UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
Form 10-Q
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarter Ended Commission File Number
September 30, 1997 1-8233
USF&G CORPORATION
(Exact name of registrant as specified in its charter)
Maryland 52-1220567
(State of Incorporation) (IRS Employer Identification No.)
6225 Centennial Way, Baltimore, Maryland 21209
(Address of principal executive offices) (zip code)
Telephone: 410-547-3000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve (12) months and (2) has been subject to such filing
requirements for the past 90 days. Yes X No __
The number of shares outstanding of the issuer's common stock as of
November 7, 1997:
Common Stock, Par Value $2.50; 112,662,009 shares outstanding.
USF&G CORPORATION Contents
PART 1 FINANCIAL INFORMATION
Item 1. Financial Statements:
Condensed Consolidated Statements of Financial Position 3
Condensed Consolidated Statements of Operations 4
Condensed Consolidated Statements of Cash Flows 6
Notes to Condensed Consolidated Financial Statements 7
Report of Independent Auditors 11
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
PART II OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K:
Exhibit 11 - Computation of Earnings per Share 24
Exhibit 12 - Computation of Ratio of Consolidated
Earnings to Fixed Charges, Distributions on
Capital Securities and Preferred Stock Dividends 26
Exhibit 15 - Letter Regarding Unaudited Interim
Financial Information 27
SIGNATURE 28
USF&G CORPORATION Condensed Consolidated Statements of Financial Position
(Unaudited)
September 30, December 31,
(in millions except per share data) 1997 1996
---------------------------------
Assets
Investments:
Fixed maturities:
Available for sale, at market (cost, 1997, $8,245; 1996, $8,066) $ 8,478 $ 8,164
Common and preferred stocks, at market (cost, 1997, $54; 1996, $16) 50 16
Short-term investments 447 535
Mortgage loans 582 406
Real estate 404 554
Other invested assets 498 401
---------------------------------
Total investments 10,459 10,076
---------------------------------
Cash 67 73
Accounts, notes and other receivables 921 763
Reinsurance receivables 1,479 1,576
Servicing carrier receivables 684 661
Deferred policy acquisition costs 464 456
Other assets 861 802
---------------------------------
Total assets $14,935 $14,407
---------------------------------
Liabilities
Unpaid losses, loss expenses and policy benefits $ 9,818 $ 9,584
Unearned premiums 1,173 1,113
Corporate debt 500 477
Real estate and other debt 5 5
Other liabilities 1,263 1,159
---------------------------------
Total liabilities 12,759 12,338
---------------------------------
USF&G-obligated mandatorily redeemable preferred capital
securities of subsidiary trusts holding solely junior
subordinated deferrable interest debentures of USF&G 296 100
---------------------------------
Shareholders' Equity
Preferred stock, par value $50.00 (12,000,000 shares authorized;
shares issued, 1997, --; 1996, 3,999,910) -- 200
Common stock, par value $2.50 (240,000,000 shares authorized;
shares issued, 1997, 111,035,030; 1996, 114,240,489) 278 286
Paid-in capital 1,022 1,091
Net unrealized gains on investments and foreign currency 133 62
Retained earnings 447 330
---------------------------------
Total shareholders' equity 1,880 1,969
---------------------------------
Total liabilities, capital securities and shareholders' equity $14,935 $14,407
---------------------------------
See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Condensed Consolidated Statements of Operations (Unaudited)
Three Months Ended September 30,
(in millions except per share data) 1997 1996
----------------------------------
Revenues
Premiums earned $656 $687
Net investment income 169 177
Other 3 3
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Revenues before net realized gains 828 867
Net realized gains on investments -- 4
----------------------------------
Total revenues 828 871
----------------------------------
Expenses
Losses, loss expenses and policy benefits 500 561
Underwriting, acquisition and operating expenses 247 265
Interest expense 9 10
----------------------------------
Total expenses 756 836
----------------------------------
Income from operations before income taxes and distributions
on capital securities 72 35
Provision for income taxes 20 --
Distributions on USF&G-obligated mandatorily redeemable
preferred capital securities of subsidiary trusts holding
solely junior subordinated deferrable interest debentures
of USF&G, net of tax 4 --
----------------------------------
Net income $ 48 $ 35
