF&G withdrew from the Maine voluntary market and as a servicing carrier
effective December 31, 1991. USF&G joined in an appeal of the 1992 Fresh Start
Order which was filed April 5, 1993 in the Maine Superior Court. In addition to
The Hartford Accident and Indemnity Company and USF&G, the National Council of
Compensation Insurance ("NCCI") and several other insurance companies which were
servicing carriers during this time frame have instituted similar appeals.
Similar appeals of the Superintendent's 1993 Fresh Start Order have been filed
by USF&G, the NCCI and several other servicing carriers in the same court. The
appeals of the 1993 Fresh Start Order will be heard on a consolidated basis.
On October 17, 1994, the Superior Court of Maine upheld the Superintendent's
finding in the 1992 Fresh Start Order that the insurance carriers failed to
exercise their good faith best efforts to expand the voluntary market and
consequently were required to bear 50 percent of the deficit relating to the
1989 and 1990 policy years. The Superior Court also held that the Superintendent
improperly held that $40 million of the deficit should be attributed to the
carriers due to servicing carrier inefficiencies and poor investment practices.
USF&G and the other parties challenging the Superintendent's order have
appealed to the Maine Law Court, the highest court in Maine, the Superior
Court's ruling on the carriers' lack of good faith and the Superintendent may
likewise appeal the Superior Court ruling that it was improper to shift $40
million of the deficit to carriers due to alleged inefficiencies and poor
investment practices.
Estimates of the potential deficits vary widely and are continuously revised as
loss and claims data matures. If the Superintendent were to prevail on all
issues, then the range of ultimate liability for USF&G, based on the most recent
estimates provided by the Superintendent and the NCCI, respectively, could range
from approximately $12 million to approximately $21 million.
Note 10 Business Combinations
On April 13, and May 22, 1995, USF&G consummated mergers with Discover Re
Managers, Inc. ("Discover Re"), and Victoria Financial Corporation ("Victoria"),
respectively. In the transactions, USF&G exchanged 5.4 million shares of common
stock, worth approximately $78.5 million, for all of the outstanding equity of
Discover Re, and 3.8 million shares of common stock, worth approximately $59.1
million, for all of the outstanding equity of Victoria. Discover Re provides
insurance, reinsurance and related services to the alternative risk transfer
market. Victoria is an insurance holding company which specializes in
nonstandard auto coverage.
Both of these business combinations are accounted for as poolings-of-interests.
Accordingly, the financial statements have been restated to reflect the mergers
with Discover Re and Victoria. A reconciliation of the previously separate
enterprises to the restated consolidated financial position and results of
operations for periods prior to the mergers are as follows:
At March 31, 1995
USF&G
Corporation USF&G
As Previously Corporation
(in millions) Reported Discover Re Victoria Adjustment As Restated
Assets
Investments:
Fixed maturities:
Held to maturity, at amortized cost $ 4,631 $ - $ 9 $ 4,640
Available for sale, at market 4,162 74 39 4,275
Common stocks, at market 38 - 2 40
Preferred stocks, at market 27 - - 27
Short-term investments 318 12 13 343
Mortgage loans 349 - - 349
Real estate 637 - - 637
Other invested assets 405 - - 405
Total investments 10,567 86 63 - 10,716
Cash 82 1 - 83
Accounts, notes, and other receivables 623 14 18 655
Reinsurance receivables 651 - - 651
Servicing carrier receivables 701 - - 701
Deferred policy acquisition costs 476 2 7 485
Other assets 829 4 9 842
Total assets $13,929 $107 $97 $ - $14,133
Liabilities
Unpaid losses, loss expenses, and policy benefits $ 9,796 $ 38 $25 $ 9,859
Unearned premiums 947 13 23 983
Corporate debt 602 - - 602
Real estate and other debt 30 - 13 43
Other liabilities 1,070 10 8 $ 1 1,089
Total liabilities 12,445 61 69 1 12,576
Shareholders' Equity
Preferred stock 265 - - 265
Common stock 253 - - $ 23 276
Paid-in capital 1,114 42 23 (23) 1,156
Net unrealized losses (65) (1) (1) (67)
Minimum pension liability (63) - - (63)
Retained earnings (deficit) (20) 5 6 (1) (10)
Total shareholders' equity 1,484 46 28 (1) 1,557
Total liabilities and shareholders' equity $13,929 $107 $97 $ - $14,133
Note: A reconciliation of the previously separate enterprises to the restated consolidated financial
position at December 31, 1994 is disclosed in USF&G's Form 10-Q for the quarter ended June 30, 1995.
Three Months Ended March 31, 1995
USF&G
Corporation USF&G
As Previously Corporation
(in millions) Reported Discover Re Victoria Adjustment As Restated
Revenues
Premiums earned $ 598 $ 6 $ 13 $ 617
Net investment income 184 1 - 185
Other 9 1 2 12
Revenues before realized gains 791 8 15 - 814
Net realized gains on investments 4 - - 4
Total revenues 795 8 15 - 818
Expenses
Losses, loss expenses, and policy benefits 504 5 9 518
Underwriting, acquisition, and operating expenses 237 3 6 $ 1 (A) 247
Interest expense 11 (1) - 10
Facilities exit costs (income) (6) - - (6)
Total expenses 746 7 15 1 769
Income from operations before income taxes 49 1 - (1) 49
Provision for income taxes (benefit) - - - - -
Net income $ 49 $ 1 $ - $(1) $ 49
Preferred stock dividend requirements 8 - - - 8
Net income available to common stock $ 41 $ 1 $ - $(1) $ 41
(A) Victoria deferred its recognition of merger-related expenses until consummation. Adjustment conforms
Victoria's accounting practice to USF&G's practice of recognizing such costs as incurred.
