USF&G CORPORATION
1996 ANNUAL REPORT
a strategically balanced approach to maximizing shareholder value
[APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
(List of graphic and image material in 1995 Annual Report to Shareholders)
Inside Front Cover
"This is the dawn of USF&G's second century. Our company has been transformed
into a highly competitive enterprise comprised of discretely organized strategic
businesses led by exceptionally strong managerial and creative talent. We have
created substantial new sources of earnings through innovative product/market
and business development initiatives. We have fostered a unique high-performance
culture of people who are committed to making a difference and practicing sound
core values."
--Norman P. Blake, Jr.
USF&G Chairman, President,
and Chief Executive Officer
USF&G CORPORATION, with assets of $14.4 billion, is a holding company for
property/casualty and life insurance operations. The corporation is comprised of
the following portfolio of strategic businesses: the Commercial Insurance Group,
the Family and Business Insurance Group, Specialty Businesses, and F&G Life.
Together, these units provide a wide variety of commercial and personal
property/casualty insurance, surety bonds, reinsurance, life insurance, and
annuity products to meet the varied risk management needs of its customers.
USF&G operates on five core values: customer first, integrity, professionalism,
innovation, and teamwork.
CONTENTS
1 Financial Highlights
2 Chairman's Letter
8 Business Overview
12 Capital Management
13 Index to Financial Information
59 Directors and Committees of the Board
60 Executive Management Committee
61 Office Locations
62 Officers
64 Shareholders' Information
Page 1
GRAPH Strong Earnings Growth and Improved Returns
(in millions)
Total Revenues Operating Income*
1992 $3,712 $(60)
1993 3,323 100
1994 3,310 135
1995 3,459 181
1996 3,498 189
(footnote) *Operating income(loss) is defined as income from operations before
realized gains, branch reorginization severance, facilities exit costs/
sublease income, certain income tax benefits, and cumulative effect of
accounting changes. The information presented in this manner is not intended
to conform with GAAP.
GRAPH Continued Improvement in Property/Casualty Underwriting Performance
USF&G Industry USF&G Industry
Combined Combined Loss Loss
Ratio** Ratio** Ratio Ratio
1992 116.9 115.8 81.8 88.1
1993 109.1 106.9 75.3 79.5
1994 108.2 108.5 73.1 81.1
1995 106.1 107.2 72.4 78.9
1996 105.9 107.0 72.1 79.8
(footnote) **Includes policyholders' dividends; 1996 industry ratios are
estimates provided by A.M. Best.
Page 2 PHOTO(caption)
Chairman, President, and Chief Executive Office
Norman P. Blake, Jr.
Page 3
Business Transformation
GRAPH Sources of 1996 Premium
New products/markets since 1993 40%
Previously existing business 60
GRAPH 1996 Return on Equity
New products/markets since 1993 14%
Previously existing business 7
Page 4
PICTURE Strategically Balanced Business Portfolio
Cost Differentiation
(distribution/process driven)
Family and Business Insurance Group
F&G Life cost leader
(scale)
value leader
Commercial Insurance Group (skill)
Specialty Businesses:
Discover Re
F&G Re
Surety
Value Differentiation
(underwriting/product driven)
(footnote) Note: The higher a business is positioned on the vertical axis, the
more it must achieve relative cost advantage to be successful. The further to
the right a business is positioned on the horizontal axis, the more the business
must achieve relative value advantage to be successful.
Page 6 (highlighted text in margin)
I anticipate that USF&G will again outperform the industry by producting
another year of improving underwriting performance despite a very challenging
business environment.
Page 8
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Page 9
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Page 10
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Page 12
GRAPH
Total Debt- Debt-plus-Preferred
Shareholders' to- Equity-to-
Equity* Equity* Total-Capitalization*
1992 $1,300 51% 59%
1993 1,363 48 60
1994 1,592 40 46
1995 1,716 35 36
1996 1,969 24 31
(footnote) *Before effect of SFAS No. 115.
Note: All ratios include the capital securities as preferred equity
Page 60
PHOTO (caption)
Glenn W. Anderson
President - Commercial Insurance Group
PHOTO (caption)
John R. Berger
President - F&G Re
PHOTO (caption)
Kenneth E. Cihiy
Executive Vice President - Claim
PHOTO (caption)
Gary C. Dunton
President - Family and Business Insurance Group
PHOTO (caption)
Dan L. Hale
Executive Vice President - Chief Financial Officer
PHOTO (caption)
Robert J. Lamendola
President - Surety Group
PHOTO (caption)
Thomas K. Lewis, Jr.
Executive Vice President - Chief Information Officer
PHOTO (caption)
Stephen W. Lilienthal
Executive Vice President - Field Development and Operations
PHOTO (caption)
John A. MacColl
Executive Vice President - General Counsel and Human Resources
PHOTO (caption)
Andrew A. Stern
Executive Vice President - Strategic Planning and Reinsurance Operations
PHOTO (caption)
Harry N. Stout
President - F&G Life
PHOTO (caption)
John C. Sweeney
Chairman - Falcon Asset Management
[END OF APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
USF&G CORPORATION Financial Highlights
Years Ended December 31
(dollars in millions except per share data) 1996 1995 1994
--------------------------------------
Consolidated Results
Revenues $ 3,498 $ 3,459 $ 3,310
Premiums earned 2,731 2,666 2,508
Net investment income 705 733 749
Net realized gains on investments 44 7 5
Facilities exit (costs)/sublease income 42 6 (183)
Income tax benefit, net 2 14 280
Net income 261 209 237
--------------------------------------
Results Per Common Share
Net income $ 2.05 $ 1.63 $ 2.00
--------------------------------------
Dividends declared $ .20 $ .20 $ .20
--------------------------------------
At December 31
1996 1995 1994
--------------------------------------
Consolidated Financial Position
Assets $14,407 $14,651 $13,980
Total debt 482 607 628
Shareholders' equity 1,969 1,984 1,441
Debt-to-(capital securities-plus-equity) 23% 31% 44%
--------------------------------------
Book value per share $ 15.48 $ 14.68 $ 9.96
Closing market price per share 20 7/8 16 7/8 13 5/8
Common shares outstanding 114,240,489 119,606,095 104,810,794
--------------------------------------
[GRAPH - SEE APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
[GRAPH - SEE APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
A Letter to our Shareholders
This past year represents the culmination of a six-year transformation of our
company into a highly competitive enterprise capable of achieving a leadership
position in our served markets and generating a higher quality and more
substantial source of earnings. This evolution of our company is in contrast
with a turnaround situation in which earnings improvements tend to be more
narrow and short lived and are generally achieved through dramatic cost
reductions, elimination of unprofitable lines of business, and capital
restructuring without any fundamental enhancement in the scope and source of
earnings. We have strategically repositioned each of our major businesses,
established new channels of distribution, expanded both product and market
scope, created major new sources of earnings through aggressive business
development, greatly enhanced our talent and technology base, and established a
unique high-performance culture committed to the practice of sound core values.
Strategic Positioning of Business Portfolio
The significance of the transformation of our company can best be appreciated by
understanding the sources of premium growth. As demonstrated by the accompanying
exhibit, approximately 40 percent of 1996 consolidated premium was realized from
new products, markets, and businesses developed since 1993. More importantly,
profitability as measured by return on equity (ROE), was generated primarily by
these new sources of earnings. This shift in business mix has been a major
factor in achieving increased earnings growth and improved returns.
This transformation is further manifested in the strategic positioning of our
business portfolio: the Family and Business Insurance Group, the Commercial
Insurance Group, Specialty Businesses, and F&G Life. The composition of our
business portfolio represents a strategically balanced assembly of individual
businesses. Each business is in its own stage of development in pursuing its
strategic mandate of achieving either a cost or value leadership position.
Depicted in the graph on page 4 is the positioning of each business in terms of
its competitive cost and value differentiation. Importantly, each of these
businesses possesses its own earnings characteristics consistent with its
risk/reward profile. In composite, these businesses represent complementary
sources of earnings capable of generating an increasingly higher quality and
more stable source of earnings.
[GRAPH - SEE APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
[GRAPH - SEE APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
Family and Business Insurance Group: FBIG was formed in 1995 by combining
personal lines and small business insurance to take advantage of market and
operating synergies. In 1996, Gary Dunton and his management team implemented an
aggressive restructuring plan to improve operating efficiencies and gain
economies of scale. Three regional Centers for Agency Services were established
to benefit from a comprehensive re-engineering of business processes and to
fully utilize new sophisticated systems capabilities. In addition, much effort
was given to upgrading the talent base through training and recruiting programs.
Concurrently, FBIG established its own dedicated field sales force, segmenting
its agency plant, and becoming more selective in agency appointments. This
reorganization brings greater focus to penetrate fewer, but more strategically
valuable agents.
Another important strategic initiative has been new product development. In an
effort to improve profit performance, FBIG is driving its business mix more
toward small business insurance. To accomplish this, a competitively superior
small business product line has been developed and is in the process of field
implementation. In addition, new interface capability via the Internet is being
developed with our agents, allowing for real time, on-line underwriting and
policy processing. By the end of 1997, many of these new product and system
enhancements will have been implemented, providing a source of growth and
improved profitability.
[PICTURE - SEE APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
Customers tell us that one of USF&G's greatest strengths is its outstanding
claim service. In 1996, we became even better. We established a centralized
claim reception and processing center in Tampa. Significant improvements in
service quality and cost effectiveness have been achieved and 24-hour,
seven-days-a-week claim handling is now available for all routine claims.
Turnaround time has also been dramatically improved. The establishment of this
new facility has allowed us the opportunity to upgrade talent, build a
high-performance service culture, and deliver greater value to our customers.
Commercial Insurance Group: CIG was established as a separate unit in 1996. This
reorganization entailed converting a shared branch network into a dedicated
field structure for CIG. In addition, CIG is redefining its agent and broker
relationships on a more selective basis. As a result, CIG has a much greater
capability to grow its book of business by more effectively penetrating its
served markets.
Since 1993, Glenn Anderson and his management team have been successful in
driving CIG's business mix towards higher margin specialty segments and excess &
surplus lines business. Separate specialty market segment programs and business
platforms have been established. Each business activity is being championed by a
specialist business leader and his/her team. Their collaborative success speaks
for itself. These specialty business activities have approximately doubled since
1993 to 42 percent of CIG's 1996 total direct written premium. CIG's specialty
segments and excess & surplus lines grew direct written premium 22 percent this
year. Together, these businesses are very profitable and are achieving a
combined ratio of less than 100 percent. Within CIG, these specialty platforms
include excess & surplus property and casualty lines, financial institutions,
technology, governmental entities, large real estate, directors & officers, and
transportation. CIG has also developed a segmented approach to the remainder of
its business, within competitive capabilities in the contractors, manufacturers
and inland marine markets. Additionally, CIG has further expanded its
international product/market scope for its domestic customers. Several joint
ventures were completed providing international property/casualty and ocean
marine cargo capabilities.
Specialty Businesses: USF&G has three discrete, stand-alone specialty
businesses: Discover Re, F&G Re, and the Surety Group. Their success is
determined by their ability to deliver competitively superior value and is
directly linked to the quality of the underwriting skill base of each
organization. Characteristically, these businesses possess a higher risk/reward
profile and require significant expertise and highly focused and well
disciplined marketing strategies. USF&G's specialty businesses have performed
well against this yardstick, with each business generating a combined ratio
below 100 percent. In addition, they produced a composite ROE of greater than 30
percent in 1996.
Discover Re: USF&G acquired Discover Re in 1995 to gain entry into the
fast-growing alternative risk transfer market. The growth of this market comes
from the displacement of the conventional commercial risk transfer market as the
demand for self-insurance programs continues to grow. Geo Estes and Scott Doyle
founded Discover Re in 1990, and since then the company has grown rapidly as it
increased its product and market scope. Presently, Discover Re is targeting the
"captive" self-insurance market as a major opportunity to complement its core
business of reinsuring individual self insureds and pools. The earnings
characteristics of this business are particularly attractive because they
generate income from both risk-bearing and fee-income activities. Fee income was
$12 million for 1996, representing a 76 percent increase over 1995.
F&G Re: Under the leadership of Paul Ingrey, F&G Re was established as a DE NOVO
start-up in 1983. Since then, F&G Re has consistently outperformed the industry
on a combined ratio basis, with an inception-to-date combined ratio of 94
percent. F&G Re has always focused on traditional property/casualty reinsurance
and financial (finite risk) reinsurance. Prior to 1993, nearly all of F&G Re`s
business was domiciled in the United States. In 1993 and subsequent years, the
international component of their activities has grown to be almost 50 percent of
the written premium. In 1996 under John Berger's leadership, several new
initiatives expanded F&G Re's reach even further: (1) the development of a DE
NOVO venture into facultative reinsurance; (2) the establishment of a Hong Kong
office to improve access into Asian markets; and (3) the acquisition of Ashley
Palmer, a well-recognized managing agency at Lloyd's of London, to gain greater
access into that market. F&G Re is well positioned to take advantage of global
market opportunities and to extend its product capabilities to generate
additional sources of high- margin revenues.
Surety Group: Surety is one of USF&G's original lines of business and has
consistently represented an attractive source of earnings and high returns.
Historically, USF&G had been one of the surety industry's leaders, but in the
late 1980s, its market share declined. In 1992, Bob Lamendola joined USF&G and
under his leadership, our Surety Group has regained its prominent industry
position. In 1994, we entered the international market with the establishment of
a Canadian subsidiary and the development of "reverse flow" capability to serve
the needs of nonU.S. concerns doing business in the United States. In December
1996, the Surety Group further enhanced its international reach with the
acquisition of Afianzadora Insurgentes, Mexico's largest surety. This
acquisition allows us to take advantage of cross-border commerce generated by
NAFTA as well as related infrastructural development in Mexico. Our Surety Group
is well positioned to sustain its prominent industry position as well as to
capitalize on the international growth prospects in the years ahead.
F&G Life: Since 1993, F&G Life has undergone a dramatic transformation. The
quality of the balance sheet and investment portfolio has significantly
improved. Employment has been lowered by 48 percent and the operating
expense/revenue ratio declined from 7.9 percent to 4.3 percent. Under the
leadership of Harry Stout and his management team, new business has grown an
average of 29 percent per year since 1993. Approximately 94 percent of new
business growth is attributable to new products, markets, and channels of
distribution developed since 1993. Pretax operating income has grown an average
of 84 percent per year over the last two years. In early 1996, F&G Life
outsourced its systems and administrative processes to achieve significant cost
efficiencies. Because of its competitive cost position, F&G Life represents an
attractive source of earnings growth at increasing rates of return. It has
become an extremely efficient developer and marketer of specialty life insurance
and annuity products.
Summary of Financial and Market Performance
USF&G's 1996 consolidated financial results reflect the improving overall
performance of our operating units, in spite of unusually large catastrophe
losses. Operating income* increased 4 percent even though catastrophe losses
exceeded recent annual averages by $40 million. Net income was $261 million, up
25 percent (reflecting capital gains realized from asset sales and adjustment of
facilities exit costs for sublease income). Return on equity was 10.5 percent on
an operating income basis,** slightly lower than 10.9 percent in 1995. Earnings
per share increased 26 percent and 5 percent on a net income and operating
income basis, respectively.
*Operating income is defined as net income excluding realized gains and
losses on investments, branch reorganization severance, facilities
exit costs/sublease income, and certain income tax benefits.
** Excluding the effects of SFAS No. 115.
Our property/casualty segment outperformed the industry in 1996 underwriting
results with a combined ratio of 105.9 percent (including 0.3 points for
policyholder dividends), compared with A.M. Best's estimated industry average of
107. This performance represents a modest 0.2 point improvement over 1995. This
underwriting result is very impressive, however, when considering that we
incurred $108 million in net catastrophe losses in 1996, the second highest
level in the history of the company. F&G Life had another strong year with a
23-percent increase in new business sales, a 60-basis point increase in
investment spread, and a 69-percent increase in after-tax operating income.
The quality of our consolidated balance sheet continued to improve as a result
of continued capital restructuring initiatives and growth in retained earnings.
Liquidity, as measured by fixed charge coverage, improved significantly from 2.8
times in 1995 to 4.1 times in 1996. Financial leverage continued to improve,
with the debt-to-equity ratio* dropping 11 points to 24 percent. This
considerable strengthening of our balance sheet and increase in earnings
resulted in our ratings being upgraded by A.M. Best, Standard & Poor's, and Duff
& Phelps. From the standpoint of shareholder value creation, book value
increased 21 percent to $15.03 per share,* and market capitalization increased
18 percent from $2.0 billion at year-end 1995 to $2.4 billion at year-end 1996.
*Excluding the effects of SFAS No. 115.
Conclusion
Significant strategic initiatives completed in 1996 represented the culmination
of a highly successful transformation process. At the dawn of our second
century, we possess the organizational focus and determination to achieve
leadership in our served markets. I believe with the completion of the
realignment of our businesses, we have greatly enhanced our ability to execute a
strategically balanced approach to creating and maximizing shareholder value.
Looking into 1997, I anticipate that USF&G will again outperform the industry by
producing another year of improving underwriting performance despite a very
challenging business environment.
On behalf of my fellow USF&G employees, I wish to express our sincere
appreciation for the confidence you have placed in our ability to build a
company worthy of your investment. You can be assured we will continue to strive
to achieve our business objectives, persevere in maintaining the quality of our
values and culture, and deliver growth in earnings and improved returns.
/s/NORMAN P. BLAKE, JR.
Norman P. Blake, Jr.
Chairman, President, and Chief Executive Officer
February 28, 1997
A Leader in Insurance Concepts
In an industry crowded with generalists, USF&G is shifting focus to being a
specialist provider of insurance products and services. The company's mission--
to be a leader in each of the markets it serves--has guided its evolution into a
portfolio of strategic businesses: the Commercial Insurance Group, the Family
and Business Insurance Group, Specialty Businesses, and F&G Life.
Each pursues different markets with a clearly defined strategy, operating
structure, and concentrated product focus, and is managed on a portfolio basis
by teams of experts cognizant of the critical success factors required in their
marketplace. Together as USF&G Corporation, the businesses maximize shareholder
value by balancing each other's unique challenges, thereby reducing aggregate
corporate risk. Each also shares the 100-year legacy of USF&G, a corporate name
recognized throughout the industry as a leader in innovative, market-specific
insurance solutions.
"Stop to watch what you have built and the structure begins to deteriorate,"
wrote John R. Bland, the founder of USF&G. Bland believed the mark of a company
is the accumulation of quality. In 1996, its centennial year, USF&G has
assembled the best talent and ideas in each of its businesses to provide the
highest quality products and services required by its broad range of customers.
COMMERCIAL INSURANCE GROUP: CIG is focused on serving the insurance needs of a
highly diversified set of customer segments. Target segments include financial,
governmental, and educational institutions; technology, manufacturing and
construction industries; and real estate, transportation, and other specific
service industries.
CIG's competitive advantage is the ability of its focused underwriting, loss
control, and claims teams to deliver customized products and services to target
clients. CIG's product offering is expansive, including highly specialized
excess & surplus lines, directors & officers, professional liability, inland and
ocean marine, and international coverages.
CIG markets its capabilities through a dedicated field network of 34 offices in
five geographic regions. Each region is responsible for implementing specific
plans based on its own market development strategies. These market penetration
plans are established in collaboration with a focused partnership network of
independent agents and brokers serving the retail, wholesale and surplus lines
channels.
As it advances its mission of specialization, CIG continues to expand its
high-profit margin businesses and value-added risk management capabilities.
FAMILY AND BUSINESS INSURANCE GROUP: FBIG has three broad product areas:
comprehensive small business insurance packages, standard personal insurance,
and nonstandard automobile insurance (provided by Victoria Financial).
Its strategy is to become a leading insurer of small commercial businesses, the
fastest growing part of the American economy. FBIG introduced a new array of
small commercial products in 1996--the Business Foundation Series. It targets
more business classes, has more than 30 built-in endorsements, and is supported
by newly developed state-of-the-art underwriting and processing systems.
FBIG's distribution strategy relies on a unique partnership with a select group
of agents who consider USF&G to be critical to their success and share its core
business values. The new Centers for Agency Services (located in Atlanta,
Baltimore and Denver) offer more focused underwriting and marketing support to
agents. A new national claim reception center in Tampa, offers faster handling
of claims, 24 hours a day, seven days a week.
FBIG also seeks stable and profitable personal lines business including
homeowners, automobile, personal excess and watercraft insurance.
DISCOVER RE provides insurance, reinsurance and related services for the
alternative risk transfer market, a broad category comprising self-insured
companies and pools, captive insurers, and risk retention groups.
Innovation is the hallmark of Discover Re. It views its customers as joint
venture partners, with participants retaining a share in the risk being
transferred. The company also provides unbundled insurance services. Both
strategies help customers to reduce their cost of risk transfer.
F&G RE reinsures property/casualty insurance companies worldwide. It is a "light
cruiser" amid the lumbering battleships of the reinsurance industry. With a
staff of only 64 employees, F&G Re takes a broad opportunistic approach that has
produced an average combined ratio of 94 percent since its inception in 1983.
THE SURETY GROUP is USF&G's oldest business, dating to the company's founding in
1896. It is also one of the largest surety companies in the world.
The Surety Group is expanding both its international and U.S.-based business,
particularly on the West Coast. The company operates in Canada via Northern
Indemnity and in Mexico through the 1996 acquisition of Afianzadora Insurgentes,
the largest surety company in Mexico.
F&G LIFE
F&G Life provides a complete line of life insurance and fixed annuity products
to specialty distributors around the country. Founded in 1959, F&G Life is an
opportunistic, entrepreneurial company that is taking a return-oriented approach
to growth.The company has one of the lowest operating cost structures in the
life insurance industry. Sales on average are growing at 22 percent a year,
while operating earnings have increased 60 percent on an average after-tax basis
over the last three years.
Like other USF&G business units, F&G Life develops and markets products that
meet specific market needs. For example, a program targeting school teachers for
tax-sheltered annuities produced more than 40,000 policies in 1996, helping to
make F&G Life the sixth largest writer of qualified payroll-deduction annuities
in the industry. The company's annuity product portfolio also includes a
thriving structured settlement business.
On the life insurance side, the company is targeting the largely untapped
middle-income senior market with a variety of term and universal life insurance
products geared toward lifestyle maintenance. In 1997, the company plans to
continue to develop other novel life insurance strategies to meet specific
market needs.
USF&G Business Overview
In 1996, USF&G completed its evolution into a portfolio of strategic businesses
with separate management, resources, target markets and distribution channels.
They provide the strategic balance to produce a higher quality of earnings.
Property/Casualty Operations (88% of revenues)
Commercial Insurance Group
37% of P/C Operations*
Broad range of commercial coverages and complete insurance packages
for targeted commercial market segments
Excess & surplus lines placements for unique risks
Family and Business Insurance Group
37% of P/C Operations*
Comprehensive commercial insurance packages for small businesses
Auto, homeowners, personal excess, and watercraft insurance for individuals
Specialty Businesses
26% of P/C Operations*
Discover Re
Tailored alternative risk transfer programs for commercial enterprises
and groups
F&G Re
Property and casualty reinsurance for worldwide risks
Surety Group
Bonds for the broad construction industry and the commercial surety
market
Life Insurance Operations (12% of revenues)
F&G Life
Fixed annuities for structured settlements of claims, tax-sheltered
annuities for teachers, and other annuities for specific market segments
Life insurance for target markets
*based on 1996 net written premium
USF&G CORPORATION Capital Management
The recapitalization of USF&G has progressed in conjunction with the company's
overall rebuilding strategy of "Fix the Foundation - Build with Vision -
Leverage Leadership." During late 1996, USF&G entered the final phase of its
capital restructuring program.
Fix the Foundation (1991 - 1993)
With USF&G's business concentration refocused on insurance, it was apparent that
our balance sheet was in need of strengthening. To address this need, we issued
$320 million of high-coupon preferred stock in 1991. This was in addition to
$200 million of preferred stock which had been issued in 1986.
Build with Vision (1994 - 1996)
While the preferred equity infusion addressed the immediate concern of capital
adequacy, it created another problem by increasing the company's cost of capital
by $32 million in additional annual dividend obligations. As the company's
operating performance improved, we were able to convert the $320 million of
preferred stock issued in 1991 into common stock by the end of 1996, thereby
reducing annual dividend requirements by $27 million.
During this period, USF&G also dramatically improved its liquidity by
refinancing approximately $505 million in short-term debt. In 1994 and 1995, we
issued $125 million in zero coupon convertible notes which do not require cash
interest payments, and $380 million of long-term debt.
As a result of all these actions, annual dividend requirements have decreased,
cash flow has increased, and financial leverage has improved dramatically.
Leverage Leadership (1996 - Forward)
Going forward, USF&G will continue to actively manage its capital to ensure that
shareholder value is maximized while maintaining the flexibility for future
growth. This was evidenced by the company's decision in 1996 to begin returning
excess capital to shareholders through the repurchase of up to 13.3 million
common shares and common stock equivalents, of which 8.6 million had been
repurchased as of year end. Also, in December 1996 and January 1997, we issued a
total of $200 million in capital securities to fund the redemption of the
remaining preferred stock, 50 percent of which was called and redeemed for cash
in January 1997.