----------------------------------
Preferred stock dividend requirements -- 5
----------------------------------
Net income available to common stock $ 48 $ 30
----------------------------------
Primary Earnings Per Share $.41 $.26
----------------------------------
Fully Diluted Earnings Per Share .40 .26
----------------------------------
Weighted-average shares outstanding (000s):
Primary 114,631 117,451
Fully diluted 119,812 117,451
----------------------------------
Dividends declared per common share $.07 $.05
----------------------------------
See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Condensed Consolidated Statements of Operations (Unaudited)
Nine Months Ended September 30,
(in millions except per share data) 1997 1996
---------------------------------
Revenues
Premiums earned $2,016 $2,028
Net investment income 513 537
Other 12 15
---------------------------------
Revenues before net realized gains 2,541 2,580
Net realized gains on investments 4 16
---------------------------------
Total revenues 2,545 2,596
---------------------------------
Expenses
Losses, loss expenses and policy benefits 1,571 1,640
Underwriting, acquisition and operating expenses 738 781
Interest expense 26 30
Facilities exit costs/(sublease income) -- (14)
---------------------------------
Total expenses 2,335 2,437
---------------------------------
Income from operations before income taxes and distributions
on capital securities 210 159
Provision for income taxes 61 --
Distributions on USF&G-obligated mandatorily redeemable
preferred capital securities of subsidiary trusts holding
solely junior subordinated deferrable interest debentures
of USF&G, net of tax 9 --
---------------------------------
Net income $ 140 $ 159
---------------------------------
Preferred stock dividend requirements 2 14
---------------------------------
Net income available to common stock $ 138 $ 145
---------------------------------
Primary Earnings Per Share $ 1.20 $ 1.21
---------------------------------
Fully Diluted Earnings Per Share 1.16 1.16
---------------------------------
Weighted-average shares outstanding (000s):
Primary 115,185 118,753
Fully diluted 120,631 129,584
---------------------------------
Dividends declared per common share $ .19 $ .15
---------------------------------
See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Condensed Consolidated Statements of Cash Flows (Unaudited)
Nine Months Ended September 30,
(in millions) 1997 1996
----------------------------------
Operating Activities
Direct premiums collected $1,606 $ 1,641
Net investment income collected 501 543
Direct losses, loss expenses and policy benefits paid (1,201) (1,310)
Net reinsurance activity (120) (7)
Underwriting and operating expenses paid (626) (557)
Interest paid (17) (23)
Income taxes paid (6) (5)
Other items, net (9) (16)
----------------------------------
Net cash provided by operating activities 128 266
----------------------------------
Investing Activities
Net sales (purchases) and maturities of short-term investments 91 (81)
Purchases of fixed maturities available for sale (1,583) (714)
Sales of fixed maturities available for sale 883 282
Maturities/repayments of fixed maturities available for sale 514 556
Purchases of other investments (337) (169)
Sales, maturities and repayments of other investments 279 162
Purchase of subsidiary (25) --
Purchases of property and equipment (66) (30)
Sales of property and equipment -- 2
----------------------------------
Net cash (used in) provided by investing activities (244) 8
----------------------------------
Financing Activities
Deposits for universal life and investment contracts 381 297
Withdrawals of universal life and investment contracts (166) (491)
Net borrowings of short-term debt 15 (18)
Repayments of long-term borrowings -- (40)
Issuance of capital securities 198 --
Issuances of common stock 17 7
Repurchases of common stock (102) (57)
Redemptions of preferred stock (200) --
Cash dividends paid to shareholders (25) (32)
Distributions on capital securities (8) --
----------------------------------
Net cash provided by (used in) financing activities 110 (334)
----------------------------------
Decrease in cash (6) (60)
Cash at beginning of period 73 119
----------------------------------
Cash at end of period $ 67 $ 59
----------------------------------
Noncash Transactions
Coinsurance of broker SPDA block:
Surrender activity $ (114) $ --
Transfer of investments and other assets in exchange
for reinsurance receivables -- 963
----------------------------------
See Notes to Condensed Consolidated Financial Statements.