Three Months Ended March 31, 1994
USF&G
Corporation USF&G
As Previously Corporation
(in millions) Reported Discover Re Victoria Adjustment As Restated
Revenues
Premiums earned $ 570 $ 5 $ 12 $ 587
Net investment income 183 1 - 184
Other 8 - 1 9
Revenues before realized gains 761 6 13 - 780
Net realized gains on investments 5 - - 5
Total revenues 766 6 13 - 785
Expenses
Losses, loss expenses, and policy benefits 509 3 10 522
Underwriting, acquisition, and operating expenses 224 2 5 231
Interest expense 9 1 (1) 9
Facilities exit costs (income) - - - -
Total expenses 742 6 14 - 762
Income from operations before income taxes 24 - (1) - 23
Provision for income taxes (benefit) 1 (1) - -
Net income $ 23 $ 1 $ (1) $ - $ 23
Preferred stock dividend requirements 12 - - 12
Net income available to common stock $ 11 $ 1 $ (1) $ - $ 11
U S F & G C o r p o r a t i o n
Report of Independent Auditors
Board of Directors
USF&G Corporation
We have reviewed the accompanying condensed consolidated statement of financial
position of USF&G Corporation as of March 31, 1995 and the related condensed
consolidated statements of operations and cash flows for the three-month periods
ended March 31, 1995 and 1994. These financial statements are the
responsibility of the company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical review
procedures to financial data and making inquiries of persons responsible for
financial and accounting matters. It is substantially less in scope than an
audit conducted in accordance with generally accepted auditing standards, which
will be performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with generally accepted accounting
principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of financial position of USF&G Corporation
as of December 31, 1994, and the related consolidated statements of operations,
stockholders' equity, and cash flows for the year then ended (not presented
herein) and, in our report dated February 24, 1995, except for Note 1.11, as to
which the date is May 22, 1995, we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in
the accompanying condensed consolidated statement of financial position as of
December 31, 1994, is fairly stated in all material respects in relation to the
consolidated statement of financial position from which it has been derived.
ERNST & YOUNG LLP
Baltimore, Maryland
May 12, 1995,
except for Note 10, as to which the date is
May 22, 1995
U S F & G C o r p o r a t i o n
Management's Discussion and Analysis of Financial Condition
and Results of Operations
This section provides an assessment of financial results and material changes in
financial position for USF&G Corporation and its subsidiaries ("USF&G") and
explains the results of operations for the quarter ended March 31, 1995. The
analysis focuses on the performance of USF&G's business segments and its
investment portfolio. This discussion updates the "Management's Discussion and
Analysis" in the 1994 Annual Report to Shareholders (Restated) and should be
read in conjunction therewith. The results of operations for the quarter ended
March 31, 1995, are compared with those for the same period of 1994, unless
otherwise noted. Financial position at March 31, 1995, is compared with
December 31, 1994. Amounts have been restated to reflect mergers with Discover
Re Managers, Inc. ("Discover Re") and Victoria Financial Corporation
("Victoria"), which were completed during the second quarter of 1995.
Restatement of prior periods is required due to the application of the pooling-
of-interests method of accounting. (Note: A glossary of certain terms used in
the discussion can be found at the end of this section. The terms are
italicized the first time they appear in text.)
Index
1. Consolidated Results 13
2. Property/Casualty Insurance Operations 14
3. Life Insurance Operations 17
4. Parent and Noninsurance Operations 18
5. Investments 18
6. Financial Condition 21
7. Liquidity 22
8. Regulation 23
9. Glossary of Terms 24
1. Consolidated Results
The table below shows the major components of net income.
Three Months Ended March 31
(in millions) 1995 1994
Income from operations before realized
gains, facilities exit costs,
and income taxes $39 $18
Net realized gains on investments 4 5
Facilities exit (costs) income 6 -
Income tax expense - -
Net income $49 $23
The table below shows the components by major business segment of income from
continuing operations before realized gains, facilities exit costs, and income
taxes.
Three Months Ended March 31
(in millions) 1995 1994
Property/casualty insurance $ 55 $ 32
Life insurance 5 4
Parent and noninsurance (21) (18)
Income from operations before realized
gains, facilities exit costs,
and income taxes $ 39 $ 18
Income from operations before realized gains, facilities exit costs, and income
taxes for the property/casualty insurance segment increased $23 million for the
quarter ended March 31, 1995, mainly due to improved underwriting results
primarily from lower catastrophes. The continued improvement in the life
insurance segment resulted principally from higher product sales and improved
profit margins. The major factor influencing the $3 million decrease for parent
and noninsurance operations was higher interest expense.
During 1994, USF&G developed and committed to a plan to consolidate its
Baltimore headquarters facilities. The plan encompasses relocating all USF&G
personnel currently residing at the 40-story office building ("the Tower") in
downtown Baltimore to the Mount Washington facilities in Baltimore which USF&G
owns. Implementation of the plan began in January 1995. The relocation of
Tower personnel will begin in mid-1995 and is expected to be substantially
completed by the end of 1996. Facilities exit costs recorded in the fourth
quarter of 1994 represented the present value of the rent and other operating
expenses incurred under the Tower lease from the time USF&G vacates the Tower
through the expiration of the lease in 2009. Potential future sublease income
was not considered in calculating the facilities exit costs as such income was
neither probable nor reasonably estimable at that time. In the first quarter of
1995, USF&G renegotiated and extended the terms of a sublease with a tenant.
The new lease, which covers the two floors of the Tower already occupied by the
tenant, expires in July 2009. The present value of the additional income to be
received over the term of the new lease, $6 million, was recognized in the first
quarter of 1995, and is shown as a separate item captioned "facilities exit
costs (income)" in the condensed consolidated statement of operations.
2. Property/Casualty Insurance Operations
Property/casualty insurance operations, the principal business segment,
accounted for 85 percent of USF&G's revenues in the first quarter of 1995
compared with 84 percent in the same period of 1994. Financial results for this
segment were as follows:
Three Months Ended March 31
(in millions) 1995 1994
Premiums earned* $ 580 $ 550
Losses and loss expenses incurred (425) (421)
Underwriting expenses (203) (194)
Net underwriting loss (48) (65)
Net investment income 110 101
Other revenues and expenses, net (7) (4)
Income from operations before realized
gains, facilities exit costs,
and income taxes $ 55 $ 32
*See Glossary of Terms
Improved underwriting results and increased net investment income were the
primary reasons for the increase in income from operations before realized
gains, facilities exit costs, and income taxes in the first quarter of 1995 when
compared with the first quarter of 1994. The underwriting improvement is
attributed to lower catastrophe losses and management's efforts over the last
several years to improve the overall quality of the book of business. Net
investment income improved primarily due to the property/casualty segment's
share of earnings from an equity interest in Renaissance Reinsurance Ltd., an
offshore reinsurance company.
2.1. Premiums earned
Premiums earned totaled $580 million for the first quarter of 1995, compared
with $550 million for the same period in 1994. The following table shows the
major components of premiums earned and premiums written.