Capital Base
At December 31
(in millions) 1996 1995 1994
---------------------------
Debt:
Current/short-term $ -- $ 80 $ 227
Long-term 482 527 401
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Total debt 482 607 628
---------------------------
Capital securities* 100 -- --
---------------------------
Shareholders' equity:
Preferred equity 200 227 396
Common equity 1,769 1,757 1,045
---------------------------
Total shareholders' equity 1,969 1,984 1,441
---------------------------
Total capitalization $2,551 $2,591 $2,069
---------------------------
* USF&G-obligated capital securities of a subsidiary trust.
Improvements in Leverage
Debt-to-equity 23% 31% 44%
Debt-to-equity before SFAS No. 115 24 35 40
(Debt-plus-preferred equity)-to-total
capitalization 31 32 49
(Debt-plus-preferred equity)-to-total
capitalization before SFAS No. 115 31 36 46
---------------------------
[GRAPH - SEE APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
USF&G CORPORATION Management's Responsibility for Financial Reporting
Financial Statements
Management is responsible for the preparation and integrity of the financial
statements and other information presented in this annual report. The financial
statements are prepared in conformity with generally accepted accounting
principles, and, therefore, include amounts based on judgments and estimates
made by management.
Internal Controls
Management is also responsible for the system of internal control. The system of
internal control encompasses the organizational structure, selection and
training of personnel, communication and enforcement of policies, procedures and
the code of conduct, and an ongoing internal audit program. The internal
controls are designed to provide reasonable assurance that financial records are
reliable for preparing financial statements, that transactions are completed as
authorized, and that assets are safeguarded. There are limitations inherent in
any system of internal control, however, including the possibility of human
error and the circumvention or overriding of controls. Accordingly, even an
effective system of internal control can provide only reasonable, not absolute,
assurance as to the reliability of the financial records. Management and USF&G's
internal auditors regularly review these controls and assess their adequacy and
effectiveness.
Audit Committee
The Board of Directors maintains an audit committee of directors who are not
employees of USF&G. The Audit Committee meets regularly with management,
internal auditors and independent auditors to review internal control and
financial reporting matters. Both the internal and independent auditors have
full and free access to the Audit Committee.
Independent Auditors
USF&G engages Ernst & Young LLP to conduct independent audits of the financial
statements in accordance with generally accepted auditing standards. Their
audits include reviews and tests of internal controls, transactions and other
information they consider necessary to express an opinion on the financial
statements.
/s/NORMAN P. BLAKE, JR. /s/DAN L. HALE
Norman P. Blake, Jr. Dan L. Hale
Chairman, President, and Executive Vice President and
Chief Executive Officer Chief Financial Officer
February 21, 1997
Index to Financial Information
Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
Eleven-Year Summary of Selected Financial Data 32
Consolidated Statement of Operations 34
Consolidated Statement of Financial Position 35
Consolidated Statement of Cash Flows 36
Consolidated Statement of Shareholders' Equity 37
Notes to Consolidated Financial Statements 38
Report of Independent Auditors 58
USF&G Corporation Management's Discussion and Analysis of Financial Condition
and Results of Operations
This discussion provides management's assessment of financial results and
material changes in financial position for USF&G Corporation (consolidated,
"USF&G" or "the Corporation"), its two primary business segments -
property/casualty insurance and life insurance - and its investment portfolio.
Property/casualty insurance is written primarily by United States Fidelity and
Guaranty Company ("USF&G Company"); life insurance and annuities are written
primarily by Fidelity and Guaranty Life Insurance Company ("F&G Life").
In connection with, and because it desires to take advantage of, the "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 Annual Report 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: Certain prior-year amounts have been reclassified to conform to the 1996
presentation. A glossary of certain terms used in this discussion can be found
in Section 9; the terms are italicized the first time they appear in the text.
Index
1. Consolidated Results 14
2. Strategic Overview 16
3. Results of Operations 18
4. Reserves and Surplus 21
5. Investments 24
6. Financial Condition 27
7. Liquidity 28
8. Legal Contingencies and Regulation 29
9. Glossary of Terms 31
1. CONSOLIDATED RESULTS
1.1. Summary of net income
The table below shows the major components of net income.
(in millions) 1996 1995 1994
-----------------------
Property/casualty insurance operations $213 $240 $201
Life insurance operations 49 27 14
Parent and noninsurance operations (72) (85) (80)
-----------------------
Income from operations before net realized gains,
branch reorganization severance, facilities
exit (costs)/sublease income and income taxes 190 182 135
Net realized gains on investments 44 7 5
Branch reorganization severance (17) -- --
Facilities exit (costs)/sublease income 42 6 (183)
Income tax benefit, net 2 14 280
-----------------------
Net income $261 $209 $237
-----------------------
Property/casualty insurance segment results decreased $27 million in 1996
compared with 1995 due primarily to increased CATASTROPHE LOSSES in 1996. From
1994 to 1995, the property/casualty segment's results increased $39 million as a
result of premium growth and improved UNDERWRITING RESULTS. The life insurance
segment's year-over-year improved results in 1996 and 1995 were due to the
combined effects of higher product sales, improved spreads on annuity and
UNIVERSAL LIFE products and lower expenses. (Refer to Section 3 of this
Analysis.)
The results for the parent company and noninsurance operations for 1996 showed a
decrease in loss from operations of $13 million when compared with 1995. This
decrease was primarily attributable to reduced parent company expenses as a
result of the Corporation consolidating its Baltimore headquarters facilities
(refer to Section 1.2 of this Analysis), and reduced interest expense due to the
refinancing and repayments of corporate debt during 1996.
Net realized gains on investments in 1996 consisted primarily of a $78 million
gain on the sale of a subsidiary and $40 million of impairment losses on certain
real estate investments (refer to Section 5.3 of this Analysis). The branch
reorganization severance in 1996 resulted from the realignment of the field
workforce under the new business units (refer to Section 2 of this Analysis).
Net income in each of the three years included facilities exit costs/sublease
income related primarily to the consolidation of the headquarters facilities,
and income tax benefits related to the recognition of deferred tax assets (refer
to Section 1.3 of this Analysis).
1.2. Facilities exit costs/sublease income
As a result of USF&G's restructuring activities in the early 1990s and ongoing
efforts to improve the overall cost effectiveness of the Corporation, USF&G's
available headquarters office space significantly exceeded its needs,
particularly at the office building ("the Tower") in downtown Baltimore. USF&G
sold the Tower in 1984 and subsequently leased it back. From 1991 through 1994,
the total headquarters staff decreased by approximately 28 percent, including a
48 percent decrease in the number of employees who were located at the Tower.
During 1994, USF&G developed and committed to a plan to consolidate its
Baltimore headquarters facilities. The plan encompassed relocating all USF&G
personnel residing at the Tower to the Corporation's Mount Washington facilities
in Baltimore. The lease on the Tower, which expires in September 2009, will not
be terminated.
Implementation of the plan began in January 1995. The relocation of the Tower
personnel began in mid-1996 and was completed in January 1997. During 1995 and
1996, $24 million of improvements were made to the Mount Washington facilities,
including reconfigured office spaces and an additional parking garage. Another
$8 million is expected to be spent in 1997 to complete the plan.
The facilities exit costs of $183 million recorded in 1994 represented the
present value of the rent and other operating expenses then estimated to be
incurred under the Tower lease from the time USF&G vacated the Tower through the
expiration of the lease in 2009. These costs did not consider any potential
future sublease income, as such income was neither probable nor reasonably
estimable at that time. During 1996 and 1995, the reserve for facilities exit
costs was increased by $13 million and $16 million, respectively, due to the
amortization of the present value discount, and was reduced by $12 million and
$10 million, respectively, of rent and other operating expenses which were paid
in 1996 and 1995 but were recognized in the 1994 charge.
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 1996 and 1995 included $54 million and $6 million,
respectively, of sublease income recognized as a result of USF&G's negotiation
of subleases with new and existing tenants. Currently, approximately 90 percent
of the Tower is sublet, including three tenants who occupy over 75 percent of
the Tower and whose subleases extend through the expiration of USF&G's lease in
2009. Net income for 1996 also included a credit of $12 million related to
reduced property tax assessments on the Tower which resulted from a settlement
reached with the State of Maryland and the City of Baltimore in June 1996.
Additionally, as a result of shifts in the overall business strategy (refer to
Section 2 of this Analysis), USF&G devised and implemented a plan in 1996 to
reorganize its branch system. This reorganization included the downsizing or
closure of several offices. For those offices where USF&G continues to be
responsible for the leases, the present value of the rent and other operating
expenses estimated to be incurred over the life of the leases and related to
unoccupied space, approximately $24 million, was recognized as facilities exit
costs in 1996.
1.3. Income taxes
The realization of deferred tax assets is dependent, in whole or in part, upon
the Corporation's ability to generate sufficient taxable income in future years.
Future levels of net income and taxable income from the core insurance
operations are dependent on several factors, including general economic and
specific insurance industry conditions, such as competitive pressures,
catastrophe losses, adverse loss experience, etc. Because of these risk factors,
as well as other factors beyond the control of management, no assurance can be
given that sufficient taxable income will be generated to realize the deferred
tax assets. Management has considered various risk factors in reaching its
conclusion that it is more likely than not that there will be sufficient future
taxable income to result in the realization of the recorded $436 million net
deferred tax asset. Based primarily upon the positive evidence associated with
the recent trend of improved operating results, USF&G has also determined that a
valuation allowance is no longer necessary as of December 31, 1996.
Beginning in 1997, USF&G expects to record income tax expense through its
Consolidated Statement of Operations, as it has now fully recognized all of its
deferred tax assets. The financial statement recognition of tax expense or
benefit is not necessarily an appropriate indicator of income taxes to be paid,
as the Corporation has income tax net operating loss carryforwards ("NOLs") of
$578 million available for regular tax purposes and $335 million for Alternative
Minimum Tax purposes remaining at December 31, 1996. These carryforwards will be
used to reduce income taxes payable in future years.
USF&G's tax returns have not been reviewed by the Internal Revenue Service
("IRS") since 1989 and the availability of the NOLs could be challenged by the
IRS upon review of returns through 1995. Management believes, however, that IRS
challenges that would limit the recoverability of the $436 million net deferred
tax asset are unlikely, and adjustments to the tax liability, if any, for years
through 1996 will not have a material adverse effect on USF&G's financial
position.
2. STRATEGIC OVERVIEW
In 1996, USF&G completed its realignment into a portfolio of businesses: the
Commercial Insurance Group ("CIG"), the Family and Business Insurance Group
("FBIG"), the Specialty Businesses, and Life Insurance. The realignment
recognizes the groups' distinctly different strategies of growth and
profitability. As individual businesses, each is able to develop its own
distinct products, distribution channels, technology systems and field
structures, and each is currently in its own stage of development, with a common
focus on long-term strategic positioning.
2.1. CIG
CIG is a product-driven business, characterized by a higher risk/higher return
book of business. CIG focuses on providing superior value-added products and
highly specialized underwriting and risk management capabilities to reach
discrete markets. Upon its base of standard middle market commercial business,
CIG is expanding its excess & surplus lines, and developing specialized product
capabilities to penetrate higher-margin market segments.
CIG reorganized its field structures in 1996, shifting from a shared,
broad-based field structure to one serving exclusively CIG target markets,
producers and customers. In addition to its general underwriting offices, CIG
operates separate business resource platforms individually dedicated to specific
specialized businesses such as excess & surplus, financial institutions,
government entities and technology, among others. CIG is also developing the
separate technological infrastructures necessary to support its varying product
lines.
Simultaneously with its field reorganization, CIG is realigning its distribution
channels to support its strategic market penetration. CIG now distributes its
products through multiple channels: retail, wholesale and surplus lines brokers
and agents. CIG is also developing various strategic alliances with other
insurance companies to further support the underwriting and servicing of
international exposures for its domestic insureds.
Enabled by these operational initiatives, CIG is steadily shifting its mix of
business from standard commercial products toward the specialized market
segments and excess & surplus lines, which management believes have profitable
growth opportunities, though they require more specialized underwriting and
entail greater risk. At the same time, CIG continues to institute various profit
improvement initiatives in its core business areas, as well as to exit markets
or restructure products where the profitability outlook is less favorable.
Overall, CIG's ability to achieve premium growth may be difficult in the near
future, given the intense price competition in the commercial lines markets and
changes in CIG's book of business, field structure and distribution systems.
2.2. FBIG
FBIG is principally a distribution-driven business consisting of small
commercial, personal and NONSTANDARD AUTO lines. This group is generally
characterized by a lower risk/lower return book of business, and, with the
exception of its exposure to natural catastrophes, can generate a stable and
consistent source of earnings. FBIG's products are commodity-like, in that
pricing, cost competitiveness and efficient processing are critical in gaining
and retaining customers, as well as achieving favorable underwriting results.
The similarities in the customer base, types of service and processing functions
between personal lines and small business commercial lines led to the
integration in 1995 of these lines into FBIG. In order to serve this customer
base with an efficient, low-cost structure, FBIG established three Centers for
Agency Services ("CASs"). These regional CASs, located in Atlanta, Baltimore and
Denver, handle all of FBIG's operations and underwriting functions except claims
handling. Claims are processed in a new Claim Reception Center in Tampa (refer
to Section 2.5 of this Analysis).
In 1996, FBIG announced that it would lower the commission rates on most of its
personal lines and some small commercial business products, effective April
1997. This action was taken to improve FBIG's profitability by bringing its
commission rates in line with industry averages. Management believes that this
action was necessary to improve FBIG's long-term competitive position and
profitability; however, this announcement has initially caused a reduction in
new business writings through the traditional agency plant, and is expected to
continue to restrain premium growth in the first half of 1997.
2.3. Specialty Businesses
USF&G's Specialty Businesses are higher risk/higher return businesses, relying
on market expertise and superior product/service value to succeed.
Discover Re
USF&G provides insurance, REINSURANCE and related services to the ALTERNATIVE
RISK TRANSFER market through Discover Re Managers, Inc. ("Discover Re"), a
wholly-owned subsidiary of USF&G Company. Discover Re is currently maintaining
its focus on its core products for individual self-insureds and pools, while
capitalizing on emerging opportunities to serve and reinsure CAPTIVE INSURERS.
Because less premium is retained on captive business, net written premium may
not rise as much as GROSS PROGRAM PREMIUM; however, the captive business is
expected to generate significant fee income.
F&G Re
Assumed reinsurance business, which has traditionally been very profitable for
USF&G, is managed by F&G Re, Inc. ("F&G Re"), a wholly-owned subsidiary of USF&G
Company. Assumed reinsurance contracts are generally written through domestic
and international reinsurance brokers, and cover a broad array of risks. In
response to the intense pricing and market share competition in the assumed
reinsurance business, F&G Re expanded its international presence in 1996, when
USF&G became a limited liability corporate partner in a Lloyd's of London
syndicate. Further international expansion is expected in 1997 with the opening
of an F&G Re office in Hong Kong, and USF&G's acquisition of Ashley Palmer
Limited, through which USF&G's Lloyd's of London managing agency acquired the
right to manage three additional syndicates, thereby increasing its capacity
under management to over (pounds)180 million (approximately $300 million). F&G
Re also established a FACULTATIVE REINSURANCE operation in 1996.
Surety Group
The Surety Group provides contract and noncontract surety bonds to construction
companies, commercial businesses and individuals. Over the last few years, the
Surety Group has been shifting its mix of business toward its small and large
contractor segments, which have historically been USF&G's most profitable surety
segments and generally produce stable underwriting profits.
In 1996, the Surety Group expanded its international presence through the
acquisition of Afianzadora Insurgentes, S.A. de C.V. ("Afianzadora"), the
largest surety bond company in Mexico. In 1997, the Surety Group will continue
to explore the expansion of its international business. The Surety Group will
also focus on growing its domestic market share, particularly in the western
United States through its new San Francisco office.
2.4. Life Insurance
Life insurance products are written through F&G Life, a wholly-owned subsidiary
of USF&G Corporation. F&G Life's principal products are DEFERRED ANNUITIES
(including tax sheltered annuities), sTRUCTURED SETTLEMENT ANNUITIES, IMMEDIATE
ANNUITIES and life insurance products.
In 1996, F&G Life completed the outsourcing of its policy administration and
information services functions. The outsourcing of these functions has already
begun to provide much of the expected benefits, such as improved customer
service and reduced per-policy operating costs. Also in 1996, F&G Life entered
into a coinsurance contract (the "Coinsurance Contract") with an unaffiliated
life insurance company to cede all of the remaining block of single premium
deferred annuities ("SPDAs") that were originally sold through stock brokerage
firms (the "broker SPDA block"). F&G Life's future profitability and cash flows
are expected to improve substantially as a result of the removal of this
significant block of underperforming business from F&G Life's direct
obligations.
Since 1993, F&G Life has introduced a variety of new products, primarily
annuities, which have dramatically increased its sales. In 1997, F&G Life plans
to continue developing new products, particularly life insurance offerings, and
broaden its distribution through the addition of specialized marketing
organizations, while also increasing its penetration of existing sales channels.
Management is also focusing its efforts on improving its INVESTMENT SPREADS on
its annuity and universal life products through asset/liability management.
2.5. Claim
In September 1996, USF&G opened a national Claim Reception Center (the "CRC") in
Tampa. The CRC provides toll-free, 24-hour claim reporting service to customers
and agents throughout the United States. Though currently in its start-up stage,
management expects the CRC to eventually process 80 percent of the total number
of property/casualty claims submitted. Advanced telecommunications systems in
place at the CRC facilitate rapid response time and enhanced data management,
while the CRC's database of preferred contractors allows for quick and reliable
claims service. The combination of these state-of-the-art systems in one center
is expected to not only improve customer service, but should also reduce
per-claim loss adjustment expenses once the CRC is fully operational.
2.6. Information systems
USF&G's long-term competitive advantage, like most companies' in the
"information age", is influenced by the speed, efficiency and reliability of its
information systems. Over the past several years, the Corporation's Information
Services Department ("I/S") has developed and implemented various client/server
programs for its users, including the systems at the CRC and FBIG's Business
Foundation System, which provides fully-automated policy processing capabilities
to the CASs. I/S focuses on balancing short-term, business-critical demands with
its long-term goal of maintaining a cost-competitive computing environment. In
that environment, the various businesses share a common systems "backbone" which
supports compatible workstations and server programs configured specifically for
each user group. Highly-specialized applications are designed with the
flexibility to be easily and efficiently altered as a business unit's needs
change, or re-used in the development of new applications. The cost-saving
benefits of this state-of-the-art environment have been, and in the near future
will continue to be, adversely impacted by the ongoing operation and maintenance
of older, more costly systems until those systems can be fully replaced.
3. RESULTS OF OPERATIONS
3.1. Property/casualty insurance
Property/casualty insurance operations, consisting of CIG, FBIG and Specialty
Businesses, accounted for 88 percent of USF&G's revenues before net realized
gains in 1996, compared with 85 percent in 1995 and 1994, and 70 percent of its
assets at December 31, 1996, compared with 68 percent at December 31, 1995 and
1994.
Financial highlights for the consolidated property/casualty insurance operations
were as follows:
(in millions) 1996 1995 1994
-------------------------
Premiums written* $2,639 $2,563 $2,389
Premiums earned* 2,586 2,492 2,356
Net underwriting losses (167) (156) (202)
Income from operations before net realized
gains, branch reorganization severance,
facilities exit costs/sublease income and
income taxes 213 240 201
-------------------------
*See Glossary of Terms
A significant measurement of a property/casualty company's underwriting
performance is its combined ratio, which is the sum of its LOSS RATIO and
EXPENSE RATIO. Consolidated property/casualty ratios, calculated based on
statutory accounting practices and generally accepted accounting principles
("GAAP"), were as follows:
1996 1995 1994
-------------------------
Statutory combined ratio* 105.6% 105.8% 107.9%
GAAP combined ratio 106.5 106.3 108.5
-------------------------
*Statutory underwriting ratios exclude the effects of policyholder dividends
which, if included, would increase the ratios by 0.3 points each year.
Note: In a period of increasing premiums and expense reductions, GAAP combined
ratios are typically higher than statutory, since the recognition of increases
in premiums written and reductions in policy acquisition costs, which are
reflected immediately in the statutory expense ratio, are deferred over the
policy term under GAAP.
Underwriting results deteriorated $11 million from 1995 to 1996, due primarily
to a high level of catastrophe losses incurred during 1996. The adverse effect
of the catastrophe losses was partially mitigated by favorable loss reserve
development, as well as by management's continuing strategic initiatives to
improve underwriting results. Overall, the combined ratios have improved
approximately 2 points since 1994 - more than 3 points when catastrophe losses
are excluded - largely as a result of management's initiatives to improve the
product/market mix, apply stricter underwriting standards, and reduce
underwriting and loss adjustment expenses.
Gross catastrophe losses totaled $114 million in 1996, compared with $71 million
in 1995 and $73 million in 1994. These losses, net of losses ceded to
reinsurers, were $108 million in 1996, $63 million in 1995 and $67 million in
1994. Catastrophes in 1996 included severe winter storms and floods in the first
quarter, and Hurricane Fran and a freak windstorm in Arizona in the third
quarter. The 1996 catastrophe losses were the second-highest level of
catastrophe losses ever experienced by USF&G, exceeded only by the 1992
catastrophe losses, which included the impact of Hurricane Andrew. The 1995
catastrophe losses were primarily due to several hurricanes, as well as various
hailstorms, tornadoes and floods, and the April 1995 bombing of the federal
building in Oklahoma City. Net catastrophe losses in 1994 were largely the
result of severe winter storms and the Los Angeles earthquake.
The table below shows the major components of property/casualty premiums
written and premiums earned.
1996 1995 1994
Premiums Premiums Premiums
(in millions) Written Earned Written Earned Written Earned
------------------------------------------------
Voluntary direct $2,194 $2,164 $2,138 $2,055 $2,018 $1,970
Ceded reinsurance (127) (135) (154) (154) (162) (150)
------------------------------------------------
Net voluntary 2,067 2,029 1,984 1,901 1,856 1,820
Pools and associations 42 55 51 75 107 124
Alternative risk transfer 27 22 27 25 27 22
Assumed reinsurance 499 480 512 490 415 395
Other premium
adjustments 4 -- (11) 1 (16) (5)
------------------------------------------------
Total property/casualty
segment $2,639 $2,586 $2,563 $2,492 $2,389 $2,356
------------------------------------------------
Voluntary direct premiums represent business generated directly by CIG, FBIG and
Surety's underwriting operations. Voluntary direct premiums written increased
three percent in 1996 in response to management's strategies to grow business in
targeted market segments. Premiums written from pools and associations decreased
61 percent since 1994, as USF&G actively reduced its exposure in the
unprofitable involuntary pools markets. Competitive pricing pressures held
assumed reinsurance premiums written in 1996 to approximately 1995 levels, after
a 23 percent growth in 1995 from 1994, which was due primarily to increases in
international business.
CIG
The following table shows underwriting results for CIG:
(dollars in millions) 1996 1995
-----------------
Voluntary direct premiums written $1,013 $975
Net premiums written 964 921
Underwriting loss (82) (97)
GAAP Underwriting Ratios:
Loss ratio 74.3% 75.6%
Expense ratio 34.3 35.5
Combined ratio 108.6 111.1
------------------
CIG voluntary direct premiums written increased four percent in 1996 when
compared with 1995. The increases were primarily in the excess & surplus lines
and specialized market segments, which represented 42 percent of CIG's direct
premiums in 1996, compared with 36 percent in 1995. In 1997, CIG expects to
continue the growth of its specialized market segments and excess & surplus
lines business, as it continues to shift its mix of business from standard
commercial lines toward these typically higher-margin product lines.
Underwriting results for CIG improved $15 million in 1996 when compared with
1995, and the combined ratio improved 2.5 points over that period, largely due
to the success of strategies, implemented as an integral part of the formation
of CIG, to improve the mix of business and control expenses. In addition, CIG's
1996 underwriting results benefited from favorable development in workers'
compensation reserves, which resulted from the recognition of the effect on
reserve estimation models of the increased use of structured settlements to
close claims. This favorable development was partially offset by reserve
increases for the current accident year in other standard commercial lines, such
as general liability and commercial auto.
FBIG
The following table shows underwriting results for FBIG:
(dollars in millions) 1996 1995
-----------------
Voluntary direct premiums written $1,007 $997
Net premiums written 989 974
Underwriting loss (147) (119)
GAAP Underwriting Ratios:
Loss ratio 79.0% 74.5%
Expense ratio 35.9 37.6
Combined ratio 114.9 112.1
-----------------
FBIG voluntary direct premiums were relatively flat in 1996 compared with 1995,
primarily due to intense competition in the personal lines markets. Management's
announcement in the third quarter of 1996 that it will lower the commission
rates on most of its personal and some small commercial business, effective
April 1997, also had an adverse impact on new business writings. FBIG incurred
abnormally high levels of catastrophe and other severe weather related losses in
1996, particularly in its homeowners lines, which adversely impacted its loss
ratio. Excluding catastrophes, loss ratios for FBIG would have been 71.5 and
71.7 in 1996 and 1995, respectively. This adverse loss experience was somewhat
offset by a 1.7 point decrease in the expense ratio from 1995 to 1996, as a
result of continued expense management. This expense ratio improvement is
expected to continue in 1997, as FBIG begins to realize expense savings as a
result of operating efficiency benefits generated by the CASs and the lower
commission rates.