USF&G CORPORATION Notes to Condensed Consolidated Financial Statements
(Unaudited)
NOTE 1 BASIS OF ACCOUNTING
The condensed consolidated financial statements are prepared in accordance with
generally accepted accounting principles ("GAAP"). These statements include the
accounts of USF&G Corporation and its subsidiaries (collectively, "USF&G" or the
"Corporation"). Certain 1996 amounts have been reclassified to conform to the
1997 presentation. The interim financial statements in this report should be
read in conjunction with the consolidated financial statements and notes thereto
in USF&G's 1996 Annual Report to Shareholders. In the opinion of management, the
accompanying unaudited condensed consolidated financial statements contain the
necessary adjustments, all of which are of a normal recurring nature for interim
period reporting purposes, for a fair presentation of results for the interim
periods. The results of operations and cash flows for interim periods presented
are not necessarily indicative of results for the full year.
NOTE 2 REVIEW OF INDEPENDENT AUDITORS
USF&G's independent auditors, Ernst & Young LLP, have performed a review of the
condensed consolidated financial statements in this Form 10-Q as to the three-
and nine-month periods ended September 30, 1997 and 1996. Their limited review
in accordance with standards established by the American Institute of Certified
Public Accountants did not constitute an audit. Accordingly, they do not express
an opinion on this information.
NOTE 3 EARNINGS PER SHARE ("EPS")
Primary EPS are based on income, after deduction of preferred stock dividends,
and the weighted-average number of common shares and common stock equivalents
outstanding during the periods. Fully diluted EPS assume the conversion of all
securities whose contingent issuance would have a dilutive effect on earnings.
Refer to the computation in Exhibit 11.
NOTE 4 NEW ACCOUNTING PRONOUNCEMENTS
4.1. Earnings Per Share
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per
Share", which simplifies the standards for computing EPS. SFAS No. 128 replaces
primary EPS with basic EPS, which excludes common stock equivalents, and
requires disclosure of diluted EPS on the face of the income statement for all
entities, such as USF&G, with complex capital structures. SFAS No. 128 is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods; however, earlier application is not permitted.
The calculation of EPS in accordance with SFAS No. 128 would not have had, and
in the future is not expected to have, a material effect on USF&G's EPS
computations or related disclosures.
4.2. Reporting Comprehensive Income
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income,"
which establishes standards for reporting and display of comprehensive income
and its components in a full set of general-purpose financial statements. This
Statement requires that an enterprise: (a) classify items of other comprehensive
income by their nature in a financial statement, and (b) display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in-capital in the equity section of a statement of financial
position. SFAS No. 130 is effective for fiscal years beginning after December
15, 1997. Once adopted, USF&G anticipates that the major impact of SFAS No. 130
will be the required reporting of unrealized gains or losses on available for
sale securities in comprehensive income.
4.3. Disclosures about Segments of an Enterprise and Related Information
In June 1997, the FASB issued SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information". The Statement establishes standards for the
way that public business enterprises report information about operating segments
in annual financial statements and requires that selected information about
operating segments be included in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas and major customers. The definition of
operating segments in this standard is based on the way that management
organizes and manages the segments within an enterprise. The Statement is
effective for fiscal years beginning after December 15, 1997. SFAS No. 131 may
require USF&G to revise and expand its business segment disclosures.
NOTE 5 RATIO OF CONSOLIDATED EARNINGS TO FIXED CHARGES
For purposes of computing the ratio of consolidated earnings to fixed charges,
distributions on capital securities and preferred stock dividends, earnings
consist of income before considering income taxes and fixed charges. Capital
securities are defined as USF&G-obligated mandatorily redeemable capital
securities of subsidiary trusts holding solely junior subordinated deferrable
interest debentures of USF&G. Fixed charges consist of interest and that portion
of rentals that is deemed to be an appropriate interest factor. Refer to the
computation in Exhibit 12.
NOTE 6 SUPPLEMENTAL CASH FLOW INFORMATION
The Condensed Consolidated Statements of Cash Flows are presented using the
"direct method," which reports major classes of cash receipts and cash payments.