Three Months Ended March 31
1995 1994
Premiums Premiums
(in millions) Earned Written Earned Written
Branch office voluntary production:
Direct $483 $492 $467 $473
Ceded reinsurance (36) (40) (36) (37)
Net branch office voluntary 447 452 431 436
Pools and associations 16 3 40 38
Discover Re and Victoria 19 17 17 18
Other premium adjustments 1 (4) (1) (9)
Total primary 483 468 487 483
Assumed reinsurance:
Finite risk 26 48 23 38
Traditional risk 71 81 40 47
Total assumed 97 129 63 85
Total $580 $597 $550 $568
Premiums earned for the quarter ended March 31, 1995, increased $30 million
compared with the same period in 1994. The increase is attributable to the
increases in branch office voluntary direct premiums and assumed reinsurance
premiums. These increases were offset somewhat by a decrease in premiums from
voluntary and involuntary pools and associations as a result of reduced
participation in these markets.
Branch office direct voluntary premiums written in the first quarter of 1995 are
four percent higher when compared with the corresponding period of 1994.
Premiums from new business increased 26 percent in the first quarter of 1995,
and retention ratios for both Commercial and Personal Lines improved when
compared to the same period in 1994.
The table below shows premiums earned and the statutory loss ratios by lines of
property/casualty insurance.
Three Months Ended March 31
1995 1994
Premiums Statutory Premiums Statutory
(dollars in millions) Earned Loss Ratio Earned Loss Ratio
Commercial lines $290 73.1% $301 74.6%
Fidelity/Surety 32 37.7 28 28.3
Personal lines 142 79.5 141 98.4
Discover Re 6 77.5 5 77.5
Victoria 13 72.5 12 78.6
Total primary 483 72.7 487 79.0
Assumed reinsurance 97 76.1 63 58.6
Total $580 73.3% $550 76.6%
The decrease in the statutory loss ratio for primary businesses for the first
three months of the year, despite significantly higher statutory loss ratios in
voluntary and involuntary pools and associations, is primarily due to the lower
level of catastrophe losses incurred by those lines in the first quarter of 1995
when compared to the first quarter of 1994. The loss ratio for assumed
reinsurance increased in the first quarter of 1995 due primarily to estimated
catastrophe losses incurred related to the January 1995 Kobe, Japan earthquake,
as well as to unfavorable development from the February 1994 Los Angeles
earthquake.
2.2. Underwriting results
Underwriting results generally represent premiums earned less incurred losses,
loss adjustment expenses, and underwriting expenses. It is not unusual for
property/casualty insurance companies to have underwriting losses that are
offset by investment income.
Underwriting gains (losses) by major business category are as follows:
Three Months Ended March 31
(in millions) 1995 1994
Commercial $(28) $(30)
Fidelity/Surety 5 4
Personal (25) (46)
Discover Re - (1)
Victoria (2) (2)
Total primary (50) (75)
Assumed reinsurance 2 10
Net underwriting losses $(48) $(65)
Voluntary $(40) $(62)
Involuntary (8) (3)
Net underwriting losses $(48) $(65)
Consolidated property/casualty underwriting ratios, calculated based on
generally accepted accounting principles ("GAAP") and statutory accounting
practices, are as follows:
Three Months Ended March 31
1995 1994
GAAP underwriting ratios:
Loss ratio 73.3% 76.5%
Expense ratio* 34.8 35.0
Combined ratio 108.1 111.5
Statutory underwriting ratios:
Loss ratio 73.3 76.6
Expense ratio 34.7 34.3
Combined ratio 108.0 110.9
*See Glossary of Terms
Underwriting results improved by $17 million in the first quarter 1995 when
compared with the same period of 1994 primarily due to lower catastrophe losses,
particularly in Personal Lines. In the first quarter of 1994, Personal Lines
underwriting results were also negatively affected by higher than normal weather
related losses not designated as catastrophe losses. Underwriting results for
the primary businesses for the first three months of 1995 also benefited from
the overall improvement in the quality and mix of business. However, this
improvement was partially offset by a $10 million increase in net underwriting
losses from voluntary and involuntary pools and associations, which included a
$3 million increase in case reserves from a pool for asbestos cases and a $2
million reserve for estimated losses incurred but not reported for the
Industrial Risk Insurance ("IRI") pool. USF&G reduced its participation in the
IRI pool from 5.5% in the first quarter of 1994 to 1.1% as of March 31, 1995,
thereby minimizing the effect of reserve increases reported by the IRI.
Underwriting results in the first quarter of 1995 included $23 million of net
catastrophe losses compared with $40 million in the same period of 1994. Gross
catastrophe losses were $27 million in the first quarter of 1995 compared with
$40 million in the same period of 1994. The assumed reinsurance business
incurred most of the 1995 net catastrophe losses, recognizing estimated losses
of $15 million for the January 1995 Kobe, Japan earthquake and further
development of $7 million in losses on the February 1994 Los Angeles earthquake.
The catastrophe losses in the first quarter of 1994 were primarily incurred by
Personal and Commercial Lines and related to severe winter snow and ice storms
and the Los Angeles earthquake. Excluding catastrophe losses, the statutory
loss ratio of 69.3 for the first three months of 1995 was relatively consistent
with that of 69.1 for the first three months of 1994.
Underwriting results showed improvement despite continuing competitive
pressures, the inflationary claims environment, and the adverse impact of
involuntary markets. Competitive pressures continue to effect underwriting
results, especially in the pricing of Commercial Lines products.
2.3. Losses incurred and loss reserves
Losses and loss adjustment expenses incurred totaled $425 million for the three
months ended March 31, 1995, compared with $421 million for the same period in
1994.
Reserves for unpaid losses and loss expenses totaled $6.1 billion at March 31,
1995, and approximate the December 31, 1994 position. Exclusive of claims from
catastrophe losses, pending claims have been reduced by 16 percent and the
number of new claims reported has decreased 15 percent since the first quarter
of 1994.
USF&G categorizes environmental, asbestos and other long term exposures where
multiple claims relate to a similar cause of loss (excluding catastrophes) as
"common circumstance claims." Reserves for losses that have been reported and
certain legal expenses are established on the "case basis." Common circumstance
claims which have emerged, while substantial, are a relatively small portion of
total claim payments and reserves.
The most significant common circumstance claim exposures include negligent
construction, environmental, and asbestos claims. Case reserves for these
exposures are less than two percent of total reserves for unpaid losses and loss
expenses at March 31, 1995. Other common circumstance claim categories stem
from a variety of situations such as lead paint, toxic fumes, breast implants,
sexual molestation and other disparate causes, provisions for which are included
in the total common circumstance case reserves. The following table sets forth
selected information for each of the three primary categories, net of ceded
reinsurance.