Specialty Businesses
Discover Re
The following table shows underwriting results for Discover Re:
(dollars in millions) 1996 1995 1994
--------------------------
Gross program premium $129 $77 $75
Net premiums written 27 27 27
Service fees 12 7 5
Underwriting gain 2 1 --
GAAP Underwriting Ratios:
Loss ratio 77.2% 79.7% 76.2%
Expense ratio 12.4 16.9 23.8
Combined ratio 89.6 96.6 100.0
--------------------------
The significant decrease in the expense ratio in 1995 from 1994 resulted from a
change in the premium assumption and net retention structure of business written
by Discover Re. As a result of the change, service fees, which were previously
recognizable as nonunderwriting income, are now classified as ceding allowances
and recognized as a reduction of underwriting expenses. These service fees
increased in 1996 when compared with 1995, due to the increased gross program
premiums.
F&G Re
The following table shows underwriting results for reinsurance assumed through
F&G Re:
(dollars in millions) 1996 1995 1994
--------------------------
Net Premiums Written:
Traditional risk $326 $297 $235
Finite risk* 173 215 180
--------------------------
Total premiums written $499 $512 $415
Underwriting gain $ 52 $ 43 $ 40
--------------------------
GAAP Underwriting Ratios:
Loss ratio 63.9% 70.2% 73.2%
Expense ratio 25.4 21.0 16.5
Combined ratio 89.3 91.2 89.7
--------------------------
*See Glossary of Terms
In recent years, large catastrophe losses, such as Hurricane Andrew in 1992 and
the Los Angeles earthquake in 1994, increased the demand for reinsurance in both
international and domestic markets. However, that demand leveled off in 1995,
and pricing and market share became increasingly significant factors in the
assumed reinsurance industry. Accordingly, 1996 assumed reinsurance premiums
written have declined slightly when compared with 1995. In response to the
increased competition, management shifted the premium mix toward the typically
higher-margin traditional risk reinsurance, resulting in the $9 million increase
in F&G Re's underwriting gain. With the current market conditions, USF&G expects
a possible decline in assumed reinsurance premiums written in 1997, which could
result in a reduced underwriting gain.
Surety
The following table shows underwriting results for the Surety Group:
(dollars in millions) 1996 1995 1994
--------------------------
Voluntary direct premiums written $174 $166 $148
Net premiums written 160 129 113
Underwriting gain 8 16 3
GAAP Underwriting Ratios:
Loss ratio 39.1% 36.5% 37.9%
Expense ratio 54.9 49.8 58.9
Combined ratio 94.0 86.3 96.8
--------------------------
Surety's direct premiums written increased five percent in 1996 when compared
with 1995, primarily due to increased penetration in the domestic contract
surety business. The 14 percent increase from 1994 to 1995 was largely related
to increased international writings in the contract surety product line.
Abnormally large contract surety losses in the first half of the year led to the
$8 million decline in underwriting gains in 1996 when compared with 1995, while
the $13 million increase in underwriting gains in 1995 over 1994 was primarily
due to premium growth, as well as lower underwriting expenses as a result of
management's reconfiguration of Surety's home office and field structures. In
1997, the Surety Group expects to increase its international presence through
new marketing distribution channels created by its 1996 acquisition of
Afianzadora.
Commercial Lines and Personal Lines
Prior to the creation of CIG and FBIG in 1995, information regarding results of
operations were segregated along product lines for commercial and personal
property/casualty insurance. The 1995 and 1994 commercial lines and personal
lines results were as follows:
Commercial Lines
(dollars in millions) 1995 1994
-----------------
Voluntary direct premiums written $1,338 $1,231
Net premiums written 1,272 1,220
Underwriting loss (139) (183)
GAAP Underwriting Ratios:
Loss ratio 74.4% 77.4%
Expense ratio 36.9 37.8
Combined ratio 111.3 115.2
-----------------
Commercial lines voluntary direct premiums written increased nine percent in
1995 when compared with 1994, the result of new business growth in targeted
specialty product lines, including excess property, inland marine,
municipalities and financial institutions. From 1994 to 1995, underwriting
results in the commercial lines category improved $44 million, and the combined
ratio improved 3.9 points. These improvements were attributable to the
implementation of strategies to improve the mix of business and control expenses
while maintaining strict underwriting standards and pricing discipline.
Personal Lines
(dollars in millions) 1995 1994
-----------------
Voluntary direct premiums written $634 $639
Net premiums written 623 614
Underwriting loss (77) (62)
GAAP Underwriting Ratios:
Loss ratio 76.3% 73.8%
Expense ratio 35.9 36.0
Combined ratio 112.2 109.8
-----------------
Personal lines voluntary direct premiums were relatively flat in 1995 when
compared with 1994, as management balanced growth in certain targeted markets
against strategies to selectively exit other markets and reduce exposure to
certain catastrophe-prone geographic areas.
3.2. Life insurance
Life insurance operations (F&G Life) represented 12 percent of USF&G's revenues
before net realized gains in 1996, compared with 14 percent in 1995 and 1994.
F&G Life also represented 29 percent of the assets at December 31, 1996,
compared with 31 percent and 33 percent at December 31, 1995 and 1994,
respectively.
The Coinsurance Contract became effective August 1, 1996. At the time of the
transaction, the broker SPDA block had a current ACCOUNT VALUE of approximately
$964 million. The transaction had no material effect on earnings, but, by
removing the broker SPDA block from F&G Life's direct obligations, it reduced
F&G Life's capital requirements. This enabled the payment of a $110 million
dividend to USF&G Corporation, thereby allowing capital to be used in other
business opportunities.
Financial highlights for F&G Life were as follows:
(in millions) 1996 1995 1994
------------------------
Sales $427 $348 $286
Premiums earned 145 174 152
Net investment income 269 306 317
Income from operations before net
realized gains, branch reorganization
severance, facilities exit costs/sublease
income and income taxes 49 27 14
------------------------
The decrease in F&G Life's premiums earned in 1996 compared with 1995 and 1994
corresponded to a decrease in sales of structured settlement annuities. Despite
this decrease, and lower net investment income (refer to Section 5.2 of this
Analysis), income for the year ended December 31, 1996 increased substantially
when compared with 1995 and 1994, largely as a result of the significant
increase in SPDA sales, improved spread management on annuity and universal life
products, and lower expenses. Results for 1995 included $4 million of
transition-related costs, including employee separation costs, as a result of
F&G Life's agreement to outsource its information services and policy
administration.
Sales
The following table shows life insurance and annuity sales (premiums and
deposits) by distribution system and product type.
(in millions) 1996 1995 1994
---------------------------
Distribution System:
Brokerage $255 $125 $ 94
Direct structured settlements 79 108 88
National wholesaler 79 91 71
Other 14 24 33
---------------------------
Total $427 $348 $286
---------------------------
Product Type:
Single premium deferred annuities $231 $112 $ 82
Structured settlement annuities 79 108 88
Tax sheltered annuities 78 84 63
Other annuities 27 30 41
Life insurance 12 14 12
---------------------------
Total $427 $348 $286
---------------------------
Sales increased significantly over the past two years, including a 107 percent
increase in SPDA sales in 1996 when compared with 1995. This sales growth was
primarily due to the introduction of new products, and management's
concentration on the expansion of existing distribution channels, while also
developing other marketing networks. Despite F&G Life's attention to product
development and expanding its distribution channels, 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. Total life insurance in force was $10.7 billion at December 31, 1996,
compared with $11.4 billion and $11.8 billion at December 31, 1995 and 1994,
respectively.
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 $471 million in 1996, compared with $587 million and
$576 million in 1995 and 1994, respectively. Despite increased surrenders during
the first half of 1996, primarily due to increased competition from other
investment vehicles, full-year 1996 surrenders were significantly below 1995 and
1994 levels, due to the coinsurance of the broker SPDA block, which greatly
reduced surrenders in the second half of the year. This reduced level of
surrenders is expected to continue in 1997.
4. RESERVES AND SURPLUS
4.1. Mass torts
USF&G categorizes long-term exposures where multiple claims relate to a similar
cause of loss (excluding catastrophes) as "mass torts". Mass tort exposures
include construction defect, 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 mass torts, net of ceded
reinsurance, comprised approximately ten percent of the total net property/
casualty reserves for unpaid losses and loss expenses at December 31, 1996, 1995
and 1994.
The following tables set forth selected information for each of the major
categories of mass torts, net of ceded reinsurance.
Construction
(in millions) Defect Environmental Asbestos
--------------------------------------
Net reserves at
December 31, 1993 $74 $249 $125
Losses incurred (6) 106 5
Claims paid (13) (26) (5)
--------------------------------------
Net reserves at
December 31, 1994 55 329 125
Losses incurred 2 10 16
Claims paid (17) (27) (5)
--------------------------------------
Net reserves at
December 31, 1995 40 312 136
Losses incurred 12 20 7
Claims paid (12) (24) (8)
--------------------------------------
Net reserves at
December 31, 1996 $40 $308 $135
--------------------------------------
Net Reserves at December 31
(in millions) 1996 1995 1994
--------------------------------------
Construction Defect:
Case reserves $ 20 $ 20 $ 18
Bulk reserves 20 20 37
--------------------------------------
Total $ 40 $ 40 $ 55
Environmental:
Case reserves $ 60 $ 57 $ 65
Bulk reserves 248 255 264
--------------------------------------
Total $308 $312 $329
Asbestos:
Case reserves $ 38 $ 36 $ 25
Bulk reserves 97 100 100
--------------------------------------
Total $135 $136 $125
--------------------------------------
The environmental incurred losses in 1994 were primarily due to a reallocation
of bulk reserves from other lines of business based on enhancements in the
actuarial database with respect to such claims. In 1995 and 1996, both case and
bulk reserve levels for environmental and asbestos have remained relatively
flat. This stability is reflective of management's belief 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. In
1996, approximately 32 percent of paid environmental claims related to matters
under which a USF&G insured was a potentially responsible party ("PRP") under
the Comprehensive Environmental Response, Compensation and Liability Act,
commonly referred to as "Superfund", but many of these PRPs were only
peripherally involved. In 1995 and 1994, respectively, 22 percent and 28 percent
of the environmental claims paid related to Superfund. (Refer to Section 8.5 of
this Analysis.)
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 financial
condition or results of operations.
4.2. Reinsurance
USF&G reinsures portions of its policy risks with other insurance companies or
underwriters. Reinsurance allows USF&G to obtain indemnification against losses
associated with insurance contracts it has written by entering into a
reinsurance contract with another insurance enterprise (the reinsurer). USF&G
pays (cedes) an amount to the reinsurer which in turn agrees to reimburse USF&G
for a specified portion of any claims paid under the reinsured contracts.
Reinsurance gives USF&G the ability to write certain individually large risks or
groups of risks, and helps to control its exposure to losses by ceding a portion
of such large risks. USF&G's ceded reinsurance agreements are generally
structured on a treaty basis whereby all risks meeting certain criteria are
automatically reinsured. USF&G's property catastrophe loss retention level at
December 31, 1996 was $75 million for both the first and second loss, with
coverage limits of $175 million in excess of the retention level. The retention
level for both 1995 and 1994 was $75 million which, in the event of a second
loss, was lowered to $50 million. Coverage limits of up to $140 million and
$165 million in excess of the first and second loss, respectively, were
available in both 1995 and 1994.
4.3. Dividend 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 USF&G Company and F&G Life, 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.
During 1996, 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
F&G Life would propose to pay in the twelve-month period beginning September 30,
1996 would be deemed extraordinary dividends and subject to the thirty-day
notice period described above. Dividends of up to $137 million are available for
payment from USF&G Company to USF&G Corporation during 1997 without being deemed
extraordinary. The application of the thirty-day notice requirement to any
dividends of its subsidiaries is not expected to materially affect the liquidity
of USF&G Corporation. Additional information regarding dividends paid to USF&G
Corporation by its insurance subsidiaries may be found in Note 7.5, "Dividend
Restrictions", to the consolidated financial statements.
4.4. Capacity
A traditional measure of growth capacity for property/casualty insurers is the
ratio of premiums written to statutory policyholders' surplus. At the end of
1996, USF&G Company's premium-to-surplus ratio was 1.8:1, compared with 1.7:1
and 1.4:1 at the end of 1995 and 1994, respectively. The increase in 1996 and
1995 when compared with 1994 was due to the reduction in the policyholders'
surplus as a result of an extraordinary dividend by which USF&G Company
transferred all of the capital stock of F&G Life to USF&G Corporation. Insurance
regulators generally accept a ceiling for this ratio of 3.0:1; therefore, at its
current ratio, USF&G has the capacity to grow by writing new business.
4.5. Risk-based capital
The National Association of Insurance Commissioners ("NAIC") has adopted model
regulations which establish minimum capitalization requirements using a
"risk-based capital" formula. These regulations define four levels at which
corrective action must be taken: (1) the "company action level", at which the
company must submit a comprehensive financial plan with specific proposals to
address certain financial problems; (2) the "regulatory action level", at which
the appropriate regulatory authorities will perform a financial analysis and
order certain corrective actions; (3) the "authorized control level", at which
the regulatory authorities may place the company under regulatory control; and
(4) the "mandatory control level", at which the regulatory authorities must
place the company under regulatory control.
Application of these levels depends upon the insurer's "adjusted risk-based
capital" as a percentage of the "minimum risk-based capital". Risk-based capital
is calculated after adjusting capital for certain asset, credit, market,
underwriting, off-balance sheet and other risks inherent in the assets,
liabilities and business of the insurer. Various levels of corrective actions
are required if the adjusted risk-based capital is less than 200 percent of the
authorized control level risk-based capital.
USF&G Company had adjusted risk-based capital of $1.3 billion, $1.2 billion and
$1.6 billion as of December 31, 1996, 1995 and 1994, respectively, which
represented 286 percent, 334 percent and 382 percent, respectively, of the
authorized control level risk-based capital. The decline from 1995 to 1996 was
primarily the result of the phase-in of the required method of calculating
risk-based capital, whereas the decline from 1994 to 1995 was primarily due to
the extraordinary dividend paid by USF&G Company to USF&G Corporation in 1995,
consisting of all of the capital stock of F&G Life. F&G Life had adjusted
risk-based capital of $294 million, $383 million and $430 million as of December
31, 1996, 1995 and 1994, respectively, which represented 467 percent, 459
percent and 425 percent of the authorized control level risk-based capital as of
those dates. Accordingly, as of the dates indicated, both USF&G Company and F&G
Life had adjusted risk-based capital significantly above the levels which would
require corrective action.
5. INVESTMENTS
USF&G maintains an investment mix concentrated in high-quality fixed-income
securities. Fixed maturities and total investments decreased in 1996 due to the
transfer of $918 million of F&G Life's fixed maturities and a $242 million
decline in unrealized gains in the remaining fixed maturities portfolio. The
fixed maturities that backed F&G Life's broker SPDA block reserves were
transferred to the unaffiliated life insurance company under the terms of the
Coinsurance Contract. The following table shows the distribution of USF&G's
investment portfolio.
At December 31
(dollars in millions) 1996 1995 1994
------------------------------
Total investments $10,076 $11,107 $10,561
------------------------------
Fixed Maturities:
Held to maturity --% --% 44%
Available for sale 81 85 39
------------------------------
Total fixed maturities 81 85 83
Common and preferred stocks -- 1 1
Short-term investments 5 3 4
Mortgage loans and real estate 10 8 9
Other invested assets 4 3 3
------------------------------
Total 100% 100% 100%
------------------------------
5.1. Investment strategy
USF&G's primary objective is to maintain a high-quality investment portfolio
structured to maximize returns consistent with the financial goals of each
business segment while operating within approved policy guidelines and
maintaining sufficient liquidity to fund cash disbursements. Investment policies
and strategies are approved by senior management and reviewed by the Board of
Directors. Sophisticated proprietary financial modeling systems are employed in
the management of the assets. Investment activities are managed based on the
individual requirements of the property/casualty and life insurance segments and
the characteristics of each segment's underlying liabilities.
The following table shows the distribution of the investment portfolio for the
property/casualty insurance segment.
At December 31
(dollars in millions) 1996 1995 1994
-----------------------------
Total investments $6,860 $6,787 $6,439
-----------------------------
Taxable fixed maturities 76% 83% 80%
Tax-exempt fixed maturities 5 1 2
Common and preferred stocks -- -- 1
Short-term investments 7 3 4
Mortgage loans 4 3 2
Real estate 3 5 6
Other invested assets 5 5 5
-----------------------------
Total 100% 100% 100%
-----------------------------
The property/casualty investment strategy encompasses factors such as risk,
duration, return and regulatory requirements. The real estate strategy has been
and continues to be to reduce equity real estate holdings and reinvest in
income-producing commercial mortgage loans. The fixed maturity strategy has been
focused on purchasing investment-grade corporate bonds with maturities that best
match the property/casualty segment's liability structure. As this segment's
income tax position changes as a result of profitability and the depletion of
its income tax NOLs, the focus will turn toward investing available cash flows
into a higher proportion of tax-exempt securities in order to maximize after-tax
investment income.
The following table shows the distribution of the investment portfolio for the
life insurance segment.
At December 31
(dollars in millions) 1996 1995 1994
----------------------------
Total investments $3,174 $4,297 $4,202
----------------------------
Taxable fixed maturities 83% 88% 82%
Common and preferred stocks -- -- --
Short-term investments 5 2 5
Policy loans 2 2 1
Mortgage loans 5 2 5
Real estate 5 4 6
Other invested assets -- 2 1
----------------------------
Total 100% 100% 100%
----------------------------
The life insurance investment strategy also encompasses factors such as risk,
duration, return and regulatory requirements, and the real estate strategy is
consistent with that of the property/casualty segment. The life insurance
segment's fixed maturity strategy emphasizes the reduction of mortgage-backed
security exposure due to the potentially volatile cash flow characteristics
compared with the underlying liabilities. The focus going forward will be to
maintain a close duration match by product line through explicitly investing new
premium cash flows to match new liabilities. The portfolio mix will remain
relatively stable with a continued emphasis on noncallable corporate bonds and
limited exposure to HIGH-YIELD BONDS and mortgage-backed securities.
5.2. Net investment income
The following table shows the components of net investment income.
(dollars in millions) 1996 1995 1994
---------------------------
Net investment income from:
Taxable fixed maturities $626 $658 $668
Tax-exempt fixed maturities 4 6 6
Common and preferred stocks 3 4 7
Short-term investments 20 23 14
Mortgage loans and real estate 48 46 58
Other investment income, net of
interest expense on funds held 19 13 9
---------------------------
Total investment income 720 750 762
Investment expenses (15) (17) (13)
---------------------------
Net investment income $705 $733 $749
---------------------------
Average annualized yields:
Total investments 6.9% 6.9% 6.9%
Fixed maturities 7.3% 7.4% 7.3%
---------------------------
Investment income declined primarily due to the aforementioned decline in F&G
Life's fixed maturities portfolio. Fluctuations in short-term interest income
were a result of varying short-term interest rates, as well as fluctuations in
the asset balances. Investment income on mortgage loans and real estate for 1996
reflected the strategy of reducing equity real estate holdings and reinvesting
in income-producing commercial mortgage loans. Included in investment income on
mortgage loans and real estate for 1994 was $8 million related to timberland
properties which were sold in 1994. Other investment income in 1996, 1995 and
1994 included $19 million, $26 million and $17 million, 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.
Future income from the investment in RenaissanceRe is subject to volatility and
exposure to catastrophe losses and other risks inherent in the property/casualty
reinsurance industry. Also netted against other investment income was interest
credited to funds held on assumed reinsurance contracts of $20 million,
$31 million and $25 million in 1996, 1995 and 1994, respectively.
5.3. Net realized gains on investments
(in millions) 1996 1995 1994
---------------------------
Net Gains (Losses) on Sales:
Fixed maturities $(12) $ 6 $ 3
Common and preferred stocks 79 4 --
Mortgage loans and real estate 17 2 7
Other 18 18 5
---------------------------
Net gains on sales 102 30 15
Impairments (58) (23) (10)
---------------------------
Net realized gains on investments $ 44 $ 7 $ 5
---------------------------
Realized gains on common and preferred stocks in 1996 were largely the result of
a $78 million gain on the sale of USF&G's ownership interest in Chancellor
Capital Management, Inc. Realized gains on sales of mortgage loans and real
estate in 1996 resulted from the sale of two operating properties and numerous
nonincome-producing land investments. Other realized gains in 1996, 1995 and
1994 primarily related to USF&G's share of gains from its equity in certain
venture capital-type limited partnerships.
During 1996, the business strategy for a land development project was revised to
accelerate the period of time to dispose of the assets through more aggressive
marketing and lower selling prices, resulting in a lower level of estimated
future cash flows. In addition, the carrying value of an operating property was
reduced as a result of the commencement of efforts to sell the property.
A $40 million reduction in the carrying value of these real estate investments
to fair value was recognized in the year ended December 31, 1996. The
investments' fair values were based on the estimated future cash flows
discounted at a market rate of interest.
5.4. Unrealized gains (losses)
The components of the changes in unrealized gains (losses) were as follows:
(in millions) 1996 1995 1994
----------------------------
Fixed maturities available for sale $(242) $ 524 $(407)
Deferred policy acquisition costs and
policy benefits adjustment 54 (106) 63
Common and preferred stocks 2 4 3
Foreign currency and other 10 (4) 3
----------------------------
Total change in unrealized
gains (losses) before taxes (176) 418 (338)
Deferred tax on net unrealized gains (33) -- --
----------------------------
Net change in unrealized gains
(losses) $(209) $ 418 $(338)
----------------------------
Fluctuations in the unrealized gains and losses on fixed maturities are
primarily a result of fluctuating interest rates. Yields on U.S. Treasuries with
2- to 30-year maturities increased an average of 78 basis points during 1996,
fell an average of 235 basis points in 1995, and increased an average of 259
basis points in 1994. As a result, the net unrealized gain on fixed maturities
available for sale at December 31, 1996 was $98 million, compared with a net
unrealized gain at December 31, 1995 of $340 million and a net unrealized loss
at December 31, 1994 of $184 million. Also affecting the 1995 change in
unrealized gains on fixed maturities was the 1995 reclassification of the entire
"held to maturity" fixed maturity portfolio to "available for sale". Unrealized
gains and losses on fixed maturities are offset by related changes in the
deferred policy acquisition costs ("DPAC") and policy benefits adjustment, which
reflects assumptions about the effect of potential sales of fixed maturities
available for sale on future amortization of the life insurance segment's DPAC.
The DPAC and policy benefits adjustment was a loss of $19 million at December
31, 1996, compared with a loss of $73 million at December 31, 1995 and a gain of
$33 million at December 31, 1994. The tax effect on net unrealized gains at
December 31, 1996 was $33 million. The tax effect on net unrealized gains
(losses) at December 31, 1995 and 1994 was offset by the deferred tax asset
valuation allowance, pursuant to Statement of Financial Accounting Standards
("SFAS") No. 109. This valuation allowance was eliminated in 1996 (refer to
Section 1.3 of this Analysis).
5.5. Fixed maturity investments
The table below details the composition of the fixed maturity portfolio.
At December 31
(dollars in millions) 1996 % 1995 % 1994 %
------------------------------------
Corporate and other
investment-grade bonds $4,673 58 $5,361 59 $5,037 56
Mortgage-backed securities 1,464 18 1,739 19 1,921 22
Asset-backed securities 731 9 999 11 942 11
U.S. Government bonds 334 4 380 4 287 3
High-yield bonds 548 7 599 7 616 7
Tax-exempt bonds 316 4 40 -- 121 1
------------------------------------
Total fixed maturities at
amortized cost 8,066 100 9,118 100 8,924 100
Total market value of
fixed maturities 8,164 9,458 8,365
------------------------------------
Net unrealized gains (losses) $ 98 $ 340 $ (559)
------------------------------------
Percent market-to-
amortized cost 101 104 94
------------------------------------
Fluctuating interest rates, which result in inversely changing bond prices, were
responsible for the volatility of the overall market-to-amortized cost ratio
between years.
While subject to prepayment risk, credit risk related to USF&G's mortgage-backed
securities portfolio at December 31, 1996 is believed to be minimal since
99 percent of such securities had AAA ratings or were collateralized by
obligations of the U.S. Government or its agencies. The net proceeds from sales,
maturities and repayments in 1996 were predominately reinvested in corporate
investment-grade and tax-exempt bonds. In 1995 and 1994, proceeds were generally
reinvested into corporate investment-grade bonds. Investment-grade bonds,
including debt obligations of the U.S. Government and its agencies, comprised
93 percent of the portfolio at December 31, 1996, 1995 and 1994. The following
table shows the credit quality of the long-term fixed maturity portfolio at
December 31, 1996.
Percent
Market-to-
Amortized Market Amortized
(dollars in millions) Cost Percent Value Cost
------------------------------------------
U.S. Government and U.S.