A reconciliation of net income to net cash provided by operating activities is
as follows:
Nine Months Ended September 30,
(in millions) 1997 1996
-------------------------------
Net income $ 140 $ 159
Adjustments to reconcile net income to
net cash provided by operating activities:
Realized gains on investments (4) (16)
Depreciation expense 30 20
Facilities exit costs/(sublease income) -- (14)
Increase/(decrease) in accrued income taxes 55 (5)
Distributions on capital securities 9 --
Change in insurance liabilities 177 149
Change in deferred policy acquisition costs (27) 40
Change in receivables (178) (152)
Change in other liabilities 15 118
Change in other assets (86) (50)
Other items, net (3) 17
-------------------------------
Net cash provided by operating activities $128 $ 266
-------------------------------
NOTE 7 UNREALIZED GAINS(LOSSES) ON INVESTMENTS
At September 30, 1997, gross unrealized gains and gross unrealized losses
pertaining to investments in common and preferred stocks totaled $1 million and
$5 million, respectively. In addition, gross unrealized gains and gross
unrealized losses on limited partnerships, foreign currency and other
investments totaled $16 million and $3 million, respectively. At September 30,
1997, there were gross unrealized gains of $246 million and gross unrealized
losses of $13 million pertaining to fixed maturities available for sale. There
were also $37 million of gross unrealized losses relating to a deferred policy
acquisition costs ("DPAC") adjustment. This DPAC adjustment was made to reflect
assumptions about the effect of potential asset sales of fixed maturities
available for sale on future DPAC amortization. Unrealized gains and losses on
fixed maturities are offset by related changes in the DPAC. The changes in DPAC
represent amounts by which deferred acquisition costs on annuity products would
be adjusted if the unrealized gains on related invested assets were to be
realized. Costs to acquire and issue annuities and life insurance policies are
generally deferred and amortized in future periods in relationship to expected
gross profits. Gains or losses in the related invested assets affect the timing
of the recognition of profit on certain annuity products; therefore, increasing
or decreasing the corresponding amortization period of the DPAC. The change in
net unrealized gains (losses) on investments and foreign currency amounted to a
gain of $71 million during the nine months ended September 30, 1997, compared
with a loss of $283 million during the nine months ended September 30, 1996.
NOTE 8 PROCEEDS FROM SALES OF FIXED MATURITY INVESTMENTS
Proceeds from sales of fixed maturities available for sale during the nine
months ended September 30, 1997, were $883 million compared with $282 million
for the same period of 1996. The 1996 proceeds exclude the F&G Life transfer of
fixed maturities under a coinsurance transaction (refer to Section 3.2 of
Management's Discussion and Analysis of Financial Condition and Results of
Operations). Realized gross gains and realized gross losses were $14 million and
$24 million, respectively, in the nine months ended September 30, 1997,
compared with $5 million and $7 million, respectively, for the same periods of
1996.
NOTE 9 CAPITAL SECURITIES OF SUBSIDIARY TRUST
On July 8, 1997, USF&G Capital III ("Capital III"), a business trust wholly
owned by USF&G, issued $100 million(100,000 shares) of 8.312% Capital
Securities, Series C ("Series C Securities"). Payments on the Series C
Securities are guaranteed by USF&G on a subordinated basis, but only to the
extent Capital III 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 III, constitutes a full and unconditional subordinated guarantee by
USF&G of Capital III's obligations under the Series C Securities.
Capital III used the proceeds from the Series C Securities issuance to purchase
$100 million principal amount of 8.312% Junior Subordinated Debentures issued by
USF&G ("Series C Debentures"). The Series C Debentures rank junior and
subordinate in right of payment to certain other indebtedness of USF&G, and
mature on July 1, 2046.
Interest payments on the Series C Debentures are deferrable, at USF&G's
option, at any time for up to five years at a time, provided there has not been
an event of default. In the event USF&G elects to defer interest payments on the
Series C Debentures, payments of distributions on the Series C Securities will
likewise be deferred. Interest and distributions continue to accrue during any
payment deferral period.
The Series C 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
C Debentures will be used to redeem a like amount of the Series C Securities.