(in millions) Negligent
Construction Environmental Asbestos
Total case and bulk reserves
at December 31, 1994 $55 $329 $125
Losses incurred - 2 2
Claims (paid) recovered (3) (12) 1
Total case and bulk reserves
at March 31, 1995 $52 $319 $128
Management believes that USF&G's reserve position is adequate relative to its
exposure to environmental and asbestos matters, and compares favorably to other
large property/casualty insurers. USF&G's customer base generally does not
include large manufacturing companies, which tend to incur most of the known
environmental and asbestos exposures. Many of USF&G's environmental claims
relate to small industrial or transportation accidents which individually are
unlikely to involve material exposures. In addition, USF&G has traditionally
been a primary coverage carrier, having written relatively little high-level
excess coverage; therefore, liability exposures are generally restricted to
primary coverage limits. In a study published in 1994, A.M. Best Company, Inc.,
an insurance rating agency, measured the environmental and asbestos reserves
held by property/casualty insurers in terms of the number of years the reserves
could fund the current rate of claim payments, described as the "survival
ratio." A.M. Best extrapolated a projected 1994 industry average of 6.9 years
based on selected industry data, although its report noted that such estimate
was subject to variation depending on, among other things, the source
information included in the study and judgmental adjustments applied by A.M.
Best to exclude two large property/casualty insurers because of what A.M. Best
regarded as extraordinary reserve strengthening for asbestos claims in response
to specific asbestos litigation exposures those companies faced. USF&G
separately calculated its 1994 survival ratio to be approximately 13.5 years for
environmental and asbestos losses. USF&G's survival ratio using a five year
average of claims payments is 11.4 years.
The level of loss reserves for both current and prior years' claims is
continually monitored and adjusted for changing economic, social, judicial and
legislative conditions, as well as for changes in historical trends as
information regarding such conditions and actual claims develops. Management
believes that loss reserves are adequate, but establishing appropriate reserves,
particularly with respect to environmental, asbestos and other long-term
exposure claims, is highly judgmental and an inherently uncertain process. It
is possible that, as conditions change and claims experience develops,
additional reserves may be required in the future. There can be no assurance
that such adjustments will not have a material adverse effect on USF&G's results
of operations or financial condition.
3. Life Insurance Operations
Life insurance operations ("F&G Life") represent 14 percent of USF&G's total
revenues for the first quarter of 1995 compared with 15 percent for the same
period of 1994. F&G Life also represents 32 percent of the assets at March 31,
1995 and December 31, 1994.
F&G Life's financial results were as follows:
Three Months Ended March 31
(in millions) 1995 1994
Premiums $ 37 $ 37
Net investment income 77 83
Policy benefits (93) (101)
Underwriting and operating expenses (16) (15)
Income from operations before realized
gains, facilities exit costs,
and income taxes $ 5 $ 4
Income comparisons between the first quarters of 1995 and 1994 were affected by
lower investment income and policy benefits. Strong expense control efforts are
resulting in generally flat underwriting and operating expenses despite the
significant increase in sales. The decrease in policy benefits is due primarily
to lower interest credited costs from the lower policyholder base. Net
investment income when compared with the same period of the previous year
decreased primarily due to the sale of a majority of the timberland investment
recorded in the first quarter of 1994. Investment income for F&G Life is
expected to decrease over the remainder of 1995 because of a declining asset
base resulting from annuities being surrendered.
3.1. Sales
The following table shows life insurance and annuity sales (premiums and
deposits) by distribution system and product type:
Three Months Ended March 31
(in millions) 1995 1994
Distribution System:
Direct-structured settlements $23 $21
Property/casualty brokerage 15 12
National brokerage 13 10
National wholesaler 24 14
Senior distribution 2 -
Other 7 8
Total $84 $65
Product Type:
Structured settlement annuities $23 $21
Single premium deferred annuities 28 17
Tax sheltered annuities 22 12
Other annuities 10 13
Life insurance 1 2
Total $84 $65
Sales increased in the first quarter of 1995 by 29 percent over the same period
in 1994. This increase was led by single premium deferred annuities ("SPDAs")
and tax sheltered annuities. F&G Life intends to continue to concentrate on the
expansion of its existing distribution channels while also developing other
marketing networks. F&G Life is also continuing the development of selected
products, and modifying current product offerings to meet customer needs.
Despite F&G Life's attention to expanding its distribution channels and to
product development, demand for its products is affected by fluctuating interest
rates and the relative attractiveness of alternative investment, annuity or
insurance products, as well as its credit ratings. As a result, there is no
assurance that the improved sales trend will continue at the same level. Total
life insurance in force was $11.7 billion at March 31, 1995 and $11.8 billion at
December 31, 1994.
3.2. Policy surrenders
Deferred annuities and universal life products are subject to surrender. Nearly
all of F&G Life's surrenderable annuity policies allow a refund of the cash
value balance less a surrender charge. The surrender charge varies by product.
Single premium deferred annuities, which represent 65 percent of surrenderable
business, have surrender charges that decline from six percent in the first
policy year to zero percent in the seventh and later policy years. Newer
products that have been issued during 1994 and 1995 have surrender charges that
decline from nine percent in the first policy year to zero percent in the tenth
and later policy years. Such built-in surrender charges provide protection
against premature policy surrender.
Policy surrenders totaled $187 million for the three months ended March 31,
1995. This compares with $131 million for the same period in 1994. Surrender
activity has increased as a result of expiring surrender charges, primarily on
the national brokerage block of SPDA, as policyholders seek other investment
alternatives. Management has implemented a policy conservation program that
provided policyholders with a competitive renewal option within F&G Life once
their surrender charge period had expired. Due to the current interest rate
environment, this option was suspended on January 1, 1995. As of March 31,
1995, policyholders representing approximately 22 percent of the expiring block
had elected this option. An additional 24 percent of the expiring block was
retained under the terms of the original contract, free of surrender charges and
at interest rates which are adjusted annually.