Government Agencies $1,767 22% $1,791 101%
AAA 1,280 16 1,295 101
AA 1,344 17 1,346 100
A 2,121 26 2,146 101
BBB 1,006 12 1,025 102
BB 288 4 295 103
B 258 3 264 102
CCC and lower 2 -- 2 100
------------------------------------------
Total $8,066 100% $8,164 101%
------------------------------------------
Information on credit quality is based upon the higher of the rating assigned to
each issue 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.
High-yield investments generally involve a greater degree of risk than
investment-grade securities. Expected returns should, however, compensate for
the added risk. USF&G attempts to minimize the risks associated with high-yield
investments by limiting the exposure to any one issuer and by closely monitoring
the creditworthiness of such issuers. At December 31, 1996, USF&G's five largest
investments in high-yield bonds totaled $64 million in amortized cost and had a
market value of $65 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.
5.6. Real estate
The table below shows the components of USF&G's real estate portfolio.
At December 31
(in millions) 1996 1995 1994
--------------------------
Mortgage loans $406 $254 $ 349
Equity real estate 554 653 662
--------------------------
Total $960 $907 $1,011
--------------------------
The increase in the real estate portfolio in 1996 was due to new mortgage loan
originations, offset in part by the sale of equity real estate. Mortgage loan
originations in 1996 consisted of fixed-rate loans collateralized by apartment
and office properties. The equity real estate sales in 1996 included two
operating properties and numerous nonincome-producing land investments. In 1995,
two equity real estate properties were sold, and certain fixed-rate,
multi-family mortgages were securitized and sold, resulting in the decrease in
the real estate portfolio in that year. These sales were consistent with USF&G's
continued strategy 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.
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 was as follows:
At December 31
1996 1995 1994
----------------------------
Geographic Region:
Pacific/Mountain 31% 33% 34%
Mid-Atlantic 23 21 17
Midwest 17 23 20
Southeast 16 12 16
Southwest 8 6 8
Northeast 5 5 5
----------------------------
Type of Property:
Office 46% 44% 37%
Apartments 24 15 24
Land 17 28 26
Retail/other 8 7 7
Industrial 5 6 6
----------------------------
At December 31, 1996, USF&G's five largest real estate investments had a book
value of $257 million. The largest single investment was a land development
project located in San Diego, with a book value of $88 million, or nine percent
of the total real estate portfolio. Mortgage loans and real estate 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, analyzed and acted upon if appropriate.
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.
6. FINANCIAL CONDITION
6.1. Assets
USF&G's assets totaled $14.4 billion at December 31, 1996, compared with
$14.7 billion and $14.0 billion at the end of 1995 and 1994, respectively. The
fluctuations from year to year were due primarily to changes in the market value
of the fixed maturity investments classified as available for sale (refer to
Section 5.4 of this Analysis). As part of the Coinsurance Contract, F&G Life
transferred $932 million of fixed maturity investments and other assets to the
coinsurer, and recorded a $964 million reinsurance receivable. As of December
31, 1996, surrender activity under the Coinsurance Contract had reduced the
related reinsurance receivable balance to $772 million.
6.2. Debt
USF&G's corporate debt totaled $477 million at December 31, 1996, compared with
$591 million at December 31, 1995 and $586 million at December 31, 1994.
During 1996, $114 million was drawn against a credit facility to fund the
repayment of the 5 1/2% Swiss Franc Bonds which matured in January 1996, and to
repurchase approximately $39 million in outstanding Zero Coupon Convertible
Notes. The balance outstanding on the credit facility was paid down with excess
corporate cash and proceeds from the issuance of capital securities (refer to
Section 6.3 of this Analysis).
USF&G's real estate and other debt totaled $5 million at December 31, 1996,
compared with $16 million and $42 million at December 31, 1995 and 1994,
respectively. Real estate and other debt decreased $11 million in 1996 as a
result of the foreclosure on a previously consolidated real estate partnership
investment.
6.3. Shareholders' equity
USF&G's shareholders' equity totaled $2.0 billion at December 31, 1996 and 1995,
and $1.4 billion at December 31, 1994. Net income and the elimination of the
minimum pension liability increased equity in 1996, but were offset by declines
in net unrealized gains on fixed maturity investments and a reduction in paid-in
capital due to the repurchase of 8.4 million shares of common stock. The
increase in shareholders' equity from 1994 to 1995 resulted from significant
unrealized gains as well as net income of $209 million. The need to record a
minimum pension liability and changes in unrealized gains and losses are
significantly affected by interest rate movements, which are beyond the control
of management. Consequently, no assurance can be given that the minimum pension
liability will not be reestablished in the near future, or that unrealized
losses will not result in significant reductions of shareholders' equity.
In January 1994, USF&G filed a shelf registration statement with the Securities
and Exchange Commission. As of the time this registration statement went into
effect, USF&G had available $647 million of unissued debt, preferred stock,
common stock and warrants to purchase debt and stock. In 1994, this registration
statement was reduced by $275 million for the issuances of the Zero Coupon
Convertible Notes and the 8 3/8% Senior Notes. The registration was further
reduced in 1995 by $150 million and $80 million for the issuances of the
7% Senior Notes and the 7 1/8% Senior Notes, respectively, leaving $142 million
of unissued debt, preferred stock, common stock and warrants available at
December 31, 1995. No debt or stock was issued under this registration in 1996.
In December 1995, USF&G Corporation, along with two business trusts in which
USF&G has a controlling interest (the "Trusts"), filed a shelf registration
statement which permits the issuance by the Trusts of up to $210 million of
capital securities. In January 1997, $100 million of capital securities were
issued under the shelf registration, with the proceeds used to redeem
approximately 50 percent of the outstanding shares of USF&G's $4.10 Series A
Convertible Exchangeable Preferred Stock. In December 1996, $100 million of
capital securities were issued in a private placement transaction, the proceeds
from which were used to pay down the balance on the credit facility.
During 1996 and 1995, USF&G called for redemption 233,550 shares and 832,650
shares, respectively, of its $10.25 Series B Cumulative Convertible Preferred
Stock ("Series B Preferred Stock"). Additionally, holders of 20,000 shares and
189,800 shares of Series B Preferred Stock voluntarily converted those shares
into common stock in 1996 and 1995, respectively. Another 24,000 shares of
Series B Preferred Stock were redeemed for cash in 1996. In total, USF&G issued
10.6 million shares of common stock in 1996 and 1995 related to the conversion
of the Series B Preferred Stock. During 1995 and 1994, USF&G issued 15.4 million
shares of common stock as a result of the redemption of all of its outstanding
$5.00 Series C Cumulative Convertible Preferred Stock ("Series C Preferred
Stock"). As a result of these transactions, over $27 million of dividends
related to the Series B and Series C Preferred Stock (net of expected dividends
on shares of common stock issued on conversion) have been eliminated over the
course of the last three years.
7. LIQUIDITY
Liquidity is a measure of an entity's ability to secure enough cash to meet its
contractual obligations and operating needs. USF&G requires cash primarily to
pay policyholders' claims and benefits, debt and dividend obligations, and
operating expenses. USF&G's sources of cash include cash flow from operations,
credit facilities, marketable securities and sales of other assets. Management
believes that internal and external sources of cash will continue to exceed
USF&G's short-term and long-term operating needs.
7.1. Cash flow
USF&G had cash flow from operating activities of $330 million for the year ended
December 31, 1996 and $399 million and $140 million for the years ended December
31, 1995 and 1994, respectively. The decline of cash flows from operating
activities for 1996 compared with 1995 was due primarily to an $82 million
decrease in net reinsurance activity due to ceding of Discover Re's increased
captive business, and a $36 million decline in net investment income collected
due to the reduced asset base (refer to Section 5.2 of this Analysis). Direct
losses, loss expenses and policy benefits paid increased in 1996 due to the
unusually high level of catastrophe losses (refer to Section 3.1 of this
Analysis). Offsetting these declines in cash flow from operations was an
increase of $105 million in direct premiums collected. In addition, deposits and
withdrawals of universal life and investment contracts, such as annuities, which
for GAAP reporting purposes are considered financing activities, had net cash
outflows of $97 million in 1996, $349 million in 1995 and $418 million in 1994.
These net cash outflows related primarily to SPDA surrender activity and
decreased in 1996 as a result of the Coinsurance Contract. Cash flows are
expected to continue to benefit in the future from the Coinsurance Contract,
which significantly reduced F&G Life's exposure to cash outflows for surrender
activity.
7.2. Credit facilities
For general corporate purposes, USF&G maintained a committed, standby credit
facility with a group of foreign and domestic banks totaling $250 million at
December 31, 1996. This facility permits either borrowing of funds or letter of
credit issuances, and will expire in 2001. In addition, at December 31, 1996,
USF&G maintained a $150 million multi-currency credit facility. There were no
borrowings against these facilities at December 31, 1996. The credit agreement
contains restrictive covenants pertaining to indebtedness, tangible net worth,
liens and other matters. USF&G was in compliance with the covenants contained in
the agreement at December 31, 1996.
8. LEGAL CONTINGENCIES AND REGULATION
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. In addition to
such litigation, USF&G Corporation and its subsidiaries are subject to other
litigation and claims in the ordinary course of their businesses. Additional
information on certain other litigation contingencies may be found in Note 14,
"Legal Contingencies", to the consolidated financial statements. In the opinion
of management, such contingencies are not expected to have a material 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.
USF&G's insurance subsidiaries are also 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 and
deposit 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. State insurance departments routinely conduct
financial and market conduct examinations and assess fines for violations of the
myriad state regulations affecting the conduct of the insurance business. 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.
It is not possible to predict the future impact of increasing regulation on
USF&G's operations.
8.1. Involuntary market plans
Most states require insurers to provide coverage for less desirable risks
through participation in mandatory programs. USF&G's participation in assigned
risk pools and similar plans, mandated now or in the future, creates and is
expected to create downward pressure on earnings. Underwriting losses from
involuntary market plans totaled $4 million in 1996, compared with $13 million
and $21 million in 1995 and 1994, respectively.
8.2. Withdrawal from business lines
Some states have adopted legislation or regulations restricting or otherwise
limiting an insurer's ability to withdraw from certain lines of business. Such
restrictions are most often found in personal lines and workers' compensation
insurance. They include prohibitions on mid-term cancellations and limiting
reasons based upon which an insurer may nonrenew policies, requirements for
amendments to underwriting standards, rates and policy forms to be approved by
state regulators, specifications of a maximum percentage of a book of business
which may be nonrenewed within the state within any twelve-month period, and
prohibitions on exiting a single line of business within a state (thus requiring
an insurer to either continue an unprofitable line or give up all lines of
business and withdraw from a state entirely). Such restrictions limit USF&G's
ability to manage its exposure to unprofitable lines and adversely affects
earnings to the extent USF&G is required to continue writing unprofitable
business.
8.3. Guaranty funds
Insurance guaranty fund laws have been adopted in most states to protect
policyholders in case of an insurer's insolvency. Insurers doing business in
those states can be assessed for certain obligations of insolvent companies to
policyholders and claimants. These assessments, under certain circumstances, can
be credited against future premium taxes. Net of such tax credits, USF&G
incurred $2 million of guaranty fund expense in 1996 and $5 million and
$9 million in 1995 and 1994, respectively.
State laws limit the amount of annual assessments which are based on percentages
(generally two percent) of assessable annual premiums in the year of insolvency.
The ultimate amount of these assessments cannot be reasonably estimated, but are
not expected to have a material adverse effect on USF&G's financial position.
8.4. NAIC proposals
The NAIC has been developing several model laws and regulations, including a
Model Investment Law and amendments to the Model Holding Company System
Regulatory Act (the "Holding Act Amendments"). The Model Investment Law defines
the investments which are permissible for property/casualty and life insurers to
hold, and the Holding Act Amendments address the types of activities in which
subsidiaries and affiliates may engage. The NAIC adopted these model laws in
1996, but the laws have not been enacted for insurance companies domiciled in
the State of Maryland, such as USF&G Company and F&G Life. Even if enacted in
Maryland or other states in which USF&G's subsidiaries are domiciled, it is
expected that these laws will neither significantly change USF&G's investment
strategies nor have any material adverse effect on USF&G's liquidity or
financial position.
8.5. Superfund
Superfund is scheduled to be reauthorized in 1997. Insurance companies, other
businesses, environmental groups and municipalities are advocating a variety of
reform proposals to revise the cleanup and liability provisions of Superfund. No
reliable prediction can be made as to the ultimate outcome of the legislative
deliberations regarding the reauthorization of Superfund or the effect such
revisions may have on USF&G.
8.6. Insurance regulatory information system
The NAIC's Insurance Regulatory Information System ("IRIS") ratios are intended
to assist state insurance departments in their review of the financial condition
of insurance companies operating within their respective states. IRIS specifies
eleven industry ratios and establishes a "usual range" for each ratio.
Significant departure from a number of ratios may lead to inquiries from state
insurance regulators. As of December 31, 1996, USF&G was within or favorably
exceeded the "usual range" for all of the IRIS ratios.
8.7. Taxation of deferred annuities
From time to time, various proposals have been considered by Congress, the
Office of Management and Budget and the Department of the Treasury to include
within an individual annuitant's current taxable income all or a portion of the
interest payments which accrue on certain deferred annuity products, including
some deferred annuity products sold by F&G Life. Currently, such interest is not
taxed until the time of distribution. All such proposals have focused on
deferred annuities and have not included annuities issued in connection with
structured settlements of claims or on tax sheltered annuities. No reliable
prediction can be made at this time as to the outcome of any such proposals or
the effect such proposals may have on F&G Life.
8.8. Glass-Steagall reform
Congress and the Administration are considering various proposals to restructure
the U.S. financial services industry through repeal or modification of the
Glass-Steagall Act and the Bank Holding Company Act. 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.
8.9. Natural disaster protection
From time to time, various proposals have been considered by Congress and the
Administration to provide a program of natural disaster protection that would
include primary insurance and reinsurance for the perils of hurricane,
earthquake, volcanic eruption and tsunami. During the current session of
Congress, a legislative proposal has been introduced to create a private
not-for-profit corporation that would serve as the primary insurer of
residential property for both the earthquake and hurricane perils. This private
not-for-profit corporation also would serve as a reinsurer of commercial risks
for earthquake and hurricane perils and as a reinsurer of residential property
for natural catastrophe perils not covered under the primary program (e.g.,
volcano, tsunami). In addition, legislation has been introduced to establish a
federal program to provide reinsurance for state residential disaster insurance
programs. No reliable prediction can be made at this time as to the outcome of
any of these proposals or the effect they may have on USF&G.
9. GLOSSARY OF TERMS
Account value: Deferred annuity cash value available to policyholders before the
assessment of surrender charges.
Alternative risk transfer ("ART"): 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.
Captive insurer: A closely-held insurance company owned by one or more
organizations whose purpose is to insure some or all of the risks of
shareholders or affiliated organizations.
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.
Deferred annuity: A life insurance product purchased with either a lump-sum or
flexible premium, which accumulates interest over a fixed period or over an
individual's lifetime, with payments deferred to a designated future time.
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.
Facultative reinsurance: The reinsurance of part or all of the insurance
provided by a single policy. Each cession is negotiated individually. The word
"facultative" connotes that both the primary insurer and the reinsurer have the
faculty or option of accepting or rejecting the individual submission (as
distinguished from the obligation to cede and accept, to which the parties agree
in treaty reinsurance).
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.
Gross program premium: Total ART premium managed, whether actually written by a
USF&G affiliate or a nonaffiliate captive insurer.
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.
Immediate annuity: A life insurance product which provides a fixed stream of
payments over a fixed period of time or over an individual's lifetime, with
payments beginning at the inception of the contract.
Investment spreads: The difference between the interest rates earned on invested
assets and the interest rates credited to policyholders.
Loss ratio: The ratio of incurred losses and loss expenses to earned premiums,
determined in accordance with SAP or GAAP.
Nonstandard auto: Automobile insurance for individuals who are unable to obtain
preferred or standard insurance coverage due to their inability to meet certain
standard underwriting criteria, based on factors such as age, type of
automobile, residence location and driving record.
Policyholders' surplus: The net assets of an insurer as reported to regulatory
agencies based on accounting practices prescribed or permitted by the NAIC 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, after the assumption and
cession of reinsurance.
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.
Structured settlement annuity: An immediate annuity sold to property/casualty
companies to fund the settlement of insurance claims.
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. It is not unusual for property/casualty
companies to have underwriting losses that are offset by investment income.
Universal life: A life insurance product which provides a death benefit for the
life of the insured and accumulates cash values to which interest is credited.
USF&G CORPORATION Eleven-Year Summary of Selected Financial Information
(dollars in millions
except per share data) 1996 1995 1994 1993
-------------------------------------------------------
Consolidated Results
Premiums earned $ 2,731 $ 2,666 $ 2,508 $ 2,521
Total revenues 3,498 3,459 3,310 3,323
Income (loss) from
continuing operations
before cumulative
effect of adopting new
accounting standards 261 209 237 130
Income (loss) from
discontinued operations -- -- -- --
Cumulative effect of adopting
new accounting standards -- -- -- 38
Net income (loss) 261 209 237 168
-------------------------------------------------------
Per Share Results
Income (loss) from continuing
operations before cumulative
effect of adopting new
accounting standards $ 2.05 $ 1.63 $ 2.00 $ .90
Income (loss) from
discontinued operations -- -- -- --
Cumulative effect of adopting
new accounting standards -- -- -- .42
Net income (loss) 2.05 1.63 2.00 1.32
Book value 15.48 14.68 9.96 11.33
-------------------------------------------------------
Investment Results
Net investment income $ 705 $ 733 $ 749 $ 753
Realized gains (losses) 44 7 5 6
Change in unrealized
gains (losses) (209) 418 (338) 220
-------------------------------------------------------
Financial Position
Assets $14,407 $14,651 $ 13,980 $14,481
Investments 10,076 11,107 10,561 11,474
Corporate debt 477 591 586 574
Real estate and other debt 5 16 42 53
Shareholders' equity 1,969 1,984 1,441 1,556
-------------------------------------------------------
Common Stock
Market high $21 3/4 $ 19 1/2 $ 16 1/8 $19 5/8
Market low 14 1/4 13 3/8 11 11/16 11 1/8
Market close 20 7/8 16 7/8 13 5/8 14 3/4
Cash dividends declared .20 .20 .20 .20
Common shares outstanding 114,240,489 119,606,095 104,810,794 91,418,372
-------------------------------------------------------
Property/Casualty Insurance
Premiums earned $ 2,586 $ 2,492 $ 2,356 $ 2,392
Net income (loss) 149 175 498 285
Statutory premiums written 2,639 2,563 2,389 2,502
-------------------------------------------------------
Statutory loss ratio 72.1 72.4 73.1 75.3
Statutory expense ratio 33.5 33.4 34.8 33.5
Statutory combined ratio 105.6 105.8 107.9 108.8
-------------------------------------------------------
Life Insurance
Sales $ 427 $ 348 $ 286 $ 205
Premium income 145 174 152 129
Net income (loss) (5) 19 12 10
-------------------------------------------------------
Noninsurance Operations
Revenues $ 74 $ 63 $ 90 $ 5
Net income (loss) 117 15 (273) (126)
-------------------------------------------------------
1992 1991 1990 1989 1988 1987 1986
- - ----------------------------------------------------------------------------------------------
$ 2,683 $ 3,213 $ 3,535 $ 3,713 $ 3,801 $ 3,888 $ 3,622
3,712 4,202 4,191 4,653 4,559 4,500 4,314
36 (145) (433) 148 251 263 276
(7) (32) (136) (31) (20) 2 (2)
-- -- -- -- -- -- --
29 (177) (569) 119 247 279 295
- - ----------------------------------------------------------------------------------------------
$ (.14) $ (2.06) $ (5.10) $ 1.52 $ 2.87 $ 3.36 $ 4.04
(.08) (.36) (1.55) (.35) (.24) .03 (.03)
-- -- -- -- -- -- --
(.22) (2.42) (6.65) 1.18 2.82 3.57 4.32
8.66 9.30 11.65 20.61 22.29 19.29 19.90
- - ----------------------------------------------------------------------------------------------
$ 820 $ 880 $ 930 $ 912 $ 796 $ 699 $ 619
148 38 (354) (36) (92) (133) 53
(18) 37 (30) 32 185 (282) (105)
- - ----------------------------------------------------------------------------------------------
$13,242 $14,555 $13,951 $13,576 $12,342 $10,171 $ 8,943
11,417 12,216 11,259 10,911 9,787 7,901 6,831
574 617 659 543 448 407 348
54 73 129 92 44 24 5
1,300 1,346 1,277 2,011 2,058 1,727 1,579
- - ----------------------------------------------------------------------------------------------
$ 15 $12 1/2 $30 3/8 $ 34 $34 3/8 $48 3/4 $46 3/4
7 1/8 5 5/8 7 28 1/4 28 1/2 26 1/4 36 1/4
12 3/8 7 1/4 7 1/2 29 28 1/2 28 3/8 39 3/4
.20 .20 2.44 2.80 2.64 2.48 2.32
89,985,083 88,566,897 88,157,862 87,864,146 83,320,477 79,193,184 69,319,067
- - ----------------------------------------------------------------------------------------------
$ 2,579 $ 3,044 $ 3,349 $ 3,548 $ 3,623 $ 3,754 $3,542
194 (41) (192) 200 318 331 309
2,475 3,064 3,651 3,717 3,903 3,854 3,701
- - ----------------------------------------------------------------------------------------------
81.8 84.0 81.8 76.4 73.0 73.2 79.1
34.8 33.1 32.9 32.8 31.2 30.1 29.1
116.6 117.1 114.7 109.2 104.2 103.3 108.2
- - ----------------------------------------------------------------------------------------------
$ 155 $ 280 $ 1,054 $ 960 $ 1,077 $ 278 $ 83
104 169 186 165 178 133 79
(5) 31 (16) 31 14 37 20
- - ----------------------------------------------------------------------------------------------
$ 17 $ 38 $ 22 $ 84 $ 114 $ 112 $ 8
(160) (167) (361) (112) (85) (88) (86)
- - ----------------------------------------------------------------------------------------------
USF&G CORPORATION Consolidated Statement of Operations
Years Ended December 31
(dollars in millions except per share data) 1996 1995 1994
--------------------------
Revenues
Premiums earned $2,731 $2,666 $2,508
Net investment income 705 733 749
Other 18 53 48
--------------------------
Revenues before net realized gains 3,454 3,452 3,305
Net realized gains on investments 44 7 5
--------------------------
Total revenues 3,498 3,459 3,310
--------------------------
Expenses
Losses, loss expenses and policy benefits 2,181 2,178 2,132
Underwriting, acquisition and operating expenses 1,044 1,048 1,001
Interest expense 39 44 37
Branch reorganization severance 17 -- --
Facilities exit costs/(sublease income) (42) (6) 183
--------------------------
Total expenses 3,239 3,264 3,353
--------------------------
Income (loss) from operations before income taxes 259 195 (43)
Provision for income taxes (benefit) (2) (14) (280)
--------------------------
Net income $ 261 $ 209 $ 237
--------------------------
Preferred stock dividend requirements 20 28 46
--------------------------
Net income available to common stock $ 241 $ 181 $ 191
--------------------------
Primary earnings per common share $ 2.05 $ 1.63 $ 2.00
Fully diluted earnings per common share 1.93 1.53 1.77
--------------------------
Weighted-average common shares outstanding (in 000s):
Primary 117,674 111,474 95,797
Fully diluted 129,490 130,186 127,808
--------------------------
See Notes to Consolidated Financial Statements.
USF&G CORPORATION Consolidated Statement of Financial Position
At December 31
(dollars in millions except per share data) 1996 1995 1994
--------------------------
Assets
Investments:
Fixed maturities:
Held to maturity, at amortized cost
(market, 1994, $4,284) $ -- $ -- $ 4,659
Available for sale, at market
(cost, 1996, $8,066;1995, $9,118;
1994, $4,265) 8,164 9,458 4,081
Common and preferred stocks, at market
(cost, 1996, $16; 1995, $70; 1994, $79) 16 65 72
Short-term investments 535 288 450
Mortgage loans 406 254 349
Real estate 554 653 662
Other invested assets 401 389 288
--------------------------
Total investments 10,076 11,107 10,561
--------------------------
Cash 73 119 69
Accounts, notes and other receivables 763 795 741
Reinsurance receivables 1,576 604 554
Servicing carrier receivables 661 699 706
Deferred policy acquisition costs 456 434 504
Other assets 802 893 845
--------------------------
Total assets $14,407 $14,651 $13,980
--------------------------
Liabilities
Unpaid losses, loss expenses and policy benefits $ 9,584 $ 9,816 $ 9,962
Unearned premiums 1,113 1,055 968
Corporate debt 477 591 586
Real estate and other debt 5 16 42
Other liabilities 1,159 1,189 981
--------------------------
Total liabilities 12,338 12,667 12,539
--------------------------
USF&G-obligated mandatorily redeemable capital
securities of subsidiary trust holding solely
junior subordinated deferrable interest
debentures of USF&G 100 -- --
--------------------------
Shareholders' Equity
Preferred stock, par value $50.00 (12,000,000
shares authorized; shares issued, 1996,
3,999,910; 1995, 4,277,460; 1994, 6,627,896) 200 213 331
Common stock, par value $2.50 (240,000,000 shares
authorized; shares issued, 1996, 114,240,489;
1995, 119,606,095; 1994, 104,810,794) 286 299 262
Paid-in capital 1,091 1,188 1,104
Net unrealized gains (losses) on investments
and foreign currency 62 271 (147)
Minimum pension liability -- (100) (63)
Retained earnings (deficit) 330 113 (46)
--------------------------
Total shareholders' equity 1,969 1,984 1,441
--------------------------
Total liabilities, capital securities
and shareholders' equity $14,407 $14,651 $13,980
--------------------------
See Notes to Consolidated Financial Statements.