Additionally, USF&G has the right, under certain circumstances related to tax
events, to shorten the maturity of the Series C Debentures to a date no earlier
than April 8, 2012, in which case the stated maturity of the Series C Securities
will likewise be affected.
The sole assets of Capital III are the Series C Debentures. Capital III does not
have operations independent of the aforementioned relationship with USF&G and
the holders of the capital securities. In the event USF&G exercises its right to
defer interest payments on the Series C 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 C 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 10 INCOME TAXES
As of December 31, 1996, USF&G had fully recognized all of its deferred tax
assets. As a result, effective January 1997, the Corporation recognizes income
tax expense in its consolidated statements of operations. The financial
statement recognition of tax expense is not necessarily an appropriate indicator
of tax to be paid, however, as the Corporation still has income tax net
operating loss carryforwards available for both regular and alternative minimum
tax purposes.
USF&G's effective tax rate for the quarter and nine months ended September 30,
1997 was less than the statutory federal income tax rate due to permanent
book/tax differences which resulted primarily from investment income generated
by tax-exempt fixed maturity investments.
NOTE 11 BUSINESS COMBINATION
On August 8, 1997, USF&G announced that it had entered into a definitive
agreement to acquire Titan Holdings, Inc. ("Titan"). Titan, which is
headquartered in San Antonio, Texas, primarily operates two specialty
property/casualty operations: Titan Auto, which writes nonstandard automobile
insurance; and Titan Public Entity, which insures small -to- medium
municipalities. Titan reported total assets of $405 million at June 30, 1997,
and written premium of $199 million for the twelve-month period ended June 30,
1997. Titan Auto and Titan Public Entity accounted for 65 percent and 35 percent
of total revenues, respectively, for the twelve-month period ended June 30,
1997.
USF&G will pay $11.60 in cash plus 0.46516 share of common stock for each Titan
share, for a total of $23.20 per Titan share, based on a USF&G share valuation
of $24.94, which was the value used in USF&G's initial offer to Titan. This
consideration is subject to adjustment pursuant to a collar arrangement. At the
$23.20 valuation, the aggregate transaction value is $234 million plus
assumption of debt.
The Corporation expects to finance the cash portion of the consideration payable
to Titan shareholders from internal resources or existing credit facilities. The
transaction is expected to close in December of 1997.
NOTE 12 LEGAL CONTINGENCIES
USF&G's insurance subsidiaries are routinely engaged in litigation in the normal
course of their businesses, including defending claims for punitive damages. As
insurers, they defend third-party claims brought against their insureds, as well
as defend themselves against first-party and coverage claims. Additional
information regarding contingencies that may arise from insurance regulatory
matters and regulatory litigation matters may be found in Section 8, "Legal
Contingencies and Regulation", of Management's Discussion and Analysis of
Financial Condition and Results of Operations in USF&G's 1996 Annual Report to
Shareholders.
In the opinion of management, such contingencies and the contingencies described
below are not expected to have a material adverse effect on USF&G's consolidated
financial position, although it is possible that the results of operations in a
particular quarter or annual period would be materially affected by an
unfavorable outcome. In each of the cases disclosed, USF&G believes it has
meritorious defenses; however, determination of the outcome cannot be made.
12.1. 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 parties are awaiting the decision of the
North Carolina Supreme Court following a hearing of both issues on 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 and trial is currently scheduled in the fourth
quarter of 1998.
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 Wyandotte 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,
but on September 17, 1997, the federal District Court granted plaintiff's 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. The defendants have
filed a motion to dismiss the case and are awaiting the decision of the trial
court following a hearing on July 14, 1997. No discovery has yet occurred.
Missouri: On February 20, 1997, six Missouri employers filed a class action
captioned Atlas Reserve Temporaries, Inc., et al.v. Vanliner Insurance Co., et
al., in the Circuit Court of Cole County, Missouri against the NCCI, USF&G and
other insurance companies which acted as servicing carriers for the Missouri
involuntary workers' compensation market. On August 26, 1997, the trial court
denied the defendants' motion to dismiss the case, and the defendants have
appealed. No discovery has yet occurred.
