UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter Ended Commission File Number
March 31, 1996 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; 119,391,630 shares outstanding as of May 9, 1996.
Page 1 of 25
USF&G CORPORATION 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 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 10
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K 20
Exhibit 11- Computation of Earnings Per Share 21
Exhibit 12- Computation of Ratio of Consolidated Earnings
to Fixed Charges and Preferred Stock
Dividends 22
Exhibit 15- Letter Regarding Unaudited Interim Financial
Information 23
SIGNATURE 24
USF&G CORPORATION CONDENSED CONSOLIDATED STATEMENT OF FINANCIAL POSITION (UNAUDITED)
AT MARCH 31 At December 31
(DOLLARS IN MILLIONS EXCEPT PER SHARE DATA) 1996 1995
-----------------------------------------------
ASSETS
Investments:
Fixed maturities:
Available for sale, at market (cost, 1996, $9,025; 1995, $9,118) $ 9,085 $ 9,458
Common and preferred stocks, at market (cost, 1996, $38; 1995, $70) 37 65
Short-term investments 364 288
Mortgage loans 269 254
Real estate 658 653
Other invested assets 452 389
-----------------------------------------------
Total investments 10,865 11,107
-----------------------------------------------
Cash 120 119
Accounts, notes, and other receivables 836 795
Reinsurance receivables 628 604
Servicing carrier receivables 689 699
Deferred policy acquisition costs 467 434
Other assets 959 893
-----------------------------------------------
Total assets $14,564 $14,651
-----------------------------------------------
LIABILITIES
Unpaid losses, loss expenses, and policy benefits $ 9,747 $ 9,816
Unearned premiums 1,075 1,055
Corporate debt 569 591
Real estate and other debt 16 16
Other liabilities 1,313 1,189
-----------------------------------------------
Total liabilities 12,720 12,667
-----------------------------------------------
SHAREHOLDERS' EQUITY
Preferred stock, par value $50.00 (12,000,000 shares authorized;
shares issued, 1996, 4,277,460; 1995, 4,277,460) 213 213
Common stock, par value $2.50 (240,000,000 shares authorized;
shares issued, 1996, 119,675,697; 1995, 119,606,095) 299 299
Paid-in capital 1,188 1,188
Net unrealized gains on investments and foreign currency 85 271
Minimum pension liability (100 ) (100 )
Retained earnings 159 113
-----------------------------------------------
Total shareholders' equity 1,844 1,984
-----------------------------------------------
Total liabilities and shareholders' equity $14,564 $14,651
-----------------------------------------------
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
USF&G CORPORATION CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
Three Months Ended March 31
(DOLLARS IN MILLIONS EXCEPT PER SHARE DATA) 1996 1995
----------------------------------------
REVENUES
Premiums earned $ 667 $ 617
Net investment income 180 185
Other 9 12
----------------------------------------
Revenues before realized gains 856 814
Net realized gains on investments 11 4
----------------------------------------
Total revenues 867 818
----------------------------------------
EXPENSES
Losses, loss expenses, and policy benefits 543 518
Underwriting, acquisition, and operating expenses 259 247
Interest expense 10 10
Facilities exit costs/(sublease income) (2) (6)
----------------------------------------
Total expenses 810 769
----------------------------------------
Income from operations before income taxes 57 49
Provision for income taxes - -
----------------------------------------
NET INCOME $ 57 $ 49
----------------------------------------
Preferred stock dividend requirements 5 8
----------------------------------------
Net income available to common stock $ 52 $ 41
----------------------------------------
PRIMARY EARNINGS PER COMMON SHARE $ .43 $ .39
----------------------------------------
FULLY DILUTED EARNINGS PER COMMON SHARE $ .42 $ .36
----------------------------------------
Weighted average common shares outstanding (000s):
Primary 119,633 107,155
Fully diluted 130,450 129,429
----------------------------------------
Dividends declared per common share $ .05 $ .05
----------------------------------------
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
USF&G CORPORATION CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (UNAUDITED)
Three Months Ended March 31
(IN MILLIONS) 1996 1995
----------------------------------
OPERATING ACTIVITIES
Direct premiums collected $ 518 $ 519
Net investment income collected 174 172
Direct losses, loss expenses and policy benefits paid (420) (445)
Net reinsurance activity 11 72
Underwriting and operating expenses paid (216) (245)
Interest paid (5) (12)
Income taxes paid - -
Other items, net (8) (6)
----------------------------------
Net cash provided from operating activities 54 55
----------------------------------
INVESTING ACTIVITIES
Net (purchases) sales and maturities of short-term investments (76) 94
Maturities/repayments of fixed maturities held to maturity - 29
Purchases of fixed maturities available for sale (218) (180)
Sales of fixed maturities available for sale 51 23
Repayments of fixed maturities available for sale 260 82
Purchases of equities and other investments (47) (11)
Sales, maturities, or repayments of equities and other investments 89 65
Purchases of property and equipment (9) (6)
Disposals of property and equipment 2 -
----------------------------------
Net cash provided from investing activities 52 96
----------------------------------
FINANCING ACTIVITIES
Deposits for universal life and investment contracts 78 78
Withdrawals of universal life and investment contracts (157) (203)
Net borrowings of short-term debt 6 -
Long-term borrowings - 1
Repayments of long-term borrowings (21) -
Issuances of common and preferred stock - 1
Cash dividends paid to shareholders (11) (14)
----------------------------------
Net cash used in financing activities (105) (137)
----------------------------------
Increase in cash 1 14
Cash at beginning of period 119 69
----------------------------------
Cash at end of period $ 120 $ 83
----------------------------------
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
USF&G CORPORATION 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 (collectively, "USF&G").