USF&G CORPORATION Consolidated Statement of Cash Flows
Years Ended December 31
(in millions) 1996 1995 1994
---------------------------
Operating Activities
Direct premiums collected $ 2,183 $ 2,078 $ 2,029
Net investment income collected 707 743 750
Direct losses, loss expenses and
policy benefits paid (1,751) (1,725) (1,884)
Net reinsurance activity (13) 69 22
Underwriting and operating expenses paid (769) (760) (789)
Interest paid (37) (37) (31)
Income taxes paid (5) (5) (12)
Other items, net 15 36 55
--------------------------
Net cash provided from operating activities 330 399 140
--------------------------
Investing Activities
Net (purchases), sales and maturities
of short-term investments (249) 148 (115)
Purchases of fixed maturities held to maturity -- -- (400)
Sales of fixed maturities held to maturity -- 21 65
Maturities/repayments of fixed maturities
held to maturity -- 110 348
Purchases of fixed maturities available for sale (1,189) (1,123) (351)
Sales of fixed maturities available for sale 588 489 345
Maturities/repayments of fixed maturities
available for sale 702 443 480
Purchases of other investments (228) (302) (434)
Sales, maturities and repayments of
other investments 412 332 482
Purchase of subsidiary (57) -- --
Purchases of property and equipment (59) (32) (33)
Sales of property and equipment 14 2 4
-------------------------
Net cash (used in) provided from investing activities (66) 88 391
-------------------------
Financing Activities
Deposits for universal life and
investment contracts 438 310 246
Withdrawals of universal life and
investment contracts (535) (659) (664)
Net repayments of short-term borrowings -- (227) (167)
Long-term borrowings -- 228 270
Repayments of long-term borrowings (125) (42) (124)
Issuance of capital securities 98 -- --
Issuances of common stock 11 6 38
Repurchases of common stock (150) -- --
Redemptions of preferred stock (2) -- (13)
Cash dividends paid to shareholders (45) (53) (66)
-------------------------
Net cash used in financing activities (310) (437) (480)
-------------------------
(Decrease) increase in cash (46) 50 51
Cash at beginning of year 119 69 18
-------------------------
Cash at end of year $ 73 $ 119 $ 69
-------------------------
Noncash Transactions
Coinsurance of broker SPDA block:
Transfer of investments and other assets in
exchange for reinsurance receivables $ 964 $ -- $ --
Surrender activity (192) -- --
-------------------------
See supplemental cash flow information at Note 1.13.
See Notes to Consolidated Financial Statements.
USF&G CORPORATION Consolidated Statement of Shareholder's Equity
Years Ended December 31
(in millions except per share data) 1996 1995 1994
--------------------------
Preferred Stock
Balance at beginning of year $ 213 $ 331 $ 455
Par value of Series B shares converted
to common shares (12) (51) --
Par value of Series C shares converted
to common shares -- (66) (111)
Par value of shares redeemed (1) (1) (13)
--------------------------
Balance at end of year 200 213 331
--------------------------
Common Stock
Balance at beginning of year 299 262 228
Par value of shares issued for conversion
of Series B shares 5 21 --
Par value of shares issued for conversion
of Series C shares -- 14 23
Par value of other shares issued 3 2 11
Par value of shares repurchased (21) -- --
--------------------------
Balance at end of year 286 299 262
--------------------------
Paid-In Capital
Balance at beginning of year 1,188 1,104 986
Excess of proceeds over par value of
Series B shares converted 7 29 --
Excess of proceeds over par value of
Series C shares converted -- 50 86
Excess of proceeds over par value of
other shares issued 8 5 32
Excess of cost over par value of shares
repurchased (129) -- --
Accrued stock-based compensation 15 -- --
Tax benefit from exercise of stock options 2 -- --
--------------------------
Balance at end of year 1,091 1,188 1,104
--------------------------
Net Unrealized Gains (Losses) on Investments
and Foreign Currency
Balance at beginning of year 271 (147) 191
Change in unrealized gains (losses) (209) 418 (338)
--------------------------
Balance at end of year 62 271 (147)
--------------------------
Minimum Pension Liability
Balance at beginning of year (100) (63) (85)
Change in unfunded accumulated benefits 100 (37) 22
--------------------------
Balance at end of year -- (100) (63)
--------------------------
Retained Earnings (Deficit)
Balance at beginning of year 113 (46) (219)
Net income 261 209 237
Common stock dividends declared
(per share, 1996, 1995 and 1994, $.20) (24) (22) (18)
Preferred stock dividends declared
(per share, 1996, Series A, $4.10, Series B,
$7.69; 1995, Series A, $4.10, Series B, $10.25;
1994, Series A, $4.10, Series B, $10.25,
Series C, $5.00) (20) (28) (46)
--------------------------
Balance at end of year 330 113 (46)
--------------------------
Total shareholders' equity $1,969 $1,984 $1,441
--------------------------
See Notes to Consolidated Financial Statements.
USF&G CORPORATION Notes to Consolidated Financial Statements
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1.1. Basis of presentation
The 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" or "the
Corporation"). Intercompany transactions are eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to the 1996
presentation. Refer to Note 1.12 regarding restatements for mergers consummated
in the second quarter of 1995. The preparation of the consolidated financial
statements in conformity with GAAP requires management to make estimates and
assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from these
estimates.
USF&G is primarily engaged in the business of insurance. Property/casualty
insurance, which accounted for 88 percent of revenues before net realized gains
in 1996, is written primarily by United States Fidelity and Guaranty Company
("USF&G Company") and is sold primarily through independent agents and brokers
supported by USF&G Company's underwriting, marketing, administrative and claim
services offices located throughout the United States. Life insurance and
annuities, which accounted for 12 percent of revenues before net realized gains
in 1996, are written primarily by Fidelity and Guaranty Life Insurance Company
("F&G Life"), and are sold throughout the United States through independent
agents, managing general agents and specialty insurance brokerage firms.
Noninsurance operations are composed primarily of the parent company and asset
management services. Additional information on the Corporation's business
segments is included in Note 16, "Information on Business Segments".
1.2. New accounting standards
Effective January 1, 1996, USF&G adopted Statement of Financial Accounting
Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets
and for Long-Lived Assets to be Disposed Of". SFAS No. 121 requires impairment
losses to be recorded on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amount. The standard also
requires 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 had been to establish valuation allowances for impairment to specific
investments where impairment is deemed other than temporary. The adoption of
SFAS No. 121 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.
In October 1995, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123, "Accounting for Stock-Based Compensation", which defines a fair value-
based method of accounting for stock options granted to employees. As allowed by
SFAS No. 123, USF&G has elected to continue applying Accounting Principals Board
Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees", and related
interpretations in accounting for its employee stock options, and has provided
pro forma disclosures of the effects on net income and earnings per share had
the fair value method for recognizing compensation expense been adopted. (Refer
to Note 9.)
In June 1996, the FASB issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities", which
provides new accounting and reporting standards for transfers and servicing of
receivables and other financial assets and extinguishments of liabilities. The
standard is based on a financial components approach that focuses on whether an
entity controls the financial assets transferred in such transactions. As
issued, the standard is effective for transactions occurring after December 31,
1996, and is to be applied prospectively. In December 1996, the FASB issued SFAS
No. 127, "Deferral of the Effective Date of Certain Provisions of FASB Statement
No. 125", which defers for one year both the criteria for determination of a
sale versus a secured borrowing for certain transactions, and new accounting
standards for assets transferred as collateral.
Once adopted, SFAS No. 125 will impact USF&G's accounting for participation in
securities lending programs as well as for assets pledged as collateral;
however, this impact will primarily be limited to classifications on the
Consolidated Statement of Financial Position. SFAS No. 125 could also affect
future financial statements to the extent USF&G enters into sales of financial
assets, extinguishments of liabilities or other applicable transactions.
1.3. Permitted statutory accounting practices
Reporting practices for insurance subsidiaries prescribed or permitted by state
regulatory authorities (statutory accounting practices) differ from GAAP.
Statutory amounts for USF&G's insurance operations follow.
(in millions) 1996 1995 1994
-------------------------
Statutory Net Income for the Years
Ended December 31:
Property/casualty insurance* $ 167 $ -- $ 173
Subsidiaries and affiliates** 8 -- --
Life insurance 27 15 30
------------------------
Statutory Surplus at December 31:
Property/casualty insurance* $1,374 $1,341 $1,621
Subsidiaries and affiliates** 243 176 155
Life insurance 213 300 326
-------------------------
*Includes USF&G Company and all subsidiaries required to be included in its
combined statutory statements. At December 31, 1994, that amount includes the
life insurance subsidiary (refer to Note 7.5).
**Includes those property/casualty subsidiaries and affiliates not included in
USF&G Company's combined statutory statements.
USF&G's primary insurance subsidiaries, USF&G Company and F&G Life, are
domiciled in the State of Maryland and prepare their statutory financial
statements in accordance with statutory accounting practices prescribed or
permitted by the Maryland Insurance Administration. Prescribed statutory
accounting practices include state laws, regulations and general administrative
rules issued by the State of Maryland as well as a variety of publications and
manuals of the National Association of Insurance Commissioners ("NAIC").
Permitted statutory accounting practices encompass all accounting practices not
so prescribed.
Property/Casualty Insurance: USF&G Company has received written approval from
the Maryland Insurance Administration to extend the required disposal period for
certain real property acquired as security for loans or other obligations. Under
the current Maryland Insurance Code, these assets are required to be disposed of
within five years from the date of acquisition. The Maryland Insurance
Administration extended this time period for certain properties up to no later
than December 31, 1997. In addition, USF&G Company has received written approval
to admit certain expenses prepaid to various governmental agencies. As of
December 31, 1996, 1995 and 1994, these permitted transactions increased
statutory surplus by $20 million, $35 million and $19 million, respectively,
over what it would have been had prescribed accounting practices been followed.
Life Insurance: In 1994, F&G Life received permission from the Maryland
Insurance Administration to reduce nonadmitted assets by the associated asset
valuation reserve subcomponent ending balance. There was no effect on statutory
surplus from electing this option at December 31, 1996 and 1995. As of December
31, 1994, this permitted accounting practice had the effect of increasing
statutory surplus by $15 million over what it would have been had prescribed
accounting practices been followed.
Since Maryland does not specifically prescribe by law or regulation reserves for
universal life ("UL") policies or group annuities, F&G Life follows reserving
practices which are permitted by the State of Maryland. For older generation
universal life policies, F&G Life holds the full account value as a reserve. For
newer generation UL policies, reserves are held based on a calculation according
to the NAIC UL Model Regulation, which has been adopted by many states. Many of
the group annuities sold by F&G Life are used to fund qualified pension and/or
profit sharing plans. For these annuities, the funds are not allocated to
individual participants, and the full account value is held as the reserve. For
group annuities where the funds and/or benefits are allocated to the individual
certificate holder, reserves are calculated according to laws prescribed for
individual annuities.
1.4. Investments
Fixed Maturities: USF&G classifies all of its fixed maturities as "available for
sale". These securities are held for an indefinite period of time and may be
sold in response to changes in interest rates and the yield curve, prepayment
risk, liquidity needs, or other factors. Fixed maturities classified as
"available for sale" are carried at market value, with unrealized gains and
losses recorded as a separate component of shareholders' equity. Unrealized
gains or losses on fixed maturities available for sale are offset by an
adjustment to life insurance deferred policy acquisition costs which is made on
a pro forma basis as if the unrealized gains or losses on those assets which
match certain life insurance liabilities were realized. Specific writedowns in
the carrying value of fixed maturities are recognized in income when an
impairment is deemed other than temporary.
At December 31, 1994, USF&G classified fixed maturities as "held to maturity" if
it had both the positive intent and ability to hold the securities until
maturity or near enough to maturity such that interest rate risk would be
substantially eliminated as a pricing factor. Fixed maturities held to maturity
were carried at amortized cost. Changes in the market values of these
investments were generally not recognized in the financial statements. On
December 4, 1995, USF&G reclassified all of its fixed maturities previously
classified as "held to maturity" to "available for sale", as permitted by
supplemental guidance issued by the FASB in November 1995.
Common and Preferred Stocks: Investments in common and preferred stocks where
USF&G has significant influence over the investees' operating and financial
policies are accounted for using the equity method and included in other
invested assets. Other investments in common and preferred stocks are carried at
market value with the resulting unrealized gains or losses reported directly in
shareholders' equity.
Securities Lending: USF&G participates in a securities lending program whereby
certain securities from its portfolio are loaned to other institutions for short
periods of time. A fee is paid to USF&G by the borrower. Collateral that exceeds
the market value of the loaned securities is maintained by the lending agent and
reported in USF&G's other invested assets with an offsetting liability reported
in other liabilities. Invested assets and other liabilities include
$128 million, $113 million and $6 million at December 31, 1996, 1995 and 1994,
respectively, related to securities lending collateral.
Mortgage Loans and Real Estate: Mortgage loans are carried at unpaid principal
balances. Real estate investments are reported at cost adjusted for equity
participation. Real estate acquired through foreclosure or deed-in-lieu of
foreclosure is initially recorded at estimated market value. Valuation
allowances are recognized for mortgage loans with deteriorations in collateral
performance which are deemed other than temporary, based on quarterly
evaluations. Impairments in the value of real estate investments are recorded as
direct reductions in the carrying value of those investments and are recognized
in income when indicators of impairment are present and the undiscounted cash
flows estimated to be generated by those assets are less than the assets'
carrying amount.
Interest and Dividend Income: Interest on fixed maturity investments is recorded
as income when earned and is adjusted for any amortization of purchase premium
or discount. Dividends on equity securities are recorded as income on
ex-dividend dates.
Realized Gains and Losses: Realized gains and losses on the sale of investments
are determined based on specific cost. Realized losses are also recorded when an
investment's net realizable value is below cost and the decline is deemed other
than temporary.
1.5. Recognition of premium revenues
Property/Casualty Insurance: Property/casualty insurance premiums are earned
principally on a pro rata basis over the lives of the policies and include
accruals for ultimate premium revenue anticipated under auditable and
retrospectively rated policies. Unearned premiums represent the portion of
premiums written applicable to the unexpired terms of policies in force.
Unearned premiums also include estimated and unbilled premium adjustments.
Life Insurance: Premiums on life insurance policies with fixed and guaranteed
premiums and benefits, and premiums on annuities with significant life
contingencies are recognized when due. Premiums received on UL policies and
annuity contracts are not recorded as revenues; instead, they are recognized as
deposits. Policy charges and surrender penalties are recorded as revenues.
1.6. Unpaid losses, loss expenses and policy benefits
Property/Casualty Insurance: The liability for unpaid property/casualty
insurance losses and loss expenses is based on an evaluation of reported losses
and on estimates of incurred but unreported losses. The reserve liabilities are
determined using adjusters' individual case estimates and statistical
projections. The liability was reported net of estimated salvage and subrogation
recoverables of $99 million at December 31, 1996 and $116 million at December
31, 1995 and 1994. Adjustments to the liability based on subsequent developments
or other changes in the estimate are reflected in results of operations in the
period in which such adjustments become known.
Certain liabilities for unpaid losses and loss expenses related to workers'
compensation coverage are discounted to present value. The carrying amount of
such workers' compensation liabilities, net of reinsurance and net of discount,
was $1.3 billion, $1.5 billion and $1.6 billion at December 31, 1996, 1995 and
1994, respectively. Interest rates of up to four percent are used to discount
these liabilities.
Life Insurance: Ordinary life insurance reserves are computed under the net
level premium method using assumptions for future investment yields, mortality
and withdrawal rates. These assumptions reflect USF&G's experience, modified to
reflect anticipated trends, and provide for possible adverse deviation. Reserve
interest rate assumptions are graded and range from 2.5 percent to 6.0 percent.
Universal life and deferred annuity reserves are computed on the retrospective
deposit method, which produces reserves equal to the cash value of the
contracts. Such reserves are not reduced for charges that would be deducted from
the cash value of policies surrendered. Reserves on immediate annuities with
guaranteed payments are computed on the prospective deposit method, which
produces reserves equal to the present value of future benefit payments.
1.7. Deferred policy acquisition costs ("DPAC")
Acquisition costs, consisting of commissions, brokerage and other expenses
incurred at policy issuance, are generally deferred. Anticipated losses, loss
expenses, policy benefits and remaining costs of servicing the policies are
considered in determining the amount of costs to be deferred. Anticipated
investment income is considered in determining whether a premium deficiency
exists related to short-duration contracts, and in determining the
recoverability of DPAC for interest-sensitive life and annuity products.
Amortization of DPAC totaled $707 million, $714 million and $668 million for the
years ended December 31, 1996, 1995 and 1994, respectively, and was included in
underwriting, acquisition and operating expenses in the Consolidated Statement
of Operations.
Property/Casualty Insurance: Property/casualty insurance acquisition costs are
amortized over the period that related premiums are earned.
Life Insurance: Life insurance acquisition costs are amortized based on
assumptions consistent with those used for computing policy benefit reserves.
Acquisition costs on ordinary life business are amortized over their assumed
premium paying periods. Universal life and investment annuity acquisition costs
are amortized in proportion to the present value of their estimated gross
profits over the products' assumed durations, which are regularly evaluated and
adjusted as appropriate.
1.8. Foreign currency translation
The functional currency for USF&G's foreign operations is typically the
applicable local currency. For those subsidiaries in highly inflationary
economies, however, the functional currency is the reporting currency (the U.S.
dollar).
Local currency balance sheet accounts are translated to U.S. dollars using
exchange rates in effect at the balance sheet date, and revenue and expense
accounts maintained in the local currency are translated using the average
exchange rates prevailing during the year. The unrealized gains or losses, net
of applicable deferred income taxes, resulting from translation are included in
shareholders' equity.
In highly inflationary economies (e.g., Mexico), monetary assets and liabilities
are remeasured into U.S. dollars using exchange rates in effect at the balance
sheet date, whereas nonmonetary balances are remeasured using historical
exchange rates. Revenue and expense accounts are remeasured using the average
exchange rates prevailing during the year for monetary transactions and
historical exchange rates for nonmonetary transactions. Realized gains or losses
resulting from remeasurement are included in net income. Such gains and losses
may be reduced or effectively eliminated by certain financial instruments used
by USF&G to reduce its foreign exchange exposure.
1.9. Earnings per common share
Primary earnings per common share are computed by subtracting dividends on
preferred stock from net income and then dividing by the weighted-average common
shares outstanding during the period. Common stock equivalents are excluded from
the calculations because their effect is not material. Fully diluted earnings
per common share assume the conversion of all securities whose contingent
issuance would have a dilutive effect on earnings.
1.10. Branch reorganization severance
During 1996, USF&G's field structure was reorganized to accommodate the transfer
of certain policy and claim processing activities from the branch offices to
three new Centers for Agency Services and the Claim Reception Center (refer to
Section 2 of Management's Discussion and Analysis of Financial Condition and
Results of Operations). Severance costs covering approximately 700 employees
from throughout the branch organization totaled $17 million in 1996.
1.11. Facilities exit costs/sublease income
During 1994, USF&G committed to a plan to consolidate its home office operations
in Baltimore, Maryland, at its Mount Washington facility. The facilities exit
costs of $183 million in 1994 represented 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 September 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. Sublease
income of $54 million and $6 million was recognized under the facilities exit
plan in 1996 and 1995, respectively, as a result of USF&G's negotiation of
subleases with new and existing tenants. A credit of $12 million was also
recognized in 1996 related to reduced property tax assessments on the Tower.
Additionally, USF&G recognized approximately $24 million of facilities exit
costs in 1996, representing the present value of the rent and other operating
expenses estimated to be incurred over the life of certain leases as a result of
the downsizing or closure of numerous branch offices.
1.12. Business combinations
On December 17, 1996, USF&G acquired Afianzadora Insurgentes, S.A. de C.V.
("Afianzadora"), a surety bond company in Mexico, for $65 million. This
acquisition, which was accounted for as a purchase, resulted in goodwill of
$18 million, which will be amortized over 20 years on a straight-line basis. The
results of Afianzadora's operations for the period from December 17 through
December 31, 1996 have not been included in USF&G's Consolidated Statement of
Operations for 1996 as they were not material.
In April and May 1995, USF&G consummated mergers with Discover Re Managers, Inc.
("Discover Re"), and Victoria Financial Corporation ("Victoria Financial"),
respectively. In the transactions, USF&G exchanged 5.4 million shares of common
stock, worth approximately $79 million, for all of the outstanding equity of
Discover Re, and 3.8 million shares, worth approximately $59 million, for all of
the outstanding equity of Victoria Financial. Discover Re provides insurance,
reinsurance and related services to the alternative risk transfer market.
Victoria Financial is an insurance holding company which specializes in
nonstandard personal lines auto coverage. Both of these business combinations
were accounted for as poolings-of-interests. Accordingly, the financial
statements were restated to reflect the mergers with Discover Re and Victoria
Financial. Results for each of the separate enterprises from January 1, 1995 to
the respective consummation dates were as follows:
Premiums Total Net
(in millions) Earned Revenues Income
---------------------------
January 1 - March 31, 1995:
USF&G $598 $ 795 $49
Discover Re 6 8 1
---------------------------
January 1 - April 30, 1995:
USF&G* $769 $1,028 $63
Victoria Financial 13 16 --
---------------------------
*Excludes Discover Re.
A reconciliation of the previously separate enterprises to the restated
consolidated results of operations and total assets for the year ended
December 31, 1994 is disclosed in USF&G's 1994 Annual Report to Shareholders
(Restated) as filed with the Securities and Exchange Commission under
Form 10-K/A in November 1995.
1.13. Supplemental cash flow information
The 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:
(in millions) 1996 1995 1994
-------------------------
Net income $ 261 $209 $ 237
Adjustments to reconcile net income
to net cash provided from
operating activities:
Net realized gains on investments (44) (7) (5)
Branch reorganization severance 17 -- --
Facilities exit costs/(sublease income) (42) (6) 183
Provision for income taxes (benefit) (2) (14) (280)
Change in insurance liabilities 66 294 72
Change in DPAC 38 (36) (60)
Change in receivables (167) (99) (24)
Change in other liabilities 56 73 (29)
Change in other assets 122 (31) 39
Change in other items, net 25 16 7
-------------------------
Net cash provided from operating
activities $ 330 $399 $ 140
-------------------------
NOTE 2 INVESTMENTS
2.1. Components of net investment income
(in millions) 1996 1995 1994
--------------------------
Fixed maturities $630 $664 $674
Common and preferred stocks 3 4 7
Short-term investments 20 23 14
Mortgage loans and real estate 48 46 58
Other investment income, net of interest
expense on funds held 19 13 9
--------------------------
Total investment income 720 750 762
Investment expenses (15) (17) (13)
--------------------------
Net investment income $705 $733 $749
--------------------------
2.2. Net realized gains on investments
(in millions) 1996 1995 1994
--------------------------
Net Gains (Losses) on Sales:
Fixed maturities $(12) $ 6 $ 3
Common and preferred stocks 79 4 --
Mortgage loans and real estate 17 2 7
Other 18 18 5
--------------------------
Net gains on sales 102 30 15
Impairments (58) (23) (10)
--------------------------
Net realized gains on investments $ 44 $ 7 $ 5
--------------------------
2.3. Gross unrealized gains (losses)
At December 31
(in millions) 1996 1995 1994
--------------------------
Unrealized Gains:
Fixed maturities available for sale $161 $ 375 $ 9
DPAC and policy benefits adjustment -- -- 33
Common and preferred stocks 2 3 2
Foreign currency and other 20 6 16
--------------------------
Gross unrealized gains 183 384 60
--------------------------
Unrealized Losses:
Fixed maturities available for sale (63) (35) (193)
DPAC and policy benefits adjustment (19) (73) --
Common and preferred stocks (2) (5) (8)
Foreign currency and other (4) -- (6)
--------------------------
Gross unrealized losses (88) (113) (207)
Deferred taxes on net unrealized gains (33) -- --
--------------------------
Net unrealized gains (losses) $ 62 $ 271 $(147)
--------------------------
2.4. Change in net unrealized gains (losses)
(in millions) 1996 1995 1994
--------------------------
Fixed maturities available for sale $(242) $ 524 $(407)
DPAC and policy benefits adjustment 54 (106) 63
Common and preferred stocks 2 4 3
Foreign currency and other 10 (4) 3
--------------------------
Total change in unrealized
gains (losses) before taxes (176) 418 (338)
Deferred taxes on net unrealized gains (33) -- --
--------------------------
Net change in unrealized gains (losses) $(209) $ 418 $(338)
--------------------------
2.5. Estimated market values of fixed maturity investments
There were no fixed maturities classified as "held to maturity" at December 31,
1996 and 1995 (refer to Note 2.6). The cost and market value of fixed maturities
held to maturity at December 31, 1994 were as follows:
Gross
Unrecognized Market
(in millions) Cost Gains Losses Value
----------------------------------
U.S. Government bonds $ 14 $-- $ (2) $ 12
Mortgage-backed securities 1,360 19 (97) 1,282
Asset-backed securities 136 -- (8) 128
Corporate bonds 3,027 12 (293) 2,746
State and political
subdivision bonds 107 1 (6) 102
Foreign government bonds 15 -- (1) 14
----------------------------------
Total $4,659 $32 $(407) $4,284
----------------------------------
The cost and market value of fixed maturities available for sale were as
follows:
At December 31, 1996
Gross
Unrealized Market
(in millions) Cost Gains Losses Value
----------------------------------
U.S. Government bonds $ 334 $ 7 $ (3) $ 338
Mortgage-backed securities 1,464 22 (3) 1,483
Asset-backed securities 731 11 (1) 741
Corporate bonds 4,882 107 (51) 4,938
State and political
subdivision bonds 425 6 (1) 430
Foreign government bonds 230 8 (4) 234
----------------------------------
Total $8,066 $161 $(63) $8,164
----------------------------------
At December 31, 1995
Gross
Unrealized Market
(in millions) Cost Gains Losses Value
----------------------------------
U.S. Government bonds $ 380 $ 21 $ -- $ 401
Mortgage-backed securities 1,739 49 (1) 1,787
Asset-backed securities 999 28 (2) 1,025
Corporate bonds 5,608 260 (25) 5,843
State and political
subdivision bonds 183 7 -- 190
Foreign government bonds 209 10 (7) 212
----------------------------------
Total $9,118 $375 $(35) $9,458
----------------------------------
At December 31, 1994
Gross
Unrealized Market
(in millions) Cost Gains Losses Value
----------------------------------
U.S. Government bonds $ 273 $-- $ (12) $ 261
Mortgage-backed securities 561 2 (28) 535
Asset-backed securities 806 1 (29) 778
Corporate bonds 2,262 4 (104) 2,162
State and political
subdivision bonds 255 2 (4) 253
Foreign government bonds 108 -- (16) 92
----------------------------------
Total $4,265 $ 9 $(193) $4,081
----------------------------------
2.6. Stated due dates of fixed maturities
The table below shows the stated due dates of fixed maturities available for
sale at December 31, 1996.