The total account value of F&G Life's deferred annuities is $2.2 billion, 16
percent of which is surrenderable at current account value (i.e., without
surrender charges). The surrender charge period on an additional $1.2 billion
of F&G Life's single premium deferred annuity products expires through the end
of 1997, of which $456 million expires during the remainder of 1995. The
experience thus far for $833 million of SPDAs where the surrender charge period
expired in the fourth quarter of 1993 through the first quarter of 1995
indicates that on average, 55 percent of the expiring block may surrender;
however, in the future, a larger percentage may surrender should interest rates
trend upward. While this will put pressure on F&G Life's ability to increase
assets, given the relatively high interest rates credited when these annuities
were issued, overall profit margins would continue to improve as they surrender
or rollover to new products with lower rates. Management believes that F&G
Life, with a liquid assets to surrender value ratio of 129 percent at March 31,
1995, continues to maintain a high degree of liquidity and has the ability to
meet surrender obligations for the foreseeable future.
4. Parent and Noninsurance Operations
Parent company interest and other unallocated expenses and net losses from
noninsurance operations were as follows:
Three Months Ended March 31
(in millions) 1995 1994
Parent Company Expenses:
Interest expense $(10) $ (8)
Unallocated expense, net (11) (9)
Noninsurance Operations - (1)
Loss from operations before realized
gains, facilities exit costs,
and income taxes $(21) $(18)
The results for parent and noninsurance operations for the first quarter of 1995
show an increase in loss from operations of $3 million when compared to the
first quarter of 1994. This increase is primarily due to higher interest
expense as a result of the higher short-term interest rate environment and the
refinancing of corporate debt in 1994.
5. Investments
At March 31, 1995, USF&G's investment mix is comparable with year-end 1994.
Long-term fixed maturities comprise 83 percent of total investments at March 31,
1995 and December 31, 1994. The table below shows the distribution of USF&G's
investment portfolio.
(dollars in millions) At March 31, 1995 At December 31, 1994
Total investments $10,716 $10,561
Fixed maturities:
Held to maturity 43% 44%
Available for sale 40 39
Total fixed maturities 83 83
Common and preferred stocks 1 1
Short-term investments 3 4
Mortgage loans and real estate 9 9
Other invested assets 4 3
Total 100% 100%
5.1. Net investment income
The following table shows the components of net investment income.
Three Months Ended March 31
(dollars in millions) 1995 1994
Net investment income from:
Fixed maturities $165 $171
Equity securities 1 1
Short-term investments 6 3
Real estate and mortgage loans 12 17
Other, less expenses 1 (8)
Total $185 $184
Average yields (annualized): 6.9% 6.6%
Investment income from fixed maturities has decreased due to an asset base which
declined in order to meet SPDA surrenders and other cash flow needs. Average
yields on fixed maturities were 7.4 percent and 7.3 percent for the quarters
ended March 31, 1995 and 1994, respectively. Interest on short-term investments
has increased due to higher short-term interest rates. Other income less
expenses improved primarily due to USF&G's share of earnings from an equity
interest in Renaissance Reinsurance Ltd. ("Renaissance Re"), an offshore
reinsurance company. USF&G recorded $8 million of net investment income from
Renaissance Re during the first quarter of 1995, compared with a loss of less
than $1 million for the first quarter 1994. Included in investment income on
real estate and mortgage loans for the first quarter of 1994 is $8 million
related to timberland properties in F&G Life which were sold in 1994.
5.2. Realized gains (losses)
The components of net realized gains (losses) include the following:
Three Months Ended March 31
(in millions) 1995 1994
Net gains (losses) from sales:
Fixed maturities $ - $ 2
Equity securities 2 (1)
Real estate and other 5 12
Total net gains 7 13
Impairments:
Fixed maturities - -
Equity securities - -
Real estate and other (3) (8)
Total impairments (3) (8)
Net realized gains $ 4 $ 5
Other realized gains of $5 million for the first quarter of 1995 primarily
relate to USF&G's equity in the realized gains of certain limited partnership
investments. F&G Life's sale of timberland properties resulted in the majority
of the realized gains from sales of real estate in the first quarter of 1994.
Provisions for impairment relate to certain investments, declines in the fair
value of which are judged to be other than temporary.
5.3. Unrealized gains (losses)
The components of the changes in unrealized gains (losses) were as follows:
Three Months Ended March 31
(dollars in millions) 1995
Fixed maturities available for sale $110
Deferred policy acquisition costs adjustment (27)
Equity securities 3
Other (6)
Total $ 80
Fixed maturity investments classified as "available for sale" are recorded at
market value with the unrealized gains/losses reported as a component of
shareholders' equity. An average interest rate decrease of 67 basis points
during the first quarter of 1995 reduced the prior year's unrealized loss on
fixed maturities available for sale from $147 million to $67 million at March
31, 1995. This was partially offset by a related change in F&G Life's DPAC
adjustment from the prior year's unrealized gain of $33 million to an unrealized
gain of $6 million at March 31, 1995. This adjustment is made to reflect
assumptions about the effect of potential asset sales of fixed maturities
available for sale on future DPAC amortization.
5.4. Fixed maturity investments
The tables below detail the composition of the fixed maturity portfolio.
(dollars in millions) At March 31, 1995 At December 31, 1994
Corporate investment-grade bonds $5,083 57% $5,031 56%
Mortgage-backed securities 1,901 21 1,921 22
Asset-backed securities 981 11 942 11
U.S. Government bonds 302 3 286 3
High-yield bonds* 596 7 616 7
Tax-exempt bonds 118 1 121 1
Other 7 - 7 -
Total fixed maturities at
amortized cost 8,988 100% 8,924 100%
Total market value of fixed maturities 8,697 8,365
Net unrealized gains (losses) $ (291) $ (559)
Percent market-to-amortized cost 97% 94%
*See Glossary of Terms
At March 31, 1995 At December 31, 1994
Net Net
Amortized Market Unrealized Amortized Market Unrealized
(in millions) Cost Value (Loss) Cost Value (Loss)
Fixed maturities:
Held to maturity $4,640 $4,422 $(218) $4,659 $4,284 $(375)
Available for sale 4,348 4,275 (73) 4,265 4,081 (184)
Total $8,988 $8,697 $(291) $8,924 $8,365 $(559)
Decreasing interest rates, which resulted in rising bond prices, were
responsible for the three percentage point increase in the fixed maturity
portfolio's overall market-to-amortized cost ratio from December 31, 1994.
Debt obligations of the U.S. Government and its agencies and other investment-
grade bonds comprised 93 percent of the portfolio at March 31, 1995 and December
31, 1994. The following table shows the credit quality of the long-term fixed
maturity portfolio as of March 31, 1995.