Intercompany transactions are eliminated in consolidation. Certain 1995 amounts
have been reclassified to conform to the 1996 presentation. The interim
financial statements in this report should be read in conjunction with the
consolidated financial statements and notes thereto in USF&G's 1995 Annual
Report to Shareholders. 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.
Effective January 1, 1996, USF&G adopted Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of". The standard includes a requirement that
impairments in the value of real estate investments be recorded as direct
reductions in the carrying value of those investments. USF&G's prior practice
was to establish valuation allowances for impairment to specific investments
where impairment is deemed other than temporary. The adoption of this standard
did not have a material effect on USF&G's financial statements since existing
valuation allowances were applied against the related impaired investments
reducing the cost basis of those investments.
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 as to the three
month periods ended March 31, 1996 and 1995. 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 AND PREFERRED STOCK
DIVIDENDS
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) 1996 1995
- ----------------------------------------------------------------
Net income $57 $ 49
Adjustments to reconcile net income
to net cash provided from operating
activities:
Realized gains on investments (11) (4)
Facilities exit costs/(sublease (2) (6)
income)
Change in insurance liabilities 31 31
Change in deferred policy
acquisition costs 18 19
Change in receivables (52) (12)
Change in other liabilities 64 (17)
Change in other assets (54) (6)
Other items, net 3 1
------------------------
Net cash provided from
operating activities $ 54 $ 55
------------------------
NOTE 6 UNREALIZED GAINS (LOSSES) ON INVESTMENTS At March 31, 1996, gross
unrealized gains and gross unrealized losses pertaining to equity securities
totaled $3 million and $4 million, respectively. In addition, gross unrealized
gains and gross unrealized losses on limited partnerships and other investments
totaled $50 million and $2 million, respectively. At March 31, 1996, there were
gross unrealized gains of $167 million and gross unrealized losses of $107
million pertaining to fixed maturities available for sale. There were also $22
million of gross unrealized losses relating to a deferred policy acquisition
costs ("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 loss of $186 million during the
three months ended March 31, 1996, compared with a gain of $80 million during
the three months ended March 31, 1995.
NOTE 7 PROCEEDS FROM SALES OF FIXED MATURITY INVESTMENTS
In December 1995, USF&G reclassified all of its fixed maturities previously
classified as "held to maturity" to "available for sale". There were no sales of
fixed maturities held to maturity during the three months ended March 31, 1995.
Proceeds from sales of fixed maturities available for sale were $51 million for
the three months ended March 31, 1996, compared with $23 million for the same
period in 1995. Gross gains and gross losses of $3 million and $2 million,
respectively, were realized on 1996 sales. Gross gains and gross losses of less
than $1 million were realized on such sales in 1995.
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, 1996 and
1995 includes sublease income of $2 million and $6 million, respectively,
recognized as a result of entering into new or renegotiated sublease agreements.
NOTE 9 LEGAL CONTINGENCIES
USF&G's insurance subsidiaries are routinely engaged in litigation in the normal
course of their businesses, including defending claims for punitive damages. As
insurers, they defend third-party claims brought against their insureds, as well
as defend themselves against first-party and 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 1995 Annual Report to Shareholders.
In the opinion of management, such contingencies and the contingencies described
below are 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 acted as a servicing carrier in North Carolina between 1990 and
1995. 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
defendants' 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. 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.
9.3. 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. The 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.
USF&G CORPORATION 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, 1996 and the related condensed
consolidated statements of operations and cash flows for the three-month periods
ended March 31, 1996 and 1995. 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, 1995, 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 23, 1996, 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, 1995, 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 14, 1996
USF&G CORPORATION 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 (collectively,
"USF&G") and explains the results of operations for the quarter ended March 31,
1996. 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 1995 Annual Report to Shareholders and should be read in
conjunction therewith. The results of operations for the quarter ended March 31,
1996 are compared with those for the same period of 1995 unless otherwise noted.
Financial position at March 31, 1996 is compared with December 31, 1995.
In connection with, and because it desires to take advantage of, the new "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995,
USF&G cautions readers regarding certain forward-looking statements in the
following discussion and elsewhere in this Form 10-Q and in any other statement
made by, or on the behalf of, USF&G, whether or not in future filings with the
Securities and Exchange Commission. Forward-looking statements are statements
not based on historical information and which relate to future operations,
strategies, financial results, or other developments. Forward-looking statements
are necessarily based upon estimates and assumptions that are inherently subject
to significant business, economic and competitive uncertainties and
contingencies, many of which are beyond USF&G's control and many of which, with
respect to future business decisions, are subject to change. These uncertainties
and contingencies can affect actual results and could cause actual results to
differ materially from those expressed in any forward-looking statements made
by, or on behalf of, USF&G. USF&G disclaims any obligation to update
forward-looking information.
(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 10
2. Property/Casualty Insurance Operations 11
3. Life Insurance Operations 13
4. Parent and Noninsurance Operations 14
5. Investments 15
6. Financial Condition 17
7. Liquidity 18
8. Regulation 18
9. Glossary of Terms 19
1. CONSOLIDATED RESULTS
The table below shows the major components of net income.
Three Months Ended March 31
(IN MILLIONS) 1996 1995
- ---------------------------------------------------------------
Income from operations before
realized gains, facilities
exit (costs)/sublease income,
and income taxes $44 $39
Net realized gains on
investments 11 4
Facilities exit
(costs)/sublease income 2 6
Provision for income taxes - -
-------------------------
Net income $57 $49
-------------------------
The table below shows the components by major business segment of income from
continuing operations before realized gains, facilities exit (costs)/sublease
income, and income taxes.