Market
(in millions) Cost Value
-------------------
In 1997 $ 314 $ 315
1998 through 2001 1,585 1,610
2002 through 2006 2,151 2,184
After 2006 1,821 1,831
-------------------
Subtotal 5,871 5,940
Mortgage/asset-backed securities 2,195 2,224
-------------------
Fixed maturities available for sale $8,066 $8,164
-------------------
Actual maturities may differ from stated due dates as borrowers may have the
right to call or prepay obligations.
Information regarding sales, repayments and maturities of fixed maturities
available for sale during 1996 is set forth in the following table. In addition
to these sales, repayments and maturities, F&G Life transferred approximately
$918 million of fixed maturities to an unaffiliated insurance company in 1996 in
a noncash exchange related to a coinsurance contract (refer to Note 12).
Gross Gross
(in millions) Cost Proceeds Gains Losses
-------------------------------------
Proceeds from sales $ 602 $ 588 $14 $(28)
Proceeds from maturities/repayments 700 702 2 --
-------------------------------------
Total proceeds $1,302 $1,290 $16 $(28)
-------------------------------------
Proceeds from sales of fixed maturities held to maturity were $21 million (with
no gross gains and gross losses of $3 million) in 1995, and $65 million (with
gross gains and gross losses of $1 million) in 1994. Sales of fixed maturities
classified as held to maturity involved 5 different issuers in 1995 and
21 different issuers in 1994, and were based on evidence of significant
deterioration of the issuers' creditworthiness, as determined from developments
related specifically to the issuers. USF&G performed a detailed analysis of the
issuers' operating trends, cash flows and ability to meet debt service.
Proceeds from sales of fixed maturities classified as available for sale in 1995
were $489 million with gross gains of $16 million and gross losses of
$13 million. In 1994, proceeds from sales of fixed maturities classified as
available for sale were $345 million with gross gains of $2 million and gross
losses of $4 million.
From January 1, 1995 through December 3, 1995, reclassifications from held to
maturity to available for sale totaled $31 million of amortized cost. These
reclassifications were based on evidence of significant deterioration of the
issuers' creditworthiness. Gross unrealized losses on these securities totaled
$9 million at the time of the reclassifications. On December 4, 1995, all
remaining securities classified as held to maturity were reclassified to
available for sale as permitted by supplemental guidance to SFAS No. 115 issued
by the FASB in November 1995. This reclassification was made to allow maximum
flexibility in the management of the investment portfolio without being
restricted by accounting interpretations. The securities had a total amortized
cost of $4.5 billion, with gross unrealized gains of $117 million, at the time
of the reclassification.
2.7. Investment commitments
USF&G has outstanding commitments to provide permanent financing for various
real estate investments. The funded amounts of these commitments are
collateralized by the real estate projects. At December 31, 1996, unfunded
commitments totaled approximately $44 million, all of which is expected to be
funded in 1997.
2.8. Nonincome-producing investments
Fixed maturities at December 31, 1996, 1995 and 1994, for which no income was
recorded during those years, totaled $1 million, $5 million and $2 million,
respectively. In addition, nonincome-producing real estate totaled $28 million,
$142 million and $208 million at December 31, 1996, 1995 and 1994, respectively.
NOTE 3 INSURANCE LIABILITIES
3.1. Property/casualty insurance reserves - unpaid losses and loss expenses
Activity in the unpaid losses and loss expenses for the property/casualty
segment is summarized as follows:
(in millions) 1996 1995 1994
---------------------------
Total reserve at beginning of year, gross $6,097 $6,158 $6,370
Less reinsurance recoverables 984 1,016 1,054
---------------------------
Net balance at January 1 5,113 5,142 5,316
---------------------------
Incurred Related To:
Current year 2,030 1,856 1,752
Prior years (162) (54) (8)
---------------------------
Total incurred 1,868 1,802 1,744
---------------------------
Paid Related To:
Current year 764 635 634
Prior years 1,190 1,196 1,284
---------------------------
Total paid 1,954 1,831 1,918
---------------------------
Net balance at December 31 5,027 5,113 5,142
Plus reserves acquired 18 -- --
Plus reinsurance recoverables 987 984 1,016
---------------------------
Total reserve at end of year, gross $6,032 $6,097 $6,158
---------------------------
Loss and loss expenses recorded in the current period financial statements are
affected by changes in estimates of insured events occurring in prior periods.
Losses incurred in 1996 and 1995 included $111 million and $77 million,
respectively, of favorable development related to prior years' experience in the
assumed reinsurance business. Given the significant uncertainty in reserving for
assumed reinsurance, favorable development from loss reserves established in
prior years is generally applied to establish reserves in the current accident
year. Another $52 million of favorable development in 1996 related to the
workers' compensation line, which resulted primarily from the recognition of the
effect on reserve estimation models of the increased use of structured
settlements to close claims. Loss reserve decreases in workers' compensation
were substantially offset by reserve increases in general liability, commercial
auto and surety lines for the current accident year.
Reserves for asbestos-related illnesses and environmental claims cannot be
estimated with traditional loss reserving techniques. Liabilities are
established for known claims (including the cost of litigation) when sufficient
information has been developed to indicate the involvement of a specific
insurance policy, and management can reasonably estimate its liability. In
addition, liabilities have been established to cover additional exposures on
both known and unasserted claims. Estimates of the liabilities are reviewed and
updated continually. Developed case law and adequate claim history do not exist
for such claims, especially because significant uncertainty exists about the
outcome of coverage litigation and whether past claim experience will be
representative of future loss experience.
3.2. Life benefit reserves
The table below shows F&G Life's benefit reserves by policy type.
At December 31
(in millions) 1996 1995 1994
---------------------------
Single Premium Annuities:
Deferred $1,314 $1,590 $1,860
Immediate 1,001 943 867
Other annuities 610 542 492
Universal/term/group life 627 644 585
---------------------------
Gross balance 3,552 3,719 3,804
Reinsurance receivable 782 4 6
---------------------------
Total reserve, net $2,770 $3,715 $3,798
---------------------------
NOTE 4 DEBT
4.1. Debt outstanding
At December 31
(in millions) 1996 1995 1994
-------------------------
Corporate:
Short-term:
Credit facility $ -- $ -- $215
5 1/2% Swiss Franc Bonds due 1996 -- 80 --
Long-term:
5 1/2% Swiss Franc Bonds due 1996 -- -- 92
Zero Coupon Convertible Notes due 2009 102 136 130
8 3/8% Senior Notes due 2001 150 150 149
7% Senior Notes due 1998 145 145 --
7 1/8% Senior Notes due 2005 80 80 --
-------------------------
Total corporate debt 477 591 586
-------------------------
Real Estate and Other:
Short-term -- -- 12
Long-term:
9.96% Secured Notes due through 1999 -- 11 14
Other 5 5 16
-------------------------
Total real estate and other debt 5 16 42
-------------------------
Total debt outstanding $482 $607 $628
-------------------------
4.2. Short-term debt
For general corporate purposes, USF&G maintained a committed, standby credit
facility with a group of foreign and domestic banks totaling $250 million at
December 31, 1996. This facility, which was entered into in March 1996, permits
either borrowing of funds or letter of credit issuances, and will expire in
2001. Prior credit facilities were in place for up to $250 million at December
31, 1995 and $400 million at December 31, 1994. USF&G pays facility fees on the
total amount of the commitments based on its long-term debt credit ratings.
There were no borrowings against the facility at December 31, 1996 and 1995.
Borrowings at December 31, 1994 totaled $215 million. Interest rates are based
on current market rates. USF&G was in compliance with the covenants contained in
these agreements at December 31, 1996, 1995 and 1994. The most restrictive
covenants require USF&G to maintain a tangible net worth of at least
$1.15 billion plus 50 percent of the net income earned during the commitment
period and an indebtedness-to-capital ratio below 55 percent.
At December 31, 1996, USF&G also maintained a $150 million multi-currency credit
facility. USF&G pays facility fees on the total amount of each commitment. At
December 31, 1996, there were no borrowings against the multi-currency credit
facility. At December 31, 1995, USF&G had both a $100 million multi-currency
credit facility and a $50 million letter of credit facility. There were no
borrowings against the multi-currency credit facility at December 31, 1995, at
which date there was a $12 million balance outstanding on the letter of credit
facility. At December 31, 1994, there were no borrowings against either
facility, both of which were established during 1994.
4.3. Debt extinguishments
On January 5, 1996, the remaining balance of the 5 1/2% Swiss Franc Bonds
matured and was repaid. The repayment was accomplished with $75 million borrowed
against the committed credit facility, with the remainder of the balance paid
from excess corporate cash. In addition, from April through August 1996, USF&G
repurchased approximately $39 million of outstanding Zero Coupon Convertible
Notes through the use of excess corporate cash and borrowings from the credit
facility. The balance of the credit facility was repaid in December 1996 with
excess corporate cash and proceeds from the issuance of capital securities
(refer to Note 6).
In 1996, real estate and other debt was reduced by $11 million as a result of a
deed-in-lieu of foreclosure whereby property with an outstanding $7 million note
was conveyed back to the lender and a $4 million loan was repaid. At December
31, 1994, real estate and other debt included $12 million under a line of credit
maintained by a subsidiary of USF&G Corporation. The balance under this credit
facility was repaid during 1995. Prepayment of $3 million of the 9.96% Secured
Notes due through 1999 further reduced real estate and other debt in 1995.
4.4. Shelf registrations
Effective February 20, 1996, USF&G Corporation, along with two business trusts
in which USF&G has a controlling interest (the "Trusts"), have a shelf
registration statement which permits the issuance by the Trusts of up to
$210 million of capital securities. In January 1997, $100 million of these
securities were issued under the shelf registration (refer to Note 6).
In addition, USF&G has available $142 million of unissued debt, preferred stock,
common stock and warrants under a 1994 shelf registration.
4.5. Redeemable debt
The Zero Coupon Convertible Notes are redeemable beginning in 1999 for an amount
equal to the original issue price plus amortized original issue discount.
4.6. Maturities of long-term debt
Real Estate
(in millions) Corporate and Other
--------------------------
1997 $ -- $--
1998 145 --
1999 -- --
2000 -- --
2001 150 --
--------------------------
NOTE 5 LEASES
USF&G occupies office facilities under lease agreements that expire at various
dates through 2009. In addition, data processing, office and transportation
equipment is leased under agreements that expire at various dates through 2001.
Most leases contain renewal options that may provide for rent increases based on
prevailing market conditions. Some leases also may contain purchase options
based on fair market value or contractual values, if greater. Capital leases are
immaterial in amount. Rent expense for the years ended December 31, 1996, 1995
and 1994 was $40 million, $44 million and $63 million, respectively. Rent
expense in 1994 included a $9 million loss on long-term subleases.
The following table shows the future minimum payments to be made under
noncancelable leases at December 31, 1996.
Home Other
Office Office Equip-
(in millions) Building Space ment Total
-------------------------------------
1997 $ 16 $22 $16 $ 54
1998 16 19 14 49
1999 19 16 6 41
2000 25 11 3 39
2001 26 6 14 46
After 2001 199 5 -- 204
-------------------------------------
Total $301 $79 $53 $433
-------------------------------------
USF&G is also the lessor under various subleases on its office facilities. The
minimum rentals to be received in the future under noncancelable subleases is
$112 million at December 31, 1996.
USF&G's principal office lease involves the Tower which the Corporation sold in
1984 and subsequently leased back. As of January 1997, USF&G has vacated the
Tower (refer to Note 1.11); however, the lease, which provides for rent
increases every five years through its expiration in September 2009, will not be
terminated. USF&G will continue to make rental payments under the lease.
NOTE 6 CAPITAL SECURITIES OF SUBSIDIARY TRUSTS
On December 24, 1996, USF&G Capital I ("Capital I"), a business trust in which
USF&G has a controlling interest, issued $100 million (100,000 shares) of 8 1/2%
Capital Securities, Series A ("Series A Securities"). Payments on the Series A
Securities are guaranteed by USF&G on a subordinated basis, but only to the
extent Capital I has funds available to make such payments. This guarantee,
considered together with the terms of debentures issued by USF&G (described
below) and an agreement for USF&G to pay other expenses and liabilities of
Capital I, constitutes a full and unconditional subordinated guarantee by USF&G
of Capital I's obligations under the Series A Securities.
Capital I used the proceeds from the Series A Securities issuance to purchase
$100 million principal amount of 8 1/2% Junior Subordinated Debentures issued by
USF&G ("Series A Debentures"). The Series A Debentures rank junior and
subordinate in right of payment to certain other indebtedness of USF&G, and
mature on December 15, 2045.
Interest payments on the Series A Debentures are deferrable, at USF&G's option,
at any time for up to five years at a time, and provided there has not been an
event of default. In the event USF&G elects to defer interest payments on the
Series A Debentures, payments of distributions on the Series A Securities will
likewise be deferred. Interest and distributions continue to accrue during any
payment deferral period.
The Series A Debentures are redeemable under certain circumstances related to
tax events at a price of $1,000 per debenture plus any accrued and unpaid
interest and a "make whole" payment. Proceeds from any redemptions of the Series
A Debentures will be used to redeem a like amount of the Series A Securities.
Additionally, USF&G has the right, under certain circumstances related to tax
events, to shorten the maturity of the Series A Debentures to a date no earlier
than June 24, 2016, in which case the stated maturity of the Series A Securities
will likewise be affected.
The Series A Debentures, as well as USF&G's interest in Capital I, are
eliminated in consolidation. The Series A Securities are shown in the
Consolidated Statement of Financial Position under the caption, "USF&G-obligated
mandatorily redeemable capital securities of subsidiary trust holding solely
junior subordinated deferrable interest debentures of USF&G".
On January 10, 1997, USF&G Capital II ("Capital II"), a second business trust in
which USF&G also has a controlling interest, issued $100 million (100,000
shares) of 8.47% Capital Securities, Series B ("Series B Securities"). Payments
on the Series B Securities are guaranteed on the same basis as the guarantee of
the Series A Securities.
Capital II used the proceeds from the Series B Securities issuance to purchase
$100 million principal amount of 8.47% Deferrable Interest Junior Subordinated
Debentures, Series B ("Series B Debentures") issued by USF&G, which mature on
January 10, 2027. The Series B Debentures also rank junior and subordinate to
certain other indebtedness of USF&G, but rank equal with the Series A
Debentures. The Series B Debentures and Series B Securities have interest/
distribution deferral terms similar to those of the Series A Debentures and
Series A Securities, described above.
The Series B Debentures are redeemable at USF&G's option at any time beginning
in January 2007 at scheduled redemption prices ranging from $1,042 to $1,000 per
debenture, plus any accrued and unpaid interest. The Series B Debentures are
also redeemable prior to January 2007 under certain circumstances related to tax
and other special events. Proceeds from any redemptions of the Series B
Debentures will be used to redeem a like amount of the Series B Securities.
Additionally, USF&G has the right, under certain circumstances related to tax
events, to shorten the maturity of the Series B Debentures to a date no earlier
than July 10, 2016.
The sole assets of Capital I and Capital II are the Series A and Series B
Debentures, respectively. Neither Capital I nor Capital II have operations
independent of the aforementioned relationships with USF&G and the holders of
their respective capital securities. In the event USF&G exercises its right to
defer interest payments on the Series A or Series B Debentures, it will be
prohibited from making payments with respect to any capital debt or securities
which rank equal or junior in right of payment to the Series A and Series B
Debentures, including cash dividends on its common or preferred stock. In no
case may the deferral of payments described above extend beyond the stated
maturity dates of the respective securities.
NOTE 7 SHAREHOLDERS' EQUITY
7.1. Classes of stock
USF&G is authorized to issue 12 million shares of $50 par value preferred stock
and 240 million shares of $2.50 par value common stock.
7.2. Preferred stock
USF&G had 4 million shares of $4.10 Series A Convertible Exchangeable Preferred
Stock ("Series A Preferred Stock") issued and outstanding at December 31, 1996,
1995 and 1994. On January 31, 1997, USF&G redeemed 50 percent of the outstanding
Series A Preferred Stock for $100 million cash.
Each remaining share of the Series A Preferred Stock entitles the holder to an
annual cumulative dividend of $4.10 and a liquidation preference of $50 plus
accrued and unpaid dividends. At the option of the holder, subject to adjustment
under certain conditions, each share of Series A Preferred Stock is convertible
to 1.206 shares of USF&G's common stock. The Series A Preferred Stock is
exchangeable in whole at USF&G's option on any dividend payment date for 8.2%
Convertible Subordinated Debentures due 2011 at a rate of $50 principal amount
per share. Shares of the Series A Preferred Stock are redeemable for cash, in
whole or in part, at USF&G's option at $50 per share plus accrued and unpaid
dividends to the redemption date.
Holders of the preferred stock are not entitled to vote, except that they may
vote separately with respect to certain matters including the authorizations of
any additional classes of capital stock that would rank senior to the preferred
stock. In the event that six quarterly dividends for Series A Preferred Stock
are unpaid, USF&G's Board of Directors will be increased by two members, and
holders of preferred stock may elect two directors until all such dividends in
arrears have been paid.
USF&G had 277,550 shares and 1.3 million shares of $10.25 Series B Cumulative
Convertible Preferred Stock ("Series B Preferred Stock") issued and outstanding
at December 31, 1995 and 1994, respectively. Additionally, at December 31, 1994,
USF&G had 1.3 million shares of $5.00 Series C Cumulative Convertible Preferred
Stock ("Series C Preferred Stock") issued and outstanding.
During 1996 and 1995, USF&G called for redemption 233,550 shares and 832,650
shares, respectively, of its Series B Preferred Stock. These shares were
converted into 1.9 million shares and 6.9 million shares, respectively, of
common stock in accordance with the terms of the Series B Preferred Stock.
Holders of an additional 20,000 shares and 189,800 shares of Series B Preferred
Stock voluntarily converted their shares into 166,320 shares and 1.6 million
shares, respectively, of common stock during 1996 and 1995. The holder of
another 24,000 shares of Series B Preferred Stock voluntarily redeemed those
shares for cash during 1996.
During 1994, USF&G called for redemption 2.4 million shares of its Series C
Preferred Stock. The remaining shares were called for redemption in 1995. As a
result of these calls, USF&G issued 15.4 million shares of common stock.
7.3. Changes in common stock shares
1996 1995 1994
------------------------------------------
Outstanding, January 1 119,606,095 104,810,794 91,418,372
Shares repurchased (8,400,700) -- --
Shares issued 3,035,094 14,795,301 13,392,422
------------------------------------------
Outstanding, December 31 114,240,489 119,606,095 104,810,794
------------------------------------------
In conjunction with a stock repurchase program instituted in 1996, USF&G
repurchased 8.4 million shares of its common stock during the year. USF&G also
issued 2.1 million shares of common stock during 1996 for the conversion of the
Series B Preferred Stock. During 1995, USF&G issued 8.5 million shares of common
stock for the conversion of the Series B Preferred Stock, and 5.5 million shares
of common stock for the conversion of the Series C Preferred Stock. Another 9.9
million common stock shares were issued in 1994 for the conversion of the Series
C Preferred Stock.
7.4. Shareholder rights plan
USF&G has a shareholder rights plan ("the plan") to deter coercive or unfair
takeover tactics and to prevent a potential purchaser from gaining control of
USF&G without offering a fair price to all of the Corporation's shareholders.
The plan, which otherwise would have expired in 1997, was extended until 2007
and amended in several respects in February 1997. Under the plan, as amended,
each outstanding share of USF&G's common stock has one preferred share purchase
right (a "right") expiring in 2007. Each right entitles the registered holder to
purchase 1/100 of a share of a new class of junior preferred stock for $105. The
rights cannot be exercised unless certain events occur that might lead to a
concentration in ownership of common shares or unless certain other events
relating to a change in control take place. At that time, each right may be
converted into rights to acquire common stock having a value of twice the $105
exercise price. In certain circumstances, the plan also provides that the rights
can be exchanged for USF&G's common stock without payment of the purchase price.
Rights held by holders of 15 percent or more of USF&G's common stock, or their
associates, may be null and void. Under certain conditions, the rights also
become convertible into the rights to acquire shares of common stock of an
acquiror having a value of twice the exercise price. USF&G will generally be
entitled to redeem the rights, at $.01 per right, any time before the tenth day
(subject to further deferral) after a 15 percent position is acquired.
7.5. Dividend 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 USF&G Company and F&G Life, 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. (Refer to Section 4.3, "Dividend Restrictions", of Management's
Discussion and Analysis of Financial Condition and Results of Operations.) 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 $134 million, $83 million and $125 million were paid during 1996,
1995 and 1994, respectively, to USF&G Corporation by USF&G Company. Such
dividends were not subject to the requirements for extraordinary dividends. In
addition, effective June 1, 1995, and with the Commissioner's consent, USF&G
Company declared an extraordinary dividend payable to USF&G Corporation for
$323 million, which consisted of all of the issued and outstanding capital stock
of F&G Life. Prior to payment of such dividend, F&G Life was a wholly-owned
subsidiary of USF&G Company. As a result of such dividend payment, F&G Life is
now a direct, wholly-owned subsidiary of USF&G Corporation. Dividends of up to
$137 million are available for payment from USF&G Company to USF&G Corporation
during 1997 without being deemed extraordinary. Dividends of $139 million and
$31 million were paid during 1996 and 1995, respectively, to USF&G Corporation
by F&G Life. In addition, effective December 29, 1995 and with the
Commissioner's consent, F&G Life declared an extraordinary dividend payable to
USF&G Corporation consisting of investments in three real estate properties,
totaling $28 million. Consequently, all of the 1996 dividends were deemed
extra-ordinary, and were paid with the Commissioner's consent. Further, any
dividends which F&G Life would propose to pay in the twelve-month period
beginning September 30, 1996 would be deemed extraordinary dividends and subject
to the thirty-day notice period.
NOTE 8 FINANCIAL INSTRUMENTS AND DERIVATIVES
Fair value information is based on quoted market prices where available. In
cases where quoted market prices are not available, fair values are based on
internal estimates using present value or other valuation techniques. Those
techniques are significantly affected by the assumptions used, such as
applicable discount rate and estimated future cash flows. Therefore, the derived
fair value estimates cannot be substantiated by comparison to independent
markets and, in many cases, could not be realized in immediate settlement of the
instrument. Fair value disclosure requirements exclude certain financial
instruments and all nonfinancial instruments. The fair value of many
insurance-related liabilities do not require disclosure. However, in its
strategy of asset/liability matching, USF&G takes into consideration the future
cash requirements of its insurance related liabilities. Had a presentation of
these liabilities been made, due to their long-term nature, the fair value of
insurance-related liabilities would have been significantly less than their
carrying value.