Percent
Market-to-
Amortized Market Amortized
(dollars in millions) Cost Percent Value Cost
U.S. Government and
U.S. Government Agencies $2,073 23% $2,027 98%
AAA 1,477 16 1,453 98
AA 1,330 15 1,254 94
A 2,453 27 2,376 97
BBB 1,059 12 1,025 97
Below BBB 596 7 562 94
Total $8,988 100% $8,697 97%
USF&G's holdings in high-yield bonds comprised seven percent of the total fixed
maturity portfolio at March 31, 1995 and December 31, 1994. Of the total high-
yield bond portfolio, 71 percent is held by the life insurance segment,
representing 10 percent of F&G Life's total investments.
The table below illustrates the credit quality of USF&G's high-yield bond
portfolio as of March 31, 1995.
Percent
Market-to-
Amortized Market Amortized
(dollars in millions) Cost Percent Value Cost
BB $352 59% $327 93%
B 242 41 233 96
CCC and lower 2 - 2 100
Total $596 100% $562 94%
The information on credit quality in the preceding two tables is based upon the
higher of the rating assigned to each issue of fixed-income maturities by either
Standard & Poor's or Moody's. Where neither Standard & Poor's nor Moody's has
assigned a rating to a particular fixed maturity issue, classification is based
on 1) ratings available from other recognized rating services; 2) ratings
assigned by the NAIC; or 3) an internal assessment of the characteristics of the
individual security, if no other rating is available.
At March 31, 1995, USF&G's five largest investments in high-yield bonds totaled
$88 million in amortized cost and had a market value of $70 million. None of
these investments individually exceeded $30 million. USF&G's largest single
high-yield bond exposure represented five percent of the high-yield portfolio
and 0.3 percent of the total fixed maturity portfolio.
5.5. Real estate
The table below shows the components of USF&G's real estate portfolio:
(in millions) At March 31, 1995 At December 31, 1994
Mortgage loans $ 349 $ 349
Equity real estate 735 760
Reserves (98) (98)
Total $ 986 $1,011
The decrease in real estate from the prior year is primarily due to first
quarter 1995 sales of two properties.
USF&G's real estate investment strategy emphasizes diversification by geographic
region and property type. The diversification of USF&G's mortgage loan and real
estate portfolio at March 31, 1995, is as follows:
Geographic Region Type of Property Development Stage
Pacific/Mountain 35% Office 37% Operating property 74%
Midwest 20 Land 26 Land development 11
Southeast 15 Apartments 25 Land packaging 15
Mid-Atlantic 17 Retail/other 7
Southwest 8 Industrial 5
Northeast 5
Real estate investments are generally appraised at least once every three years.
Appraisals are obtained more frequently under certain circumstances such as
significant changes in property performance or market conditions. All of these
appraisals are performed by professionally certified appraisers.
At March 31, 1995, USF&G's five largest real estate investments had a book value
of $301 million. The largest single investment was a land development project
located in San Diego, California with a book value of $93 million, or nine
percent of the total real estate portfolio. Mortgage loans and real estate
investments not performing in accordance with contractual terms, or performing
significantly below expectation, are categorized as nonperforming. The level of
nonperforming real estate investments at March 31, 1995 is consistent with
December 31, 1994.
The book value of the components of nonperforming real estate are as follows:
(dollars in millions) At March 31, 1995 At December 31, 1994
Real estate acquired through foreclosure
or deed-in-lieu of foreclosure* $117 $117
Land investments* 58 56
Nonperforming equity investments* 35 35
Total nonperforming real estate $210 $208
Real estate valuation allowance $(98) $(98)
Reserves/nonperforming real estate 47% 47%
*See Glossary of Terms
Valuation allowances are established for impairments of mortgage loans and real
estate equity values based on periodic evaluations of the operating performance
of the properties and their exposure to declines in value. The allowance totaled
$98 million, or ten percent of the entire real estate portfolio at March 31,
1995 and December 31, 1994. In light of USF&G's current plans with respect to
the portfolio, management believes the allowance at March 31, 1995 continues to
adequately reflect the current condition of the portfolio. Should deterioration
occur in the general real estate market or with respect to individual properties
in the future, additional reserves may be required. Prospectively, efforts will
continue to reduce risk and increase yields in the real estate portfolio by
selling equity real estate when it is advantageous to do so and reinvesting the
proceeds in medium-term mortgage loans.
6. Financial Condition
6.1. Assets
USF&G's assets totaled $14.1 billion at March 31, 1995, compared with $14.0
billion at December 31, 1994. The increase is primarily due to a $110 million
increase in the market value of fixed maturity investments available for sale.
6.2. Debt
USF&G's corporate debt totaled $602 million at March 31, 1995, compared with
$586 million at December 31, 1994. The increase in debt is primarily
attributable to $14 million of foreign currency translation adjustments from
non-U.S. dollar denominated debt. As a result of entering into currency forward
agreements, there was no effect on net income from translation of non-U.S.
dollar denominated debt. USF&G's real estate and other debt totaled $43 million
at March 31, 1995 and $42 million at December 31, 1994.
On May 11, 1995, USF&G issued $150 million of 7% Senior Notes due 1998.
Interest on the debt is payable semiannually. Proceeds from the issuance will
be used to repay or repurchase outstanding indebtedness. Subject to market
conditions, USF&G plans to refinance other outstanding debt over the next
several years.
6.3. Shareholders' equity
USF&G's shareholders' equity totaled $1.6 billion at March 31, 1995, compared
with $1.4 billion at December 31, 1994. The increase is primarily the result of
approximately $110 million increase in unrealized gains on fixed maturity
investments available for sale less a $27 million change in the related life
insurance segment DPAC adjustment. In addition, shareholders' equity increased
due to net income of $49 million less $13 million in common and preferred stock
dividends.
6.4. Capital strategy
During 1994, USF&G called for redemption 2.4 million shares of its Series C
Preferred Stock. The remaining shares were called for redemption effective
February 24, 1995. As a result of these calls, over 93 percent of the Series C
Preferred Stock converted into 14.7 million shares of common stock in accordance
with the terms of the Series C Preferred Stock. Pursuant to arrangements the
Corporation previously entered into with an unaffiliated financial institution,
USF&G sold 716,600 shares of common stock to this institution to fund a portion
of the cash redemptions resulting from these calls.