Three Months Ended March 31
(IN MILLIONS) 1996 1995
- ---------------------------------------------------------------
Property/casualty insurance $ 52 $ 55
Life insurance 11 5
Parent and noninsurance (19) (21)
-------------------------
Income from operations before
realized gains, facilities
exit (costs)/sublease income,
and income taxes $ 44 $ 39
-------------------------
The $3 million decline in property/casualty segment income from operations
before realized gains, facilities exit (costs)/sublease income, and income taxes
was primarily related to increased catastrophe and other significant weather
related losses incurred during the quarter. Income from operations before
realized gains, facilities exit (costs)/sublease income, and income taxes for
the life insurance segment increased $6 million for the quarter ended March 31,
1996, mainly due to improved profit margins on its products. Parent and
noninsurance operations were generally in line with the corresponding period of
the prior year.
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 and is generally
proceeding as originally planned. The relocation of the majority of Tower
personnel is expected to be completed by the end of the year.
In the first quarter of 1996, USF&G renegotiated and extended sublease terms
with several tenants and added one new tenant. The present value of the
additional income to be received over the term of the new leases, $2 million,
was recognized in the first quarter of 1996, and is shown as a separate item
captioned "facilities exit costs/(sublease income)" in the condensed
consolidated statement of operations. Similarly, $6 million of sublease income
was recognized in the first quarter of 1995 as a result of renegotiation of a
sublease with a tenant.
2. PROPERTY/CASUALTY INSURANCE OPERATIONS
Property/casualty insurance operations, the principal business segment,
accounted for 87 percent of USF&G's revenues in the first quarter of 1996
compared with 85 percent in the same period of 1995. Financial results for this
segment were as follows:
Three Months Ended
March 31
(IN MILLIONS) 1996 1995
- -----------------------------------------------------------------
Premiums earned* $ 636 $ 580
Losses and loss expenses incurred (463) (425)
Underwriting expenses (213) (203)
---------------------------------
Net underwriting loss (40) (48)
Net investment income 109 110
Other revenues and expenses, net (17) (7)
---------------------------------
Income from operations before
realized gains, facilities
exit (costs)/sublease income,
and income taxes $ 52 $ 55
---------------------------------
*SEE GLOSSARY OF TERMS
Improved UNDERWRITING RESULTS in the first quarter of 1996 were offset by an
increase in other expenses, resulting in a $3 million decrease in income from
operations before realized gains, facilities exit (costs)/sublease income, and
income taxes for the period when compared with the first quarter of 1995. The
underwriting improvement is attributable to premium growth and a refinement of
workers' compensation reserves, offset somewhat by significant CATASTROPHE
LOSSES and other severe weather related losses incurred in the 1996 quarter.
Increased policyholders' dividends and foreign currency translation losses were
the primary reasons for the increase in other expenses.
2.1. PREMIUMS
- --------------------------------------------------------------------------------
The following table shows the major components of premiums earned and PREMIUMS
WRITTEN.
Three Months Ended March 31
1996 1995
------------------ -------------------
PREMIUMS Premiums
(IN MILLIONS) EARNED WRITTEN Earned Written
- -------------------------------------------------------------------
Voluntary production:
Commercial lines $ 346 $ 344 $ 303 $ 317
Personal lines 157 153 157 148
Surety 37 41 36 40
--------------------------------------
Total voluntary direct
production 540 538 496 505
Ceded reinsurance* (45) (29) (36) (40)
--------------------------------------
Net voluntary production 495 509 460 465
Alternative risk transfer* 6 3 6 4
Pools and associations 17 10 16 3
Other premium adjustments 1 - 1 (4)
--------------------------------------
Total primary 519 522 483 468
--------------------------------------
Assumed reinsurance:
Finite risk* 36 43 26 48
Traditional risk 81 86 71 81
--------------------------------------
Total assumed 117 129 97 129
--------------------------------------
Total segment $ 636 $ 651 $ 580 $ 597
--------------------------------------
*SEE GLOSSARY OF TERMS
Premiums earned for the quarter ended March 31, 1996 increased $56 million, or
almost ten percent, compared with the same period in 1995. The increase was
experienced across most product lines, particularly Commercial Lines and assumed
reinsurance. Direct voluntary premiums written in the first quarter of 1996 are
six percent higher when compared with the corresponding period of 1995,
primarily due to growth in Commercial Lines new business.
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.
The table below shows underwriting gains (losses) and the statutory LOSS RATIOS
by lines of property/casualty insurance.
Three Months Ended March 31
1996 1995
----------------------- ------------------------
STATUTORY Statutory
UNDERWRITING LOSS Underwriting Loss
(DOLLARS IN MILLIONS) RESULTS RATIO Results Ratio
- ----------------------------------------------------------------------
Commercial lines $(14) 68.9 % $(28) 72.7 %
Personal lines (39) 92.3 (27) 78.9
Surety (2) 56.2 5 36.2
Alternative risk transfer - 78.7 - 77.5
-------------------------------------------------
Total primary (55) 75.3 (50) 72.7
Assumed reinsurance 15 59.1 2 76.1
-------------------------------------------------
Total segment $(40) 72.4 % $(48) 73.3 %
-------------------------------------------------
Voluntary $(41) 72.4 % $(40) 71.8 %
Involuntary 1 71.2 (8) 134.5
-------------------------------------------------
Total segment $(40) 72.4 % $(48) 73.3 %
-------------------------------------------------
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
1996 1995
- -----------------------------------------------------------
GAAP underwriting ratios:
Loss ratio 72.8 % 73.3 %
Expense ratio* 33.5 34.8
Combined ratio 106.3 108.1
Statutory underwriting ratios:
Loss ratio 72.4 73.3
Expense ratio 33.4 34.7
Combined ratio 105.8 108.0
---------------------------
*SEE GLOSSARY OF TERMS
Underwriting results improved by $8 million in the first quarter 1996 when
compared with the same period of 1995 despite higher catastrophe losses and
significant weather related losses not designated as catastrophes. These losses
were mitigated by a $30 million reduction in workers' compensation reserves as a
result of the significant use of structured settlements to close medical claims
in 1995. Inclusion of structured settlement payment patterns in the previously
existing actuarial models for workers' compensation reserves tended to
overestimate the indicated reserves. Based upon the results of revised modeling
techniques a refined estimate of required reserves was developed in the first
quarter of 1996. Additionally, while written premiums have increased nine
percent in the current quarter, related expenses have increased only five
percent, resulting in the 1.3 point decrease in the expense ratios compared with
the first quarter of 1995. Underwriting results for the primary businesses for
the first three months of 1995 benefited from lower catastrophe and weather
related losses and an overall improvement in the quality and mix of business.