8.1. Financial instruments
Cash and Short-Term Investments: The carrying amounts reported in the
Consolidated Statement of Financial Position for these instruments approximate
their fair values.
Fixed Maturity Investments: Fair values for publicly traded fixed maturity
investments are based on quoted market prices. For privately placed fixed
maturities, estimated fair values are derived by discounting expected future
cash flows using a current market rate applicable to the yield, credit quality
and maturity of the investment. At December 31, 1996, the amortized costs and
market values of fixed maturity investments were as follows:
Amortized Market
(in millions) Cost Value
-------------------------
Publicly traded $7,736 $7,833
Private placements 330 331
-------------------------
Total fixed maturity investments $8,066 $8,164
-------------------------
All fixed maturities are classified as available for sale and are reported in
the Consolidated Statement of Financial Position at market value.
Common and Preferred Stocks: The carrying values of common and preferred stocks
as reported in the Consolidated Statement of Financial Position are based on
quoted market prices and reflect their fair values.
Mortgage Loans and Policy Loans: The fair values for mortgage loans and policy
loans are estimated based on discounted cash flow analyses, using interest rates
currently being offered for loans with similar credit risk. Loans with similar
characteristics are aggregated for purposes of the calculations. At December 31,
1996, the carrying amounts and fair values of investments in mortgage loans and
policy loans were as follows:
Carrying Fair
(in millions) Amount Value
------------------------
Mortgage loans $406 $423
Policy loans 74 77
------------------------
Other Assets and Other Liabilities: Other invested assets considered financial
instruments include equity interests in minority ownership investments,
interests in limited partnerships and related notes receivable. It is not
practicable to estimate their fair value due to the closely-held nature of these
investments.
Other assets and liabilities considered financial instruments include agents'
balances receivable, prepaid and accrued expenses and other receivables
generally of a short-term nature. It is assumed the carrying value of these
financial instruments approximates their fair value.
Short- and Long-Term Debt: The carrying amount of USF&G's short-term borrowings
approximates its fair value. The fair value of long-term debt is based on market
quotes or estimated discounted cash flow analyses, based on USF&G's current
incremental borrowing rates for similar types of borrowing arrangements. The
carrying amounts and estimated fair value of debt instruments at December 31,
1996 were as follows:
Carrying Fair
(in millions) Amount Value
------------------------
Corporate long-term $477 $503
Real estate and other 5 5
------------------------
Total $482 $508
------------------------
Investment Contracts: Fair values for F&G Life's single premium deferred
annuities, other deferred annuities, single premium immediate annuities and
supplementary contracts are primarily derived by estimating the cost to
extinguish its liabilities under an assumption reinsurance transaction. The
estimated statutory profits the assuming company would realize from the
transaction are discounted at a typical internal rate of return objective. If
such a transaction were to occur, GAAP would require the unamortized balance of
deferred policy acquisition costs associated with these liabilities to be
immediately expensed. The amount of the related unamortized DPAC was
approximately $104 million at December 31, 1996. The fair values of the
remaining liabilities under investment contracts are estimated using discounted
cash flow calculations, based on interest rates currently being offered for like
contracts with similar maturities.
The carrying amounts and estimated fair values of F&G Life's liabilities for
investment contracts at December 31, 1996 were as follows:
Carrying Fair
(in millions) Amount Value
------------------------
Single premium deferred annuities $ 542 $ 507
Other deferred annuities 533 478
Single premium immediate annuities
and supplementary contracts 96 91
Group annuities 83 80
------------------------
Total $1,254 $1,156
------------------------
Off-Balance Sheet Financial Instruments: The fair values of USF&G's unfunded
real estate commitments and its financial commitment on investments totaled
$44 million at December 31, 1996, and were estimated using discounted cash flow
analyses based on USF&G's current incremental borrowing rate for similar types
of borrowing arrangements. The fair value of foreign exchange options, which are
derived from quoted market prices, and common stock put options, which are
determined using option pricing models, were less than $1 million at December
31, 1996. The estimates of the fair value of USF&G's interest rate swaps were
obtained from the counterparties to the agreement or were derived by discounting
the expected future cash flows, and totaled $1 million at December 31, 1996.
8.2. Derivatives
USF&G uses derivative instruments to manage foreign exchange and interest rate
risk, reduce borrowing costs and minimize the impact of rate fluctuations on the
settlement of debt and other financial instruments. USF&G is subject to the risk
that the counterparties will fail to perform. However, these risks are mitigated
by the credit quality of the counterparties and the gains and losses of the
underlying instruments. USF&G seeks to manage the credit risk through monitoring
procedures and investigation of counterparties to the transactions. USF&G does
not use derivative instruments for trading purposes.
Foreign Exchange Options: The Corporation relies predominantly on natural hedges
to manage foreign exchange rate risk by maintaining offsetting foreign asset and
foreign liability positions wherever possible, without sacrificing other
financing objectives. Foreign exchange derivative instruments in use at
December 31, 1996 consisted of a (pounds) 3.8 million call option which will
expire in March 1997.
Common Stock Put Options: In support of USF&G's share repurchase plan, the
Corporation has written put options on its common stock. At December 31, 1996,
put options outstanding on 551,463 common shares were "out of the money".
Interest Rate Instruments: The Corporation uses interest rate derivatives
selectively to enable it to maintain a certain fixed/floating rate exposure
given the current and projected interest rate environment. In conjunction with
the 8 3/8% Senior Notes, USF&G has outstanding two interest rate swaps with a
total notional amount of $150 million which convert the fixed interest payments
from this debt to floating rate debt for the first three years of the seven-year
term of the debt. In April 1996, USF&G entered into two 5-year interest rate
swaps associated with the Corporation's 7 1/8% Senior Notes which mature in June
2005. This transaction converts the debt to floating rate debt from fixed rate
with a total notional amount of $80 million. At December 31, 1996, USF&G had
approximately 52 percent fixed rate debt ($252 million) and 48 percent floating
rate debt ($230 million) after accounting for the effect of these interest rate
swaps.
These agreements involve, to varying degrees, interest rate and credit risk. The
notional amount represents the amount of the underlying debt to which the swaps
apply, not future cash requirements. The maximum credit risk related to the swap
agreements is the amount related to periodic settlements, which is not material
at December 31, 1996.
NOTE 9 STOCK-BASED COMPENSATION
Stock options have been granted to full-time officers and key employees under
three incentive plans: Stock Option Plan of 1987, Stock Option Plan of 1990 and
Stock Incentive Plan of 1991 (collectively, the "Management Plans"). In
addition, the 1994 Stock Plan for Employees of USF&G (the "Broad-Based Plan")
grants eligible employees, other than officers and key employees participating
in other stock incentive plans, options to purchase shares.
The Corporation applies APB No. 25 and related interpretations in accounting for
its employee stock options. Under APB No. 25, no compensation expense is
recognized since the exercise price of the options is equal to the market price
of the underlying stock on the date of the grant.
In addition, under the Corporation's Long-Term Incentive Program ("LTIP"), USF&G
awards shares of common stock to full-time officers based on three-year
performance goals established by the Board of Directors. Compensation expense,
determined under APB No. 25 as the number of shares to be issued at a given
performance level times the current market price of the stock, is accrued over
the three-year performance cycle. Net income for 1996 included $13 million of
compensation expense for LTIP awards.
Under the Management Plans and Broad-Based Plan, the Corporation may grant
options to participating employees to purchase up to 9 million and 4 million
shares of common stock, respectively. Under all plans, the exercise price of
each option equals the market price of USF&G's stock on the date of grant, and
an option's maximum term is ten years. Options vest ratably over three years
under the Management Plans, and vest after two years under the Broad-Based Plan.
Had compensation expense for these plans been determined based on the fair value
of awards at the grant date, as prescribed by SFAS No. 123, net income and
earnings per share would have been as follows:
1996 1995
-----------------
Pro forma net income (in millions) $ 254 $ 205
Pro forma primary earnings per share 1.99 1.59
Pro forma fully diluted earnings per share 1.88 1.51
-----------------
Note: SFAS No. 123 applies to awards granted in fiscal years that begin after
December 15, 1994; therefore, no pro forma disclosures are provided for 1994.
Consequently, the effects of applying SFAS No. 123 shown here are not likely to
be representative of the effects in future years due to the exclusion of awards
granted in prior years but vesting (and therefore expensed) in 1995 and 1996.
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model. The following weighted-average assumptions
were used for grants in 1996 and 1995, respectively: dividend yield of 1.24
percent and 1.53 percent; expected volatility of 25.0 percent and 25.4 percent;
risk-free interest rates of 6.36 percent and 7.25 percent for the Management
Plans, and 5.98 percent and 7.07 percent for the Broad-Based Plan; and expected
lives for both 1996 and 1995 of seven years for options issued under the
Management Plans and four years for options issued under the Broad-Based Plan.
The Black-Scholes method is one of many models used to calculate the fair value
of an option. Because the models are sensitive to changes in the different
assumptions used, the effect on fair value estimates can be significant.
Accordingly, the derived fair value of options cannot be substantiated by
comparison to independent markets. The fair value also cannot be realized in
immediate settlement.
A summary of the status of USF&G's stock option plans as of December 31, 1996
and 1995, and changes during the years ended on those dates is presented below:
1996 1995
Weighted- Weighted-
Average Average
Shares Exercise Price Shares Exercise Price
-----------------------------------------------------------
Outstanding at
beginning of year 7,290,207 $12.97 5,908,451 $12.86
Granted 3,363,988 14.63 2,714,806 13.72
Exercised (910,396) 11.45 (733,603) 7.33
Surrendered or
cancelled (642,391) 15.30 (599,447) 16.86
-----------------------------------------------------------
Outstanding at
end of year 9,101,408 $13.95 7,290,207 $12.97
-----------------------------------------------------------
Options exercisable
at end of year 3,714,777 $13.39 2,707,398 $12.82
-----------------------------------------------------------
Weighted-average fair
value of options granted
during the year $ 4.55 $ 4.63
-----------------------------------------------------------
In 1994, 2,245,500 options were granted at a weighted-average exercise price of
$14.42, while 483,590 options were exercised and 677,595 options were
surrendered or cancelled.
The following table summarizes information about stock options outstanding at
December 31, 1996:
Range of Options Outstanding Options Exercisable
Exercise Remaining Average Average
Price Number Life* Price** Number Price**
----------------------------------------------------------------
$6.25-10 1,168,035 4.9 $ 9.06 1,122,097 $ 9.22
11-15 7,399,621 8.2 14.12 2,156,587 14.04
16-20 318,166 7.6 16.89 220,507 16.65
21-28 -- -- -- -- --
29-30.82 215,586 2.2 29.77 215,586 29.77
----------------------------------------------------------------
$6.25-30.82 9,101,408 7.6 $13.95 3,714,777 $13.39
----------------------------------------------------------------
*Represents weighted-average remaining contractual life of options in years.
**Represents weighted-average exercise price of options.
NOTE 10 RETIREMENT BENEFITS
10.1. Retirement plans
USF&G has noncontributory retirement plans covering most regular full-time
employees of the Corporation and its affiliates. An employee's pension benefit
is based on salary, years of service and Social Security benefits. USF&G makes
contributions to the retirement plans based on amounts required to be funded
under provisions of the Employee Retirement Income Security Act of 1974, as
amended. The plans' funded status and amounts recognized in the consolidated
financial statements were as follows:
At December 31
(dollars in millions) 1996 1995 1994
-------------------------
Actuarial Present Value of:
Accumulated benefit obligation $370 $ 388 $303
Vested benefits 355 372 291
-------------------------
Plan assets at fair value $379 $ 348 $289
Projected benefit obligation 385 403 313
-------------------------
Funded status (6) (55) (24)
Unrecognized net loss 105 134 98
Unrecognized prior service cost (benefit) (15) (19) (22)
Adjustment for minimum pension liability -- (100) (63)
-------------------------
Net prepaid/(accrued) pension cost $ 84 $ (40) $(11)
-------------------------
Actuarial Assumptions:
Weighted-average discount rate 7.50% 7.00% 8.75%
Average rate of increase in future
compensation levels 5.0 5.0 5.0
Expected long-term rate of return
on assets 8.5 8.5 8.5
-------------------------
As a result of the higher interest rate environment, USF&G increased the
discount rate assumption as of December 31, 1996, which caused the accumulated
benefit obligation to decrease. In accordance with SFAS No. 87, USF&G had
recorded a minimum pension liability as a separate reduction of shareholders'
equity for the underfunded amount, representing the accumulated benefit
obligation in excess of the fair value of the plans' assets, plus the amount of
prepaid pension costs, as of December 31, 1995 and 1994. During 1996, USF&G
increased its fundings to the pension plan, which, combined with the increased
discount rate, eliminated the previously recorded minimum pension liability.
The assets held by the plan consist primarily of fixed-income and equity
securities. USF&G classifies prepaid pension cost with other assets and accrued
pension cost with other liabilities in the Consolidated Statement of Financial
Position.
The components of net pension expense were as follows:
(in millions) 1996 1995 1994
-------------------------
Service cost $ 8 $ 5 $ 6
Interest cost 28 27 26
Actual return on plan assets (20) (63) 10
Net amortization and deferral (4) 43 (29)
-------------------------
Net periodic pension expense $ 12 $ 12 $ 13
-------------------------
10.2. Postretirement benefits
USF&G sponsors a defined-dollar postretirement health care (medical and dental)
plan and noncontributory life insurance plan covering most regular full-time
employees of the Corporation and its affiliates. USF&G's contributions and costs
are determined based on the annual salary and the type of coverage elected by
covered employees. USF&G's contributions to the plan are a percentage of plan
costs based on age and service of employees at retirement. Additionally, the
plan costs are capped at projected 1997 cost levels, and retiree contributions
are increased for the total medical costs over the projected levels.
USF&G accrues the cost of health care, life insurance and other retiree benefits
when the employees' services are rendered, and funds the health care and life
insurance benefit costs principally on a pay-as-you-go basis.
The plans' combined funded status and amounts recognized in the consolidated
financial statements were as follows:
At December 31
(in millions) 1996 1995 1994
-------------------------
Accumulated Postretirement Benefit Obligation:
Retirees $43 $48 $45
Fully eligible active plan participants 1 1 1
Other active plan participants 7 8 6
-------------------------
51 57 52
Plan assets at fair value -- -- --
-------------------------
Funded status 51 57 52
Unrecognized net gain (loss) 2 (4) 1
-------------------------
Accrued postretirement benefit costs $53 $53 $53
-------------------------
USF&G classifies accrued postretirement benefit costs with other liabilities in
the Consolidated Statement of Financial Position.
Net periodic postretirement benefit costs consisted of $1 million of service
cost and $4 million of interest cost for each of the years ended December 31,
1996, 1995 and 1994. The weighted-average annual assumed rate of increase in per
capita cost of covered benefits (i.e., medical trend rate) for the plans is 7.25
percent for 1997 (7.75 percent and 9.00 percent for 1996 and 1995, respectively)
and is assumed to decrease to 5.25 percent in 2002 for participants age 65 or
younger, and 7.00 percent for 1997 (7.40 percent and 7.75 percent for 1996 and
1995, respectively), decreasing to 5.25 percent for participants over age 65,
and remain at that level thereafter. Increasing the assumed medical trend rate
by one percentage point in each year would increase the accumulated
postretirement benefit obligation by approximately $4 million and the aggregate
of the service and interest cost components of net periodic postretirement
benefit cost for the year by less than $1 million. The weighted-average discount
rate used in determining the accumulated postretirement benefit obligation was
7.50 percent, 7.00 percent and 8.75 percent at December 31, 1996, 1995 and 1994,
respectively.
NOTE 11 INCOME TAXES
USF&G Corporation and its subsidiaries file a consolidated federal income tax
return. Deferred tax liabilities or assets are recognized for the estimated
future tax effects attributable to net operating loss carryforwards ("NOLs") and
to temporary differences between the tax basis and GAAP basis of an asset or a
liability. A valuation allowance is required if, based on the weight of
available evidence, it is more likely than not that some or all of the deferred
tax asset will not be realized.
At December 31, 1996, the net deferred tax asset of $436 million recorded by
USF&G was supported by a combination of forecasted taxable income and a tax
strategy that USF&G would implement to prevent NOLs from expiring. Based on the
weight of positive and negative evidence, USF&G believes that it is more likely
than not that it will be able to realize all of its deferred tax assets.
Accordingly, there was no valuation allowance at December 31, 1996.
11.1. Significant components of deferred tax assets and liabilities
At December 31
(in millions) 1996 1995 1994
-------------------------
Deferred Tax Liabilities:
DPAC $146 $139 $165
Net unrealized gains 33 95 --
Prepaid pension cost 29 21 18
Real estate 15 -- --
Other invested assets 4 -- 5
Other 37 32 --
-------------------------
Total deferred tax liabilities 264 287 188
-------------------------
Deferred Tax Assets:
Facilities exit costs 51 75 74
Unpaid losses and loss expenses 228 236 249
Future policy benefits 59 66 54
Unearned premiums 54 54 45
Foreign reinsurance 47 56 50
Net unrealized losses -- -- 52
Real estate -- 5 25
Other invested assets -- 27 --
Minimum pension liability -- 35 22
Postretirement benefits 19 19 19
Other 40 8 33
NOLs 202 207 263
-------------------------
Total deferred tax assets 700 788 886
Valuation allowance for deferred tax assets -- 36 249
-------------------------
Deferred tax assets, net of
valuation allowance 700 752 637
-------------------------
Net deferred tax assets $436 $465 $449
-------------------------
The components of the changes in the valuation allowance were recorded through
shareholders' equity and operations, as follows:
At December 31
(in millions) 1996 1995 1994
-------------------------
Changes Recognized in Shareholders' Equity:
Change related to net unrealized
(gains) losses $ 95 $(147) $ 119
Change related to minimum
pension liability (35) 13 (8)
-------------------------
Total changes recognized in
shareholders' equity 60 (134) 111
-------------------------
Changes Recognized in Statement of Operations:
Reduction for increased likelihood
of realization (96) (81) (267)
Other adjustments -- 2 (10)
-------------------------
Total changes recognized in
statement of operations (96) (79) (277)
-------------------------
Total change in valuation allowance $(36) $(213) $(166)
-------------------------
11.2. Components of provision for income taxes (benefit)
(in millions) 1996 1995 1994
-------------------------
Current tax $ 8 $ 61 $ 32
NOL utilization (5) (56) (22)
-------------------------
Current tax, net of NOL utilization 3 5 10
Deferred tax (benefit) 91 62 (23)
Adjustment of the beginning of the
year valuation allowance (96) (81) (267)
-------------------------
Provision for income taxes (benefit) $ (2) $(14) $(280)
-------------------------
Income taxes paid $ 5 $ 5 $ 12
-------------------------
11.3. Reconciliation of taxes at federal rates to provision for income taxes
(benefit)
(in millions) 1996 1995 1994
-------------------------
Tax at federal rates $ 91 $ 68 $ (16)
Tax Effect (Benefit):
Adjustment of the beginning of the
year valuation allowance (96) (81) (267)
Tax-exempt interest income (2) (2) (3)
Adjustment of property/casualty salvage
and other subrogation accruals -- -- 6
Other 5 1 --
-------------------------
Provision for income taxes (benefit) $ (2) $(14) $(280)
-------------------------
11.4. Net operating loss carryforwards
At December 31, 1996, USF&G had NOLs remaining for tax return purposes expiring
in 2006. The amount and timing of recognizing the benefit of these NOLs depends
on future taxable income and limitations imposed by tax laws. The approximate
amounts of USF&G's NOLs on a regular tax basis and an alternative minimum tax
("AMT") basis at December 31, 1996 were as follows:
(in millions) Tax Return
--------------
Regular tax basis $578
AMT basis 335
--------------
NOTE 12 REINSURANCE
USF&G reinsures portions of its policy risks with other insurance companies or
underwriters, and assumes policy risks from other insurance companies and
through participation in pools and associations. Reinsurance gives USF&G the
ability to write larger risks and control its exposure to losses from
catastrophes or other events that cause unfavorable underwriting results.
USF&G's ceding reinsurance agreements are generally structured on a treaty basis
whereby all risks meeting certain criteria are automatically reinsured. Amounts
recoverable from reinsurers are estimated in a manner consistent with the claim
liability associated with the reinsured policy. Reinsurance contracts do not
relieve USF&G from its obligation to policyholders. Failure of reinsurers to
honor their obligations could result in losses to USF&G. USF&G evaluates the
financial condition of its reinsurers and monitors concentrations of credit
risks arising from similar economic characteristics of the reinsurers to
minimize its exposure to significant losses from reinsurer insolvencies.
At December 31, 1996, 1995 and 1994, property/casualty reinsurance receivables
totaled $794 million, $600 million and $548 million, respectively. Of these
amounts, approximately $95 million, $100 million and $122 million, respectively,
were associated with the Workers' Compensation Reinsurance Bureau ("WCRB"), a
single voluntary reinsurance association of primary workers' compensation
insurers formed for the purpose of providing excess of loss reinsurance to its
members. USF&G is a member of this pool. Each member is required to hold
collateral, for the benefit of all member companies, in the form of
investment-grade securities equaling 115 percent of the member's share of
outstanding receivables of the WCRB. This collateral requirement mitigates the
risk of the WCRB becoming insolvent. Risk of loss is minimal for the remainder
of receivables due to similar pool arrangements with collateral requirements,
other contracts where funds are withheld, or letters of credit maintained.
Credit risk is also diversified among numerous reinsurers.
Additionally, USF&G has been active in the involuntary market as a servicing
carrier whereby USF&G processes business for a pool but takes no direct
underwriting risk because it is directly reimbursed for the cost of processing
policies and settling any related claims. Servicing carrier receivables of
$661 million, $699 million and $706 million associated with this business are
separately disclosed in the Consolidated Statement of Financial Position at
December 31, 1996, 1995 and 1994, respectively.
Effective August 1, 1996, F&G Life entered into a coinsurance contract with an
unaffiliated life insurance company to cede a significant portion of F&G Life's
block of single premium deferred annuities (the "broker SPDA block"). As part of
the transaction, F&G Life transferred $932 million of investments and other
assets to the coinsurer, and recorded a reinsurance receivable of $964 million.
The transaction had no material effect on USF&G's 1996 net income. As of the end
of the year, surrender activity under the coinsurance contract had reduced
the broker SPDA block and the related reinsurance receivable balances to
$772 million. At December 31, 1996, 1995 and 1994, F&G Life's reinsurance
receivables totaled $782 million, $4 million and $6 million, respectively.
The effect of reinsurance on USF&G's premiums and losses was as follows:
1996
Premiums Losses Unpaid Unearned
(in millions) Written Earned Incurred Losses Premiums
--------------------------------------------------
Property/Casualty:
Direct $2,401 $2,346 $1,721 $4,614 $ 991
Assumed 621 609 372 1,418 122
--------------------------------------------------
Gross 3,022 2,955 2,093 6,032 1,113
Ceded (383) (369) (225) (987) (120)
--------------------------------------------------
Net 2,639 2,586 1,868 5,045 993
Life N/A 145 313 3,552 N/A
--------------------------------------------------
Total $2,639 $2,731 $2,181 $8,597 $ 993
--------------------------------------------------
1995
Premiums Losses Unpaid Unearned
(in millions) Written Earned Incurred Losses Premiums
--------------------------------------------------
Property/Casualty:
Direct $2,318 $2,253 $1,607 $4,675 $ 945
Assumed 634 637 436 1,422 110
--------------------------------------------------
Gross 2,952 2,890 2,043 6,097 1,055
Ceded (389) (398) (241) (984) (136)
--------------------------------------------------
Net 2,563 2,492 1,802 5,113 919
Life N/A 174 376 3,719 N/A
--------------------------------------------------
Total $2,563 $2,666 $2,178 $8,832 $ 919
--------------------------------------------------
1994
Premiums Losses Unpaid Unearned
(in millions) Written Earned Incurred Losses Premiums
--------------------------------------------------
Property/Casualty:
Direct $2,303 $2,284 $1,660 $ 4,826 $ 855
Assumed 594 588 407 1,332 113
--------------------------------------------------
Gross 2,897 2,872 2,067 6,158 968
Ceded (508) (516) (323) (1,016) (116)
--------------------------------------------------
Net 2,389 2,356 1,744 5,142 852
Life N/A 152 388 3,804 N/A
--------------------------------------------------
Total $2,389 $2,508 $2,132 $ 8,946 $ 852
--------------------------------------------------
Included in assumed unpaid losses in the preceding tables are $34 million,
$52 million and $86 million related to loss portfolio transfer agreements at
December 31, 1996, 1995 and 1994, respectively. USF&G has not entered into any
such agreements to cede its unpaid losses.
NOTE 13 FINANCIAL GUARANTEES
As of December 31, 1996, USF&G was contingently liable for par value amounts
totaling approximately $113 million on financial guarantee exposures ceded
through reinsurance agreements with a monoline insurance company in which USF&G
formerly had a minority ownership interest.