On April 13, and May 22, 1995, USF&G consummated mergers with Discover Re and
Victoria, respectively. In the transactions, USF&G exchanged 5.4 million
shares of its common stock, worth approximately $78.5 million, for all of the
outstanding equity of Discover Re, and 3.8 million shares of common stock, worth
approximately $59.1 million, for all of the outstanding equity of Victoria.
Discover Re provides insurance, reinsurance and related services to the
alternative risk transfer market. Victoria is an insurance holding company
which specializes in nonstandard auto coverage.
7. Liquidity
7.1. Cash flow from operations
USF&G had cash flow from operations of $53 million and $13 million for the
quarters ended March 31, 1995 and 1994, respectively. The primary factor for
the increase is a $36 million increase in premiums collected, a $52 million
increase in net reinsurance activity which relates to an increase in assumed
reinsurance written premium of $44 million over the prior quarter.
7.2. Credit facilities
At March 31, 1995, USF&G maintained a $400 million committed credit facility
with a group of foreign and domestic banks. Borrowings outstanding under the
credit facility totaled $215 million at March 31, 1995 and December 31, 1994.
The credit agreement contains restrictive covenants pertaining to indebtedness,
tangible net worth, liens and other matters. USF&G was in compliance with these
covenants at March 31, 1995 and December 31, 1994.
In addition, at March 31, 1995, USF&G maintained a $100 million foreign currency
credit facility and a $100 million letter of credit facility. At March 31,
1995, there were no borrowings on the foreign currency credit facility; the
balance outstanding on the letter of credit facility was $11 million.
7.3. Marketable securities
USF&G's fixed-income, equity security, and short-term investment portfolios are
liquid and represent substantial sources of cash. The market value of its
fixed-income securities was $8.7 billion at March 31, 1995, which represents 97
percent of its amortized cost. At March 31, 1995, equity securities, which are
reported at market value in the balance sheet, totaled $67 million. Short-term
investments totaled $343 million.
7.4. Liquidity restrictions
There are certain restrictions on payments of dividends by insurance
subsidiaries that may limit USF&G's ability to receive funds from its
subsidiaries. Under the Maryland Insurance Code, a Maryland insurance subsidiary
such as USF&G Company must provide the Maryland Insurance Commissioner with not
less than thirty days' prior written notice before payment of an "extraordinary
dividend" to its holding company. "Extraordinary dividends" are dividends
which, together with any dividends paid during the immediately preceding twelve
month period, would be in excess of 10% of the subsidiary's statutory
policyholders' surplus as of the prior calendar year end. Extraordinary
dividends may not be paid until either such thirty day period has expired and
the Commissioner has not disapproved the payment or the Commissioner has
approved the payment within such period. In addition, ten days' prior notice
of any other dividend must be given to the Maryland Insurance Commissioner prior
to payment, and the Commissioner has the right to prevent payment of such
dividend if it is determined that such payment could impair the insurer's
surplus or financial condition. Dividends of approximately $157 million are
currently available for payment to USF&G Corporation from USF&G Company during
1995 without providing the notice required for extraordinary dividends.
8. Regulation
USF&G's insurance subsidiaries are subject to extensive regulatory oversight in
the jurisdictions where they do business. This regulatory structure, which
generally operates through state insurance departments, involves the licensing
of insurance companies and agents, limitations on the nature and amount of
certain investments, restrictions on the amount of single insured risks,
approval of policy forms and rates, setting of capital requirements, limitations
on dividends, limitations on the ability to withdraw from certain lines of
business such as personal lines and workers' compensation, and other matters.
From time to time, the insurance regulatory framework has been the subject of
increased scrutiny. At any one time there may be numerous initiatives within
state legislatures or state insurance departments to alter and, in many cases,
increase state authority to regulate insurance companies and their businesses.
Proposals to adopt a federal regulatory framework have also been discussed. It
is not possible to predict the future impact of increasing state or potential
federal regulation on USF&G's operations. Additional information regarding
legal and regulatory contingencies may be found in Note 10, "Legal
Contingencies," to the condensed consolidated financial statements, as well as
in USF&G's 1994 Annual Report to Shareholders (Restated).
8.1. Glass-Steagall reform
During the current session of Congress, legislative proposals to restructure the
U.S. financial services industry through repeal or modification of the Glass-
Steagall Act and the Bank Holding Company Act have been advanced in both Houses
of Congress and advocated by the Administration. The proposals would, to
varying degrees, allow banks to affiliate with other financial services
providers, including insurance companies. It is unclear whether or to what
extent any final legislation would address bank insurance authority, and no
reliable prediction can be made at this time as to the ultimate outcome of the
legislative deliberations regarding restructuring of the financial services
industry or the effect such legislation may have on USF&G.
9. Glossary of Terms
Account value: Deferred annuity cash value available to policyholders before
the assessment of surrender charges.
Catastrophe losses: Property/casualty insurance claim losses resulting from a
sudden calamitous event, such as a severe storm, are categorized as
"catastrophes" when they meet certain severity and other criteria determined by
a national organization.
Expense ratio: The ratio of underwriting expenses to net premiums written, if
determined in accordance with statutory accounting practices ("SAP"), or the
ratio of underwriting expenses (adjusted by deferred policy acquisition costs)
to earned premiums, if determined in accordance with GAAP.
High-yield bonds: Fixed maturity investments with a credit rating below the
equivalent of Standard & Poor's "BBB". In addition, nonrated fixed maturities
that, in the judgment of USF&G, have credit characteristics similar to those of
a fixed maturity rated below BBB are considered high-yield bonds.
Involuntary pools and associations: Property/casualty insurance companies are
required by state laws to participate in a number of assigned risk pools,
automobile reinsurance facilities, and similar mandatory plans ("involuntary
market plans"). These plans generally require coverage of less desirable risks,
principally for workers compensation and automobile liability, that do not meet
the companies' normal underwriting standards. As mandated by legislative
authorities, insurers generally participate in such plans based upon their
shares of the total writings of certain classes of insurance.
Liquid assets to surrender value: GAAP liquid assets (publicly traded bonds,
stocks, cash, and short-term investments) divided by surrenderable policy
liabilities, net of surrender charges. A measure of a life insurance company's
ability to meet liquidity needs in case of policy surrenders.
Loss ratio: The ratio of incurred losses and loss adjustment expenses to earned
premiums, determined in accordance with SAP or GAAP, as applicable. The
difference between SAP and GAAP relates to deposit accounting for GAAP related
to financial reinsurance assumed.