However, the first quarter of 1995 also 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 pool.
Underwriting results in the first quarter of 1996 included $35 million of net
catastrophe losses compared with $23 million in the same period of 1995. Gross
catastrophe losses were $36 million in the first quarter of 1996 compared with
$27 million in the same period of 1995. The primary businesses incurred $33
million of catastrophe losses in the first three months of 1996 from severe
winter storms and floods. 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.
Underwriting results showed improvement despite continuing competitive pressures
and the inflationary claims environment. Competitive pressures continue to
effect underwriting results, especially in the pricing of Commercial Lines
products.
During 1995, with the goal of continuing the improvement in underwriting
results, USF&G realigned its product segments based on the basic drivers of its
different businesses, resulting in the formation of the product-driven
Commercial Lines Middle Market Group ("Middle Market") and the
distribution-driven Family and Business Insurance Group ("FBIG"). The following
table shows selected financial information for Middle Market and FBIG (1995
amounts are estimates, based on actual Commercial and Personal Lines results).
Three Months Ended March 31*
1996 1995
-----------------------------------------
STATUTORY Statutory
PREMIUMS LOSS Premiums Loss
(DOLLARS IN MILLIONS) WRITTEN RATIO** Written Ratio**
- --------------------------------------------------------------
Middle Market $255 64.7 % $226 76.0 %
FBIG 242 88.1 239 74.6
Surety 41 56.2 40 36.2
Alternative risk
transfer 3 78.7 4 77.5
------------------------------------------
Total $541 75.3 % $509 72.7 %
------------------------------------------
* STATUTORY LOSS RATIOS FOR MIDDLE MARKET AND FBIG ARE
ESTIMATES FOR THE FULL YEAR 1995.
** REFLECTS ESTIMATES OF CERTAIN COMPONENTS SUCH AS CEDED
REINSURANCE PREMIUMS AND LOSSES, LOSS DEVELOPMENT FOR YEARS
1995 AND PRIOR, AND CERTAIN UNDERWRITING EXPENSES.
2.3. LOSS RESERVES
- --------------------------------------------------------------------------------
Reserves for unpaid losses and loss expenses totaled $6.1 billion at March 31,
1996, and approximate the December 31, 1995 position. Exclusive of claims from
catastrophe losses, the number of new claims reported in the first quarter of
1996 has increased 16 percent since the corresponding period of 1995, due to the
significant number of weather related losses not designated as catastrophes in
the 1996 period. At the same time, however, pending claims have increased only
2 percent.
USF&G categorizes long-term exposures where multiple claims relate to a similar
cause of loss (excluding catastrophes) as "common circumstance claims." Common
circumstance claim exposures include negligent construction, environmental and
asbestos claims.
Reserves for losses that have been reported and certain legal expenses are
established on the "case basis." Bulk reserves are established in addition to
the case reserves to reflect unreported claims and future development on
reported claims. Total case and bulk reserves for these common circumstance
claims, net of ceded reinsurance, comprise approximately ten percent of total
net property/casualty reserves for unpaid losses and loss expenses at March 31,
1996 and December 31, 1995.
The following table sets forth selected information for each of the three
primary categories, net of ceded reinsurance.
Negligent
(IN MILLIONS) Construction Environmental Asbestos
- ---------------------------------------------------------------
Total case and bulk
reserves at
December 31, 1995 $40 $312 $136
Losses incurred 3 8 1
Claims paid (2) (7) (2)
----------------------------------------
Total case and bulk
reserves at
March 31, 1996 $41 $313 $135
----------------------------------------
Management believes that USF&G's reserve position is adequate relative to its
exposure to environmental and asbestos matters. 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.
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 12 percent of USF&G's total
revenues for the first quarter of 1996 compared with 14 percent for the same
period of 1995. F&G Life also represents 31 percent of the assets at March 31,
1996 and December 31, 1995.
F&G Life's financial results were as follows:
Three Months Ended March 31
(IN MILLIONS) 1996 1995
- ----------------------------------------------------------------
Premiums $ 31 $ 37
Net investment income 74 77
Policy benefits (80) (93)
Underwriting and operating expenses (14) (16)
--------------------
Income from operations before
realized gains, facilities
exit (costs)/sublease income,
and income taxes $ 11 $ 5
--------------------
Income comparisons between the first quarters of 1996 and 1995 were affected by
reductions in premiums, investment income, policy benefits, and underwriting and
operating expenses. Premiums declined mainly due to a reduced level of
structured settlement sales in the quarter, while net investment income declined
due to a reduced asset base created by the surrender of annuities. The decrease
in policy benefits is due primarily to lower interest credited on a smaller
annuity block of business, as well as the resetting of interest rates on new and
renewal annuities. Strong expense control efforts resulted in a decrease in
underwriting and operating expenses.