In addition, USF&G has other financial guarantee obligations where the par value
guaranteed totaled $7 million at December 31, 1996, maturing at various dates
through 2000. USF&G has also committed, in connection with the sale of certain
real estate mortgages, to assumption of the first $15 million in losses, if any,
that would arise as a result of default on multi-family mortgages securitized as
mortgage-backed securities.
NOTE 14 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. Additionally,
contingencies may arise from insurance regulatory matters and regulatory
litigation matters (refer to Note 14.2).
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.
14.1. Workers' compensation litigation
A series of class actions have been filed against the National Council on
Compensation Insurance ("NCCI"), the insurance companies which served as
servicing carriers in various states, and the National Workers' Compensation
Reinsurance Pool ("NWCRP"). The complaints generally allege that the defendants
conspired to fix servicing carrier fees at unreasonably high and noncompetitive
levels thereby allegedly causing inflated deficits in the voluntary market,
excessive expansion of the residual market and excessive contraction of the
voluntary market. The plaintiffs generally seek unspecified compensatory and
punitive damages and in some cases civil penalties, treble damages under state
antitrust laws, and temporary and permanent injunctive relief. Plaintiffs'
counsel in these cases have, from time to time, indicated that similar cases may
be filed in other states. USF&G believes that it has meritorious defenses to
each of the class actions and has determined to defend the actions vigorously.
Each of the currently pending cases is described below.
North Carolina: On November 24, 1993, N.C. Steel, Inc., and six other North
Carolina employers filed a class action captioned N.C. Steel, Inc., et al., v.
National Council on Compensation Insurance, et al., in the General Court of
Justice, Superior Court Division, Wake County, North Carolina against the 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.
On February 14, 1995, the trial court granted the defendants' motion to dismiss
the complaint. The plaintiffs appealed, and on July 16, 1996, the North Carolina
Court of Appeals affirmed the dismissal of the plaintiffs' first claim for
relief, which is premised on alleged excessive rates, but reversed the trial
court's decision to dismiss the plaintiffs' second claim for relief, which is
premised on employers allegedly being improperly shifted from the voluntary
market to the assigned risk market as a result of stricter underwriting caused
by high residual market burdens. The North Carolina Supreme Court has agreed to
review both decisions. A hearing is set for March 18, 1997.
South Carolina: On August 22, 1994, the Attorney General of the State of South
Carolina filed a suit captioned State of South Carolina, County of Greenville,
et al. v. National Council on Compensation Insurance, et al., in the County of
Greenville, South Carolina against the NCCI, the NWCRP, USF&G and seven other
insurance companies which served as servicing carriers for the South Carolina
involuntary workers' compensation market. The Attorney General alleges that the
conspiracy occurred for an unspecified period of time prior to January 1994.
Discovery is underway in the case.
Alabama: 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 against the
NCCI, the NWCRP, USF&G and numerous other insurance companies which served as
servicing carriers for the Alabama involuntary workers' compensation market. The
parties to the litigation have reached a settlement agreement which requires the
defendants to seek approval from the Alabama Insurance Department for changes in
the Alabama workers' compensation system designed to facilitate the depopulation
of the Alabama workers' compensation assigned risk market. In addition, the
settlement calls for the establishment of funding of a special committee to
study ways to improve the management and operation of the Alabama workers'
compensation assigned risk plan, and payment of attorneys fees. The settlement
was approved by the court on December 19, 1996 and the impact on USF&G was
immaterial.
Kansas: On October 7, 1996, a Kansas employer filed a class action captioned
Amundson & Associates Art Studies, Ltd., et al., v. National Council on
Compensation Insurance, et al., in the District Court of Wyndotte County, Kansas
against the NCCI and the insurance companies which acted as servicing carriers
for the Kansas involuntary workers' compensation market. The defendants removed
the case to the United States District Court for the District of Kansas and the
plaintiff has filed a motion to remand the case to the state court. No discovery
has yet occurred.
Tennessee: On December 31, 1996, four Tennessee employers filed a class action
captioned Jo Ann Forman, Inc., et al., v. National Council on Compensation
Insurance, et al., in the Chancery Court of Marion County, Tennessee against the
NCCI, NWCRP and the insurance companies which acted as servicing carriers for
the Tennessee involuntary workers' compensation market. No discovery has yet
occurred.
14.2. Regulation
USF&G's insurance subsidiaries are subject to extensive regulatory oversight in
the jurisdictions where they do business. 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. It is not possible to predict the
future impact of increasing regulation on USF&G's operations. (Additional
information regarding regulatory matters may be found in Section 8, "Legal
Contingencies and Regulation", of Management's Discussion and Analysis of
Financial Condition and Results of Operations.)
NOTE 15 INTERIM FINANCIAL DATA (UNAUDITED)
Quarter
(in millions except per share data) First Second Third Fourth*
-------------------------------------------
Revenues 1996 $867 $858 $871 $902
1995 818 856 885 900
1994 786 812 835 877
-------------------------------------------
Net income 1996 $ 57 $ 67 $ 35 $102
1995 49 46 49 65
1994 23 74 76 64
-------------------------------------------
Primary earnings
per common share** 1996 $.43 $.52 $.26 $.84
1995 .39 .35 .37 .52
1994 .11 .66 .67 .54
-------------------------------------------
Fully diluted earnings
per common share** 1996 $.42 $.50 $.26 $.79
1995 .36 .33 .35 .48
1994 .11 .56 .58 .47
-------------------------------------------
*The fourth quarter 1996, 1995 and 1994 results reflect tax benefits of
$3 million, $15 million and $210 million, respectively (refer to Note 11). The
fourth quarter 1996 and 1994 results also reflect $(30) million and $183 million
in facilities exit costs/(sublease income) as discussed in Note 1.11.
** The sum of quarterly income per share amounts may not equal the full year's
amount due to stock issuances, repurchases and redemptions during presented
periods.
NOTE 16 INFORMATION ON BUSINESS SEGMENTS
USF&G's principal business segments are property/casualty insurance and life
insurance.
16.1. Assets
The assets of the insurance operations are primarily investments. Foreign
assets, consisting primarily of the assets of Afianzadora (refer to Note 1.12),
are not material. Assets of the business segments were as follows:
At December 31
(in millions) 1996 1995 1994
----------------------------
Property/casualty insurance $10,099 $ 9,967 $ 9,487
Life insurance 4,204 4,591 4,575
Noninsurance operations and eliminations 104 93 (82)
----------------------------
Consolidated total $14,407 $14,651 $13,980
----------------------------
16.2. Operations
USF&G's insurance business is geographically diversified throughout North
America. Reinsurance and noninsurance operations are located in the United
States, Europe and various foreign countries. Foreign operations, in total,
are not material.
During 1995, USF&G realigned its property/casualty product segments, resulting
in the formation of the Commercial Insurance Group ("CIG") and the Family and
Business Insurance Group ("FBIG"). The business written by these groups had
previously been included, on different bases, in the Commercial Lines and
Personal Lines segments. Specialty businesses - Discover Re, F&G Re and Surety -
were virtually unaffected by the change. Summarized financial information for
the business segments is as follows:
Income (Loss) from
Operations Before
Revenues Income Taxes***
(in millions) 1996 1995 1994* 1996 1995 1994*
--------------------------------------------------
Property/Casualty Insurance
Underwriting Results:
CIG $ 954 $ 876 $ -- $ (82) $ (97) $ --
FBIG 989 982 -- (147) (119) --
Commercial lines -- -- 1,206 -- -- (183)
Personal lines -- -- 626 -- -- (62)
Discover Re 22 25 22 2 1 --
F&G Re 480 490 395 52 43 40
Surety 141 119 107 8 16 3
--------------------------------------------------
Property/casualty
underwriting results 2,586 2,492 2,356 (167) (156) (202)
Net investment income** 441 438 429 441 438 429
Net realized gains (losses)
on investments** 63 14 (9) 63 14 (9)
Other 10 12 10 (106) (42) 1
--------------------------------------------------
Total property/casualty
insurance 3,100 2,956 2,786 231 254 219
--------------------------------------------------
Life Insurance:
Premium income 145 174 152
Net investment income 269 306 317
Net realized gains (losses)
on investments (57) 1 --
Other -- 1 1
--------------------------------------------------
Total life insurance 357 482 470 (8) 28 14
--------------------------------------------------
Noninsurance operations
and eliminations 41 21 54 36 (87) (276)
--------------------------------------------------
Consolidated total $3,498 $3,459 $3,310 $ 259 $ 195 $ (43)
--------------------------------------------------
*CIG and FBIG did not exist in 1994; therefore, information is disclosed under
the previous business lines. Comparable information for 1995 is: Revenues -
Commercial Lines, $1,223 million, Personal Lines, $635 million; Income (Loss)
from Operations Before Income Taxes - Commercial Lines, $(139) million, Personal
Lines, $(77) million.
**Net investment income and net realized gains (losses) on investments are not
allocated to property/casualty categories.
***Income (loss) from operations before income taxes for 1996 and 1994 included
facilities exit (costs)/income by segment as follows: Property/casualty,
$(28) million and $28 million, respectively; and Noninsurance operations,
$70 million and $(211) million, respectively.
USF&G CORPORATION Report of Independent Auditors
Board of Directors
USF&G Corporation
We have audited the accompanying consolidated statement of financial position of
USF&G Corporation as of December 31, 1996, 1995 and 1994, and the related
consolidated statements of operations, cash flows and shareholders' equity for
the years then ended. These financial statements are the responsibility of the
Corporation's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of USF&G Corporation
at December 31, 1996, 1995 and 1994, and the consolidated results of its
operations and its cash flows for the years then ended, in conformity with
generally accepted accounting principles.
/s/ERNST & YOUNG LLP
Baltimore, Maryland
February 21, 1997
USF&G CORPORATION Directors and Committees of the Board
Directors
H. Furlong Baldwin
Chairman of the Board and
Chief Executive Officer
Mercantile Bankshares Corporation
1981*
Michael J. Birck
President and Chief Executive Officer
Tellabs, Inc.
1993*
Norman P. Blake, Jr.
Chairman of the Board, President,
and Chief Executive Officer
USF&G Corporation
1990*
George L. Bunting, Jr.
President
Bunting Management Group
1981*
Robert E. Davis
Managing Director
Axess Corporation
1990*
Kenneth M. Duberstein
Chairman and Chief Executive Officer
The Duberstein Group
1996*
Dale F. Frey
Retired Chairman of the Board
and President
General Electric Investment Corporation
1991*
Robert E. Gregory, Jr.
Chairman of the Board and
Chief Executive Officer
London Fog Corporation
1988*
Robert J. Hurst
Vice Chairman
Goldman, Sachs & Co.
1988*
Dr. Wilbur G. Lewellen
Herman C. Krannert
Distinguished Professor of Management
Purdue University
1992*
Henry A. Rosenberg, Jr.
Chairman of the Board and
Chief Executive Officer
Crown Central Petroleum Corporation
1981*
Larry P. Scriggins
Partner
Piper & Marbury, L.L.P.
1981*
Anne Marie Whittemore
Partner
McGuire Woods Battle & Boothe, L.L.P.
1993*
R. James Woolsey
Partner
Shea & Gardner
1995*
Advisory Member of the Board
Clay Jackson
Chairman
USF&G National Agency Council
President
Cooper, Love & Jackson Insurance
Agency, Inc.
1996*
*Year of original election.
Committees of the Board
Executive Committee
Norman P. Blake, Jr.
Chairman
H. Furlong Baldwin
George L. Bunting, Jr.
Dale F. Frey
Robert E. Gregory, Jr.
Robert J. Hurst
Finance Committee
H. Furlong Baldwin
Chairman
Dale F. Frey
Wilbur G. Lewellen
Larry P. Scriggins
Anne Marie Whittemore
R. James Woolsey
Audit Committee
Robert E. Gregory, Jr.
Chairman
Michael J. Birck
Robert E. Davis
Dale F. Frey
Henry A. Rosenberg, Jr.
R. James Woolsey
Compensation Committee
George L. Bunting, Jr.
Chairman
Michael J. Birck
Robert E. Davis
Robert E. Gregory, Jr.
Wilbur G. Lewellen
Henry A. Rosenberg, Jr.
Nominating Committee
Robert J. Hurst
Chairman
H. Furlong Baldwin
George L. Bunting, Jr.
Robert E. Davis
Larry P. Scriggins
Anne Marie Whittemore
USF&G CORPORATION Executive Management Committee
EXECUTIVE MANAGEMENT COMMITTEE
Norman P. Blake, Jr.
Chairman, President, and Chief Executive Officer
[PHOTOS - SEE APPENDIX TO ELECTRONIC FORMAT DOCUMENT]
USF&G CORPORATION Office Locations
USF&G Corporation
Home Office
Baltimore, Maryland
(410) 547-3000
Claim Reception Center
Tampa, Florida
(813) 663-3000
COMMERCIAL INSURANCE GROUP
Northeast Region
Blue Bell, Pennsylvania
(215) 540-2700
Framingham, Massachusetts
(508) 270-0015
Hartford, Connecticut
(914) 251-2300
Purchase, New York
(914) 251-2300
Syracuse, New York
(315) 449-5100
Mid-Atlantic Region
Baltimore, Maryland
(410) 578-2000
Charleston, West Virginia
(304) 344-1692
Columbus, Ohio
(614) 793-1500
Harrisburg, Pennsylvania
(717) 671-8001
Pittsburgh, Pennsylvania
(412) 261-2550
Richmond, Virginia
(804) 747-0300
Southeast Region
Atlanta, Georgia
(770) 390-5500
Charlotte, North Carolina
(704) 544-0400
Jackson, Mississippi
(601) 982-5555
Louisville, Kentucky
(502) 429-7000
Meridian, Mississippi
(601) 693-1731
Nashville, Tennessee
(615) 370-8400
Tampa, Florida
(813) 289-4589
Central Region
Chicago, Illinois
(630) 472-9030
Dallas, Texas
(972) 386-4542
Des Moines, Iowa
(515) 223-5700
Detroit, Michigan
(810) 643-6433
Indianapolis, Indiana
(317) 267-2700
Kansas City, Kansas
(913) 661-9700
Milwaukee, Wisconsin
(414) 860-0479
Oklahoma City, Oklahoma
(405) 843-7300
St. Louis, Missouri
(314) 966-3416
West Region
Denver, Colorado
(303) 812-9000
Helena, Montana
(406) 442-2270
Phoenix, Arizona
(602) 864-2525
Portland, Oregon
(503) 684-0880
Salt Lake City, Utah
(801) 269-5656
Seattle, Washington
(206) 285-3636
Walnut Creek, California
(510) 942-0363
FAMILY AND BUSINESS INSURANCE GROUP
Center for Agency Services
Atlanta, Georgia
(770) 390-5876
Baltimore, Maryland
(410) 998-3164
Denver, Colorado
(303) 812-9616
Victoria Financial
Cleveland, Ohio
(216) 461-3461
SPECIALTY BUSINESSES
Discover Re Companies
Farmington, Connecticut
(860) 674-2660
Pittsburgh, Pennsylvania
(800) 945-2070
San Francisco, California
(415) 543-8111
F&G Re
Morristown, New Jersey
(201) 898-9393
Ashley Palmer Limited
London, England
44-171-488-0103
Surety Group
Atlanta, Georgia
(770) 390-5603
Baltimore, Maryland
(410) 578-2020
Birmingham, Alabama
(205) 995-4175
Charlotte, North Carolina
(704) 544-7165
Chicago, Illinois
(414) 860-3190
Denver, Colorado
(303) 812-9015
Harrisburg, Pennsylvania
(717) 671-7420
Indianapolis, Indiana
(317) 267-2710
Jackson, Mississippi
(601) 987-0830
Kansas City, Kansas
(913) 661-3435
Quincy, Massachusetts
(617) 376-4800
San Antonio, Texas
(210) 321-2202
Afianzadora Insurgentes
Mexico City, Mexico
5-25-726-9223
Northern Indemnity
Toronto, Ontario, Canada
(416) 214-1878
F&G LIFE
Baltimore, Maryland
(888) 697-5433 (LIFE)
Thomas Jefferson Life
Purchase, New York
(800) 778-7735
SUBSIDIARIES
Falcon Asset Management
Baltimore, Maryland
(410) 205-6400
USF&G Realty Advisors
Baltimore, Maryland
(410) 625-5500
USF&G CORPORATION Officers
USF&G Insurance
President
Norman P. Blake, Jr.
COMMERCIAL INSURANCE GROUP
President
Glenn W. Anderson
Senior Vice President
Anita Devan
Vice President
Robert A. Bernatchez
Richard P. Campagna
Alan K. Crater
Gregor Doman
Jeff J. Gans
Joseph J. George
Ronald L. Goldberg
Marr T. Haack
Henry J. Jacobs
Kevin M. Nish
Thomas O. Ramsbacher
Field Development and Operations
Executive Vice President
Stephen W. Lilienthal
Vice President
Charles C. Baldwin, Jr.
Steven A. LaShier
Regional Vice President
William R. Cossari - Purchase
Janet D. Frank - Denver
Hernando Madronero - Chicago
M. Lee Patkus - Baltimore
L. Bud Roberts - St. Louis
Louis R. Snage, Jr. - Charlotte
Marita Zuraitis - Atlanta
Branch Vice President
Paul H. Beil - Columbus
Anthony D. Everett - Jackson
R. Paul Feemster - Louisville
Larry W. Fitch - Oklahoma City
Charles E. Foura - Nashville
Derrick D. Iseler - Detroit
Charles W. Kincaid, Jr. - Charleston
Douglas McDonough - Richmond
John Murphy - Syracuse
Brian F. Quinn - Walnut Creek
Richard W. Ramell - Harrisburg
Barry Seago - Chicago
Robert R. Southard - Tampa
John A. Umberger - Delaware Valley
Melvin R. Workman - Salt Lake City
FAMILY AND BUSINESS INSURANCE GROUP
President
Gary C. Dunton
Senior Vice President
James R. Lewis
Kim B. Rich
Vice President
Mehran Assadi
Timothy F. Daniels
Glen E. Dye
F. Walker Garrett
Earnest E. Hines
Frank J. Kotarba
Roy G. Shrum
David D. Toombs
Victoria Financial
President
Robert W. Mueller
Vice President
Cynthia Cardwell
Michael W. Dietry
Barry LaRue
Joseph Metz
Katherine Nolan
Larry Polena
Mark VanDam
Stuart Willner
SPECIALTY BUSINESSES
Discover Re Companies
Chairman and Chief Executive Officer
George L. Estes III
President and Chief Operating Office
Scott P. Doyle
Executive Vice President -
Chief Financial Officer
Albert F. Collings
Senior Vice President
John J. Bennett
Robert D. Byler
Richard E. Cartland
Vice President
William Taylor Budde
Kenneth A. Cormier
Nancy B. Foster
Hale Holden III
Rhonda K. Miller
Susan D. Putterman
Russell J. Renvyle
Robert D. Schultz
F&G Re
President
John R. Berger
Executive Vice President
Dwight R. Evans
Timothy J. Olson
Wayne C. Paglieri
Senior Vice President
Thomas G. Devine, Sr.
Peter A. Dodge
Roland W. Jackson
Charles B. Penruddocke
John F. Rathgerber
Gregory J. Richardson
David Skurnick
Vice President/Counsel
Andrew Nosal
Ashley Palmer Limited
Chairman
John R. Berger
Deputy Chairman
Martin Ashley
Surety Group
President
Robert J. Lamendola
Senior Vice President
Frederick J. Gurba
Vice President
Peter W. Carman
David L. Hussey - Eastern Division
John F. Phinney - Western Division
Brent E. Snelgrove - Western Division
Gary A. Wilson
Afianzadora Insurgentes
Chief Executive Officer
Carlos Abascal
Northern Indemnity, Inc.
Vice President
Patrick Webb
F&G LIFE
President
Harry N. Stout
Vice President
Gary F. Haynes
Timothy C. Nicholson
Michel Perreault
Bruce H. Saul
Mark E. Singleton
OPERATIONS
Claim
Executive Vice President
Kenneth E. Cihiy
Vice President
Robert E. Burnham
Robert S. Kines
Thomas W. Salinsky
Catherine E. Smith
Charles M. Stapleton
Thomas M. Trezise
Finance
Executive Vice President-
Chief Financial Officer
Dan L. Hale
Vice President
Francis X. Bossle
Thomas A. Bradley
G. Jay Erbe, Jr.
Ronald C. Mishler
Patricia J. Scarff
James E. Stangroom
Larry Walters
Barbara L. Yewell
Human Resources
Executive Vice President
John A. MacColl
Vice President
Charles Conley
David James Dowling
Franco Moscardi
Chris Pettingill
Shalom Saar
Information Services
Executive Vice President -
Chief Information Officer
Thomas K. Lewis, Jr.
Vice President
Michelle G. Benvenga
James M. Ditmore
James C.R. Graham
Kevin B. Higgins
Albert E. Mazei
Legal
Executive Vice President -
General Counsel
John A. MacColl
Vice President
John A. Andryszak
John D. Corse
J. Kendall Huber
Rosemary Quinn
John F. Simanski
Strategic Planning/
Corporate Marketing
Executive Vice President
Andrew A. Stern
Vice President
Kerrie Burch-DeLuca
William Glenn Kenney
John M. Lummis
Walter L. Wdowiak
SUBSIDIARIES
Falcon Asset Management
Chairman
John C. Sweeney
President
Geoffrey C. Getman
Executive Vice President
Salvatore Correnti
Senior Vice President-
Chief Financial Officer
John C. Barber
USF&G Realty Advisors
President
Charles R. Werhane
Vice President
Duane M. Danielsen
Jon B. Savage
Joseph A. Wesolowski
USF&G CORPORATION Shareholder's Information
Corporate Headquarters
6225 Smith Avenue
Baltimore, Maryland 21209
(410) 547-3000
Annual Meeting
The Annual Meeting of Shareholders will be held Wednesday, May 21, 1997, at 9:00
a.m. at the Sheraton Baltimore North, 903 Dulaney Valley Road, Towson, Maryland.
Reports Filed with the Securities and Exchange Commission
A copy of USF&G Corporation's Annual Report on Form 10-K or Quarterly Reports on
Form 10-Q, as filed with the Securities and Exchange Commission, may be obtained
without charge upon request to John F. Hoffen, Jr., corporate secretary, at the
corporate headquarters.
Stock Exchange Listing
Common Stock: USF&G Corporation's common stock (ticker: FG) is listed on the New
York Stock Exchange. The common stock appears in the NYSE Composite Listing as
USFG. The common stock is also listed on the Pacific Stock Exchange, the London
Stock Exchange, and the Swiss Stock Exchanges.
Preferred Stock: USF&G Corporation's $4.10 Series A Convertible Exchangeable
Preferred Stock (ticker: FGpA) is listed on the New York Stock Exchange. The
preferred stock appears in the NYSE Composite Listing as USFGpf, and is also
listed on the Pacific Stock Exchange.
Transfer Agent/Registrar
The Bank of New York is transfer agent, registrar, and dividend disbursing agent
for USF&G Corporation's common and preferred stock. Inquiries regarding stock
transfer requirements, dividend payments, the Dividend Reinvestment and Stock
Purchase Plan, or address changes should be addressed to:
The Bank of New York
P.O. Box 11258
Church Street Station
New York, New York 10286
Attention: Shareholders' Relations Department
1-800-524-4458
Stock and Dividend Information
The following table presents 1995 and 1996 data on the sale prices of USF&G
Corporation's common stock on the New York Stock Exchange Composite Listing by
quarter, and the dividends paid per share of common stock. At February 28, 1997,
there were 21,865 registered shareholders and the closing price was $22.50 per
share.
Sale Price
High Low Dividends Paid
--------------------------------------
1995
First quarter $15 1/2 $13 3/8 $.05
Second quarter 17 1/4 13 3/4 .05
Third quarter 19 1/2 15 .05
Fourth quarter 19 1/2 16 .05
--------------------------------------
1996
First quarter $17 1/2 $14 1/4 $.05
Second quarter 16 5/8 15 .05
Third quarter 18 5/8 15 .05
Fourth quarter 21 3/4 17 3/4 .05
--------------------------------------
USF&G Shareholder Direct 1-800-545-USFG
USF&G provides 24-hour, toll-free access to the latest information about the
corporation at 1-800-545-USFG (8734). Shareholders can listen to USF&G
Corporation's financial information or request a copy to be sent by fax or
mail. This service replaced our traditional printed quarterly report, providing
faster, more convenient access to the latest news about USF&G. A site on the
Internet is also available with the same information at
http://www.shareholder.com/usfg.
Additionally, USF&G's corporate website will be available later this year at
http://www.usfg.com.
For Additional Information
Investors and analysts requesting additional information regarding USF&G
Corporation may dial toll-free 1-800-335-USFG (8734), or call directly:
Larry Walters
Vice President-Investor Relations
(410) 205-5300
Independent Auditors
Ernst & Young LLP
One North Charles
Baltimore, Maryland 21201
The financial section is printed on recycled paper
Design: USF&G Design Team
Cover photography: Cliff Riedinger/Alaska Stock Images
Executive photography: Paul Fetters
Printing: S&S Graphics, Inc.