Nonperforming real estate: Mortgage loans and real estate investments that are
not performing in accordance with their contractual terms or that are performing
at an economic level significantly below expectations. Included in the table of
nonperforming real estate are the following terms:
Deed-in-lieu of foreclosure: Real estate to which title has been obtained in
satisfaction of a mortgage loan receivable in order to prevent foreclosure
proceedings.
Land investments: Land investments that are held for future development
where, based on current market conditions, returns are projected to be
significantly below original expectations.
Nonperforming equity investments: Equity investments with cash and GAAP
return on book value less than five percent, but excluding land investments.
Policyholders' surplus: The net assets of an insurer as reported to regulatory
agencies based on accounting practices prescribed or permitted by the National
Association of Insurance Commissioners and the state of domicile.
Premiums earned: The portion of premiums written applicable to the expired
period of policies.
Premiums written: Premiums retained by an insurer.
Underwriting results: Property/casualty pretax operating results excluding
investment results, policyholders' dividends, and noninsurance activities;
generally, premiums earned less losses and loss expenses incurred and
"underwriting" expenses incurred.
U S F & G C o r p o r a t i o n
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
Exhibit 3. Articles of Incorporation.
Exhibit 11. Computation of Earnings per Share.
Exhibit 12. Computation of Ratio of Earnings to Fixed
Charges and Preferred Stock Dividends.
Exhibit 15. Letter Regarding Unaudited Interim Financial
Information.
(b) Reports on Form 8-K.
The Registrant filed a Form 8-K on January 12, 1995, reporting under Item 5,
Other Events, a press release announcing the signing of a definitive agreement
by which USF&G will acquire all of the outstanding Discover Re Managers, Inc.,
equity for approximately $78.5 million of USF&G common stock and options.
The Registrant filed a Form 8-K on January 20, 1995, reporting under Item 5,
Other Events, a press release announcing information as to fourth quarter
earnings expectations in addition to an announcement relating to plans to
consolidate its Baltimore facilities.
The Registrant filed a Form 8-K on January 25, 1995, reporting under Item 5,
Other Events, a press release announcing its call for redemption of all
outstanding shares of Series C Cumulative Convertible Preferred Stock.
U S F & G C o r p o r a t i o n
Exhibit 11 - Computation of Earnings Per Share (Unaudited)
Three Months Ended March 31
(dollars in millions except per share data) 1995* 1994*
Net Income Available to Common Stock
Primary:
Net income $ 49 $ 23
Less preferred stock dividend requirements (8) (12)
Net income available to common stock $ 41 $ 11
Fully Diluted:
Net income $ 49 $ 23
Less preferred stock dividend requirements (4) (12)
Add interest expense on convertible notes 1 -
Net income available to common stock $ 46 $ 11
Weighted Average Shares Outstanding
Primary Common Shares 107,155,309 93,294,912
Fully Diluted:
Common shares 107,155,309 93,294,912
Assumed conversion of preferred stock 14,026,292 -
Assumed exercise of stock options 1,020,338 -
Assumed conversion of zero coupon convertible subordinated notes 7,227,255 -
Total 129,429,194 93,294,912
Earnings Per Common Share
Primary (A) $.39 $.11
Fully Diluted (B) $.36 $.11
* Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial
Corporation, which were completed during the second quarter of 1995. Restatement of prior periods is
required due to the application of the pooling-of-interests method of accounting.
(A) Shares issuable under stock options (1,016,560 shares in 1995 and 1,219,119 in 1994) have not been
used as common stock equivalents in the computation of primary earnings per common share presented on
the face of the Condensed Consolidated Statement of Operations because the dilutive effect is not
material.
(B) Fully diluted earnings per common share amounts are calculated assuming the conversion of all
securities whose contingent issuance would have a dilutive effect on earnings. The 1995 calculation
assumes the conversion of preferred stock series B and C and the zero coupon convertible subordinated
notes, as well as shares issuable under stock options.
U S F & G C o r p o r a t i o n
Exhibit 12 - Computation of Ratio of Consolidated Earnings to Fixed Charges
and Preferred Stock Dividends
Three Months Ended March 31
(dollars in millions) 1995* 1994*
Fixed Charges
Interest expense $ 10 $ 9
Portion of rents representative of interest 5 7
Total fixed charges 15 16
Preferred stock dividend requirements (A) 8 12
Combined Fixed Charges and Preferred Stock Dividends $ 23 $ 28
Consolidated Earnings Available for Fixed Charges and Preferred Stock Dividends
Income from operations before income taxes $ 49 $ 23
Adjustments:
Fixed charges 15 16
Consolidated earnings available for fixed charges and
preferred stock dividends $ 64 $ 39
Ratio of Consolidated Earnings to Fixed Charges 4.2 2.4
Ratio of Consolidated Earnings to Combined Fixed
Charges and Preferred Stock Dividends 2.8 1.4
* Amounts have been restated to reflect mergers with Discover Re Managers, Inc., and Victoria Financial
Corporation, which were completed during the second quarter of 1995. Restatement of prior periods is
required due to the application of the pooling-of-interests method of accounting.
(A) Preferred stock dividend requirements of $8 million in 1995 and $12 million in 1994 divided by 100%
less the effective income tax rate of 0.8% in 1995 and 1.6% in 1994.
U S F & G C o r p o r a t i o n
Exhibit 15 - Letter Regarding Unaudited Interim Financial Information
U S F & G Corporation
We are aware of the incorporation by reference in the Registration Statement
Numbers 33-20449, 33-9405, 33-33271, 33-21132, 33-51859, and 33-63333 on Form S-
3; and Numbers 2-61626, 2-72026, 2-98232, 33-16111, 33-35095, 33-38113, 33-
43132, 33-45664, 33-45665, 33-61965, 33-55667, 33-55669, 33-55671, and 33-59535
on Form S-8, of our report on the unaudited condensed consolidated interim
financial statements of USF&G Corporation which is included in its Form 10-Q/A
for the quarter ended March 31, 1995.
Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part
of the registration statements prepared or certified by accountants within the
meaning of Section 7 or 11 of the Securities Act of 1933.
ERNST & YOUNG LLP
Baltimore, Maryland
October 6, 1995
U S F & G C o r p o r a t i o n
Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
USF&G Corporation
By /s/DAN L. HALE
Dan L. Hale
Executive Vice President and
Chief Financial Officer
Dated at Baltimore, Maryland
October 6, 1995