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) 1996 1995
- --------------------------------------------------------------
DISTRIBUTION SYSTEM:
Direct-structured settlements $ 21 $ 23
Brokerage 29 30
National wholesaler 20 24
Other 7 7
-------------------------
Total $ 77 $ 84
-------------------------
PRODUCT TYPE:
Structured settlement annuities $ 21 $ 23
Single premium deferred annuities 23 28
Tax sheltered annuities 20 22
Other annuities 9 10
Life insurance 4 1
-------------------------
Total $ 77 $ 84
-------------------------
Sales decreased nine percent in the first quarter of 1996 when compared with the
same period in 1995. This decrease was spread across various product types, with
the majority in single premium deferred annuities ("SPDAs"). 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, no assurances can be provided relative to prior sales trends. Total life
insurance in force was $11.2 billion at March 31, 1996 and $11.4 billion at
December 31, 1995.
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.
F&G Life's current product offerings have surrender charges that decline from
nine percent in the first policy year to zero percent by the tenth policy year.
Such built-in surrender charges provide protection against premature policy
surrender.
Policy surrenders totaled $141 million for the three months ended March 31,
1996. This compares with $187 million for the same period in 1995. Surrender
activity has decreased due primarily to a policy conservation program
implemented by management. This program provided policyholders with a
competitive renewal option within F&G Life once their surrender charge period
had expired. As of March 31, 1996, policyholders representing approximately 18
percent of the expiring block had elected this option. An additional 26 percent
of the expiring block continued 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 $2.0 billion, 24
percent of which is surrenderable at current account value (i.e., without
surrender charges). The surrender charge period on an additional $675 million of
F&G Life's single premium deferred annuity products expires through the end of
1998, of which $626 million expires during the remainder of 1996. The experience
thus far for $1.4 billion of SPDAs where the surrender charge period expired in
the fourth quarter of 1993 through the first quarter of 1996 indicates that, on
average, 54 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 139 percent at March 31, 1996, 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 noninsurance
operations were as follows:
Three Months Ended March 31
(IN MILLIONS) 1996 1995
- --------------------------------------------------------
Parent Company Expenses:
Interest expense $(10) $(10)
Unallocated expense, net (9) (11)
Noninsurance Operations - -
----------------------
Loss from operations before
realized gains, facilities
exit (costs)/sublease income,
and income taxes $(19) $(21)
----------------------
The results for the parent and noninsurance operations for the first quarter of
1996 were generally in line with the results for the same quarter of the prior
year.
In March 1996, USF&G sold Kepner-Tregoe, Inc., its management consulting
subsidiary, to a holding company formed by Kepner-Tregoe, Inc.'s management. Net
income of the subsidiary for the year ended December 31, 1995 was $2 million
from revenue of $39 million.
5. INVESTMENTS
At March 31, 1996, USF&G's investment mix is comparable with year-end 1995.
Long-term fixed maturities comprise 84 percent of total investments at March 31,
1996 and 85 percent at December 31, 1995. Fixed maturities and total investments
have decreased due to a decline in unrealized gains in the available for sale
portfolio. The table below shows the distribution of USF&G's investment
portfolio.
AT MARCH 31, At December 31,
(DOLLARS IN MILLIONS) 1996 1995
- ---------------------------------------------------------------
Total investments $10,865 $11,107
--------------------------------------
Fixed maturities 84 % 85 %
Common and preferred stocks - 1
Short-term investments 3 3
Mortgage loans and real
estate 9 8
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) 1996 1995
- -------------------------------------------------------------
Net investment income from:
Fixed maturities $165 $165
Common and preferred stocks 1 1
Short-term investments 4 6
Mortgage loans and
real estate 10 12
Other investment income, net
of interest expense on
funds held 4 5
--------------------------------
Total investment income 184 189
Investment expenses (4) (4)
--------------------------------
Net investment income $180 $185
--------------------------------
Average annualized yields:
Total investments 6.7 % 6.9 %
Fixed maturities 7.3 % 7.4 %
--------------------------------
Investment income has decreased $5 million or three percent when compared with
1995. Interest on short-term investments has decreased due to lower short-term
interest rates and a lower average short-term investment base. Investment income
on mortgage loans and real estate for the first quarter of 1996 declined
primarily due to a lower investment base, resulting from the sales of certain
mortgage loans in 1995. Other investment income includes $5 million and $8
million for the quarters ending March 31, 1996 and 1995, respectively, of income
related to USF&G's share of earnings from an equity interest in RenaissanceRe
Holdings, Ltd. ("RenaissanceRe"), a property reinsurance company in Bermuda. The
decrease in earnings from RenaissanceRe primarily related to $2 million of
income that was realized in 1995 as a result of a recapitalization of the
company. Future income from the investment in RenaissanceRe is subject to
volatility and exposure to catastrophe losses and other risks inherent to the
property/casualty reinsurance industry. Also netted against other investment
income is interest credited to funds held on assumed reinsurance contracts of $5
million and $7 million for the quarters ended March 31, 1996 and 1995,
respectively.
5.2. REALIZED GAINS (LOSSES)
- --------------------------------------------------------------------------------
The components of net realized gains (losses) include the following:
Three Months Ended March 31
(IN MILLIONS) 1996 1995
- ------------------------------------------------------------
Net gains from sales:
Fixed maturities $ 1 $ 1
Common and preferred stocks - 1
Mortgage loans and
real estate 4 1
Other 6 4
-------------------------
Total net gains from sales 11 7
Impairments - (3)
-------------------------
Net realized gains $11 $ 4
-------------------------
Other realized gains primarily relate to USF&G's share of gains from its equity
in certain venture capital type limited partnerships. Impairments relate to
specific investments and are realized when the decline in fair value is deemed
other than temporary, or when the fair value is significantly less than book
value and it is probable that the investment will be sold before any recovery in
value can occur.
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) 1996
- ------------------------------------------------------------
Fixed maturities available for sale $(280)
Deferred policy acquisition costs
and policy benefits adjustment 51
Equity securities 1
Other 42
---------
Total $ (186)
---------
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. Yields on 2- to 30-year maturities increased an average of
69 basis points during the first quarter of 1996, which reduced the unrealized
gain on fixed maturities available for sale from $340 million at December 31,
1995 to $60 million at March 31, 1996. This was partially offset by a related
change in F&G Life's deferred policy acquisition costs ("DPAC") and policy
benefits adjustment from an unrealized loss of $73 million at December 31, 1995
to an unrealized loss of $22 million at March 31, 1996. This adjustment is made
to reflect assumptions about the effect of potential asset sales of fixed
maturities available for sale on future DPAC amortization. The change in
unrealized gains on other investments primarily relates to USF&G's share of
unrealized gains from its equity interests in certain venture capital type
limited partnerships.
5.4. FIXED MATURITY INVESTMENTS
- --------------------------------------------------------------------------------
The tables below detail the composition of the fixed maturity portfolio.
AT MARCH 31, At December 31,
(DOLLARS IN MILLIONS) 1996 1995
- -----------------------------------------------------------------
Corporate and other
investment-grade bonds $5,373 59% $5,361 59%
Mortgage-backed securities 1,684 19 1,739 19
Asset-backed securities 983 11 999 11
U.S. Government bonds 337 4 380 4
High-yield bonds* 613 7 599 7
Tax-exempt bonds 35 - 40 -
---------------------------------
Total fixed maturities
at amortized cost 9,025 100% 9,118 100%
Total market value of fixed
maturities 9,085 9,458
---------------------------------
Net unrealized gains $ 60 $ 340
---------------------------------
Percent market-to-amortized cost 101% 104%
---------------------------------
*SEE GLOSSARY OF TERMS
Increasing interest rates, which resulted in declining bond prices, were
responsible for the three percentage point decrease in the fixed maturity
portfolio's overall market-to-amortized cost ratio from December 31, 1995.
Debt obligations of the U.S. Government and its agencies and other
investment-grade bonds comprised 93 percent of the portfolio at March 31, 1996
and December 31, 1995. The following table shows the credit quality of the
long-term fixed maturity portfolio as of March 31, 1996.
Percent
Market-to-
Amortized Market Amortized
(DOLLARS IN MILLIONS) Cost Percent Value Cost
- ------------------------------------------------------------------
U.S. Government and
U.S. Government Agencies $1,962 22% $1,989 101%
AAA 1,451 16 1,458 101
AA 1,478 16 1,467 99
A 2,453 27 2,471 101
BBB 1,068 12 1,091 102
Below BBB- 613 7 609 99
-----------------------------------------
Total $9,025 100% $9,085 101%
-----------------------------------------
USF&G's holdings in high-yield bonds comprised seven percent of the total fixed
maturity portfolio at March 31, 1996, and December 31, 1995. Of the total
high-yield bond portfolio, 67 percent is held by the life insurance segment,
representing 11 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, 1996.
Percent
Market-to-
Amortized Market Amortized
(DOLLARS IN MILLIONS) Cost Percent Value Cost
- ------------------------------------------------------------------
BB $384 63% $378 99%
B 221 36 224 101
CCC and lower 8 1 7 87
-------------------------------------------
Total $613 100% $609 99%
-------------------------------------------
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, 1996, USF&G's five largest investments in high-yield bonds totaled
$97 million in amortized cost and had a market value of $86 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 less than one percent of the total fixed maturity portfolio.
5.5. MORTGAGE LOANS AND REAL ESTATE
- --------------------------------------------------------------------------------
The table below shows the components of USF&G's mortgage loan and real estate
investment portfolio:
(IN MILLIONS) AT MARCH 31, 1996 At December 31, 1995
- --------------------------------------------------------------
Mortgage loans $269 $254
Equity real estate, net 658 653
-----------------------------------------
Total $927 $907
-----------------------------------------
The increase in real estate from December 31, 1995 is primarily due to first
quarter 1996 new loan originations.
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, 1996, is as follows:
GEOGRAPHIC REGION TYPE OF PROPERTY
- ------------------------------------------------------------
Pacific/Mountain 35% Office 45%
Midwest 24 Land 23
Mid-Atlantic 18 Apartments 17
Southeast 12 Retail/other 9
Northeast 6 Industrial 6
Southwest 5
USF&G adopted Statement of Financial Accounting Standards No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
Of", in the first quarter of 1996. The standard includes a requirement that
impairments in the value of real estate investments be recorded as direct
reductions in the carrying value of those investments. USF&G's prior practice
was to establish valuation allowances for impairment to specific investments
where impairment is deemed other than temporary. The adoption of this standard
did not have a material effect on USF&G's financial statements since existing
valuation allowances of $85 million were applied against the related impaired
investments reducing the cost basis of those investments. A $10 million
valuation allowance remaining at March 31, 1996 applies to the mortgage loan
portfolio.
Mortgage loan and real estate investments are evaluated on a quarterly basis as
part of management's asset quality review process. This process ensures that the
financial and operating aspects of a property's performance are closely
monitored and analyzed. At March 31, 1996, USF&G's five largest real estate
investments had a book value of $303 million. The largest single investment was
a land development project located in San Diego, California with a book value of
$86 million, or nine percent of the total real estate portfolio.
Although USF&G anticipates that any sales of real estate will be in an orderly
fashion as and when market conditions permit, if USF&G was required to dispose
of a significant portion of its real estate in the near term, it is likely that
it would recover amounts substantially less than the related carrying values.
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 $14.6 billion at March 31, 1996, compared with $14.7
billion at December 31, 1995. The decrease is primarily a result of the $186
million decrease in net unrealized gains.
6.2. DEBT
- --------------------------------------------------------------------------------
USF&G's corporate debt totaled $569 million at March 31, 1996, compared with
$591 million at December 31, 1995. The decrease in debt is directly attributable
to the repurchase of $20 million of Zero Coupon Convertible Subordinated Notes.
On January 6, 1996, $75 million was drawn against the committed credit facility
to repay the balance due upon maturity of the previously outstanding 5 1/2%
Swiss Franc Bonds. Subject to market conditions, USF&G plans to refinance or
repurchase other outstanding debt over the next several years.
On April 12, 1996, USF&G entered into a 5 year, $80 million notional principle,
fixed for floating interest rate swap. This instrument effectively converts the
7 1/8% Senior Notes to floating rate debt with an initial rate of approximately
5.6%.
6.3. SHAREHOLDERS' EQUITY
- --------------------------------------------------------------------------------
USF&G's shareholders' equity totaled $1.8 billion at March 31, 1996, compared
with $2.0 billion at December 31, 1995. The decrease is primarily the result of
the $186 million decrease in net unrealized gains. In addition, shareholders'
equity increased due to net income of $57 million less $11 million in common and
preferred stock dividends.
6.4. CAPITAL STRATEGY
- --------------------------------------------------------------------------------
In April 1996, USF&G announced a plan to repurchase up to five million shares of
the corporation's common stock. The purchases will be made from time to time via
open market purchases, block trades, or as otherwise determined by management.
The timing and amount of purchases will depend on market conditions and
corporate requirements. The purchases will be funded primarily through excess
parent company cash flow.
7. LIQUIDITY
7.1. CASH FLOW
- --------------------------------------------------------------------------------
USF&G had cash flow from operations of $54 million and $55 million for the
quarters ended March 31, 1996 and 1995, respectively. USF&G has generated
positive cash flow from operations for seven consecutive quarters generally as a
result of premium growth and the overall improvement in underwriting
fundamentals and expense control. In addition, deposits and withdrawals of
universal life and investment contracts, such as annuities, had net cash
outflows of $79 million in the first quarter of 1996 compared with $125 million
in the first quarter of 1995 as a result of decreased SPDA surrender activity.
7.2. CREDIT FACILITIES
- --------------------------------------------------------------------------------
At March 31, 1996, USF&G maintained a $250 million committed credit facility
with a group of foreign and domestic banks. Borrowings outstanding under the
credit facility totaled $78 million at March 31, 1996. There were no borrowings
against the facility at December 31, 1995. The increase in borrowings is a
result of the use of the facility to repay the balance due upon maturity of the
5 1/2% Swiss Franc Bonds and to repurchase Zero Coupon Convertible Subordinated
Notes. 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, 1996 and December 31, 1995.
In addition, at March 31, 1996, USF&G maintained a $150 million foreign currency
credit facility. There were no borrowings on the foreign currency credit
facility as of March 31, 1996.
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 $9.1 billion at March 31, 1996, which represents 101
percent of its amortized cost. At March 31, 1996, equity securities, which are
reported at market value in the balance sheet, totaled $37 million. Short-term
investments totaled $364 million.
7.4. LIQUIDITY RESTRICTIONS
- --------------------------------------------------------------------------------
There are certain restrictions on payments of dividends by insurance
subsidiaries that may limit USF&G Corporation's ability to receive funds from
its subsidiaries. Under the Maryland Insurance Code, Maryland insurance
subsidiaries, such as United States Fidelity and Guaranty Company ("USF&G
Company") and Fidelity and Guranty Life Insurance Company, must provide the
Maryland Insurance Commissioner (the "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 ten percent 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 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.
Effective June 1 and December 29, 1995, respectively, USF&G Company and F&G
Life, with the Commissioner's consent, paid extraordinary dividends to USF&G
Corporation. Because any dividends paid during the immediately preceding
twelve-month period are considered when determining whether future dividends
constitute extraordinary dividends, any dividends which USF&G Company or F&G
Life would propose to pay in the twelve-month periods beginning June 1 and
December 29, 1995, respectively, would be deemed extraordinary dividends and
subject to the thirty-day notice period described above. The application of the
thirty-day notice requirement to dividends of these subsidiaries is not expected
to materially affect the liquidity of USF&G Corporation.
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 9, "Legal Contingencies," to
the condensed consolidated financial statements, as well as in USF&G's 1995
Annual Report to Shareholders.
9. GLOSSARY OF TERMS
ACCOUNT VALUE: Deferred annuity cash value available to policyholders before the
assessment of surrender charges.
ALTERNATIVE RISK TRANSFER: A form of insurance through which a company
self-insures the predictable frequency portion of its own losses and purchases
insurance for the less frequent, high severity losses that could have a major
financial impact on the company.
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.
FINITE RISK REINSURANCE: Reinsurance arrangements providing coverage at lower
margins than traditional risk reinsurance in return for a lower probability of
loss to the reinsurer.
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.
LIQUID ASSETS TO SURRENDER VALUE: SAP-basis 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 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 certain financial
reinsurance assumed.
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.
REINSURANCE: For a consideration, an assuming insurer agrees to indemnify a
ceding insurer against all or part of the loss the latter may sustain under the
policy or policies it has issued. The legal rights of the insured are not
affected by the transaction and the ceding insurer remains liable to the insured
for payment of policy benefits.
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.
USF&G CORPORATION PART II. OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS.
Exhibit 4A. Credit and Reimbursement Agreement dated as of March 29,
1996 among USF&G Corporation and Morgan Guaranty Trust
Company of New York, as agent.
Exhibit 4B. Credit Agreement dated as of March 29, 1996 among USF&G
Corporation and Deutsche Bank AG, as agent.
Exhibit 11. Computation of Earnings per Share.
Exhibit 12. Computation of Ratio of Consolidated Earnings to Fixed
Charges and Preferred Stock Dividends.
Exhibit 15. Letter Regarding Unaudited Interim Financial
Information.
(B) REPORTS ON FORM 8-K.
There were no reports on Form 8-K filed during the first quarter of 1996.
USF&G CORPORATION EXHIBIT 11 - COMPUTATION OF EARNINGS PER SHARE (UNAUDITED)
Three Months Ended March 31
(DOLLARS IN MILLIONS EXCEPT PER SHARE DATA) 1996 1995
---------------------------------------
NET INCOME AVAILABLE TO COMMON STOCK
Primary:
Net income $ 57 $ 49
Less preferred stock dividend requirements (5) (8)
---------------------------------------
Net income available to common stock $ 52 $ 41
---------------------------------------
Fully diluted:
Net income $ 57 $ 49
Less preferred stock dividend requirements (4) (4)
Add interest expense on convertible notes 1 1
---------------------------------------
Net income available to common stock $ 54 $ 46
---------------------------------------
WEIGHTED AVERAGE SHARES OUTSTANDING
Primary common shares 119,633,350 107,155,309
---------------------------------------
Fully diluted:
Common shares 119,633,350 107,155,309
Assumed conversion of preferred stock 2,308,106 14,026,292
Assumed exercise of stock options 1,529,202 1,020,338
Assumed conversion of zero coupon convertible subordinated notes 6,979,647 7,227,255
---------------------------------------
Total 130,450,305 129,429,194
---------------------------------------
EARNINGS PER COMMON SHARE
Primary (A) $ .43 $ .39
Fully diluted (B) $ .42 $ .36
---------------------------------------
(A) SHARES ISSUABLE UNDER STOCK OPTIONS (1,529,202 SHARES IN 1996 AND 1,016,560
IN 1995) 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 CALCULATIONS ASSUME THE CONVERSION OF PREFERRED STOCK
SERIES B AND THE ZERO COUPON CONVERTIBLE SUBORDINATED NOTES, AS WELL AS SHARES
ISSUABLE UNDER STOCK OPTIONS. THE 1995 CALCULATION ALSO ASSUMES THE CONVERSION
OF PREFERRED STOCK SERIES C.
USF&G CORPORATION EXHIBIT 12 - COMPUTATION OF RATIO OF CONSOLIDATED EARNINGS TO FIXED CHARGES AND
PREFERRED STOCK DIVIDENDS (UNAUDITED)
Three Months Ended March 31
(DOLLARS IN MILLIONS) 1996 1995
--------------------------------------------
FIXED CHARGES
Interest expense $ 10 $ 10
Portion of rents representative of interest 3 5
--------------------------------------------
Total fixed charges 13 15
Preferred stock dividend requirements (A) 5 8
--------------------------------------------
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS $ 18 $ 23
--------------------------------------------
CONSOLIDATED EARNINGS AVAILABLE FOR FIXED CHARGES AND PREFERRED
STOCK DIVIDENDS
Income from operations before income taxes $ 57 $ 49
Adjustments:
Fixed charges 13 15
--------------------------------------------
Consolidated earnings available for fixed charges and
preferred stock dividends $ 70 $ 64
--------------------------------------------
RATIO OF CONSOLIDATED EARNINGS TO FIXED CHARGES (B) 5.2 4.2
RATIO OF CONSOLIDATED EARNINGS TO COMBINED FIXED
CHARGES AND PREFERRED STOCK DIVIDENDS (B) 3.9 2.8
--------------------------------------------
(A) PREFERRED STOCK DIVIDEND REQUIREMENTS OF $5 MILLION IN 1996 AND $8 MILLION
IN 1995 DIVIDED BY 100% LESS THE EFFECTIVE INCOME TAX RATE OF 0.5% IN 1996 AND
0.8% IN 1995.
(B) THE RATIO OF CONSOLIDATED EARNINGS BEFORE FACILITIES EXIT (COSTS)/SUBLEASE
INCOME TO FIXED CHARGES WAS 5.1 AND 3.9 FOR 1996 AND 1995, RESPECTIVELY. THE
RATIO OF CONSOLIDATED EARNINGS BEFORE FACILITIES EXIT (COSTS)/SUBLEASE INCOME TO
COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS WAS 3.8 AND 2.6 FOR 1996
AND 1995, RESPECTIVELY.
USF&G CORPORATION EXHIBIT 15 - LETTER REGARDING UNAUDITED INTERIM
FINANCIAL INFORMATION
USF&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, 33-63333, and 33-65471
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,
33-59535 and 33-64839 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 for the quarter ended March 31, 1996.
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
May 14, 1996
USF&G CORPORATION 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
May 14, 1996
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q
USF&G CORPORATION
For the Quarter Ended Commission File Number
March 31, 1996 1-8233
A copy of all other of the Corporation's Exhibits to the March 31, 1996
Form 10-Q report not included herein may be obtained without charge upon
written request to John F. Hoffen, Jr., corporate secretary,
at the corporate headquarters:
100 Light Street
Baltimore, Maryland 21202