12.2. 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.
USF&G CORPORATION Report of Independent Auditors
Board of Directors
USF&G Corporation
We have reviewed the accompanying condensed consolidated statement of financial
position of USF&G Corporation as of September 30, 1997 and the related condensed
consolidated statements of operations for the three- and nine-month periods
ended September 30, 1997 and 1996 and the condensed consolidated statements of
cash flows for the nine months ended September 30, 1997 and 1996. These
financial statements are the responsibility of the company's management.
We conducted our reviews in accordance with standards established by the
American Institute of Certified Public Accountants. A review of interim
financial information consists principally of applying analytical review
procedures to financial data and making inquiries of persons responsible for
financial and accounting matters. It is substantially less in scope than an
audit conducted in accordance with generally accepted auditing standards, which
will be performed for the full year with the objective of expressing an opinion
regarding the financial statements taken as a whole. Accordingly, we do not
express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to the accompanying condensed consolidated financial statements referred
to above for them to be in conformity with generally accepted accounting
principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of financial position of USF&G Corporation
as of December 31, 1996, and the related consolidated statements of operations,
shareholders' equity, and cash flows for the year then ended (not presented
herein) and, in our report dated February 21, 1997, we expressed an unqualified
opinion on those consolidated financial statements. In our opinion, the
information set forth in the accompanying condensed consolidated statement of
financial position as of December 31, 1996, is fairly stated in all material
respects in relation to the consolidated statement of financial position from
which it has been derived.
ERNST & YOUNG LLP
Baltimore, Maryland
November 11, 1997
USF&G CORPORATION Management's Discussion and Analysis of Financial Condition
and Results of Operations
This section provides an assessment of financial results and material changes in
financial position for USF&G Corporation and its subsidiaries (collectively,
"USF&G" or the "Corporation") and explains the results of operations for the
quarter and nine months ended September 30, 1997. The analysis focuses on the
performance of USF&G's strategic businesses and its investment portfolio. This
discussion updates the "Management's Discussion and Analysis of Financial
Condition and Results of Operations" in the 1996 Annual Report to Shareholders
and should be read in conjunction therewith. The results of operations for the
quarter and nine months ended September 30, 1997 are compared with those for the
same periods of 1996 unless otherwise noted. Financial position at September 30,
1997 is compared with December 31, 1996.
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 Form 10-Q and in any other statement
made by, or on the behalf of, USF&G, whether or not in future filings with the
Securities and Exchange Commission. Forward-looking statements are statements
not based on historical information and which relate to future operations,
strategies, financial results or other developments. Forward-looking statements
are necessarily based upon estimates and assumptions that are inherently subject
to significant business, economic and competitive uncertainties and
contingencies, many of which are beyond USF&G's control and many of which, with
respect to future business decisions, are subject to change. These uncertainties
and contingencies can affect actual results and could cause actual results to
differ materially from those expressed in any forward-looking statements made
by, or on behalf of, USF&G. USF&G disclaims any obligation to update
forward-looking information.
Note: Certain prior-year amounts have been reclassified to conform to the 1997
presentation. A glossary of certain terms used in the discussion can be found in
Section 8; the terms are italicized the first time they appear in the text.
Index
1. Consolidated Results 12
2. Strategic Overview 13
3. Results of Operations 13
4. Reserves and Surplus 17
5. Investments 18
6. Financial Condition 20
7. Liquidity 21
8. Glossary of Terms 21
1. CONSOLIDATED RESULTS
The table below shows the major components of net income.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
-------------------------------------
Property/casualty insurance $ 81 $ 36 $ 237 $ 147
Life insurance 17 13 46 36
Parent and noninsurance (26) (18) (77) (54)
-------------------------------------
Operating income* 72 31 206 129
Net realized gains on investments -- 4 4 16
Facilities exit (costs)/sublease income -- -- -- 14
Provision for income taxes (20) -- (61) --
Distributions on capital securities,
net of tax (4) -- (9) --
-------------------------------------
Net income $ 48 $ 35 $ 140 $ 159
-------------------------------------
*See Glossary of Terms
Operating income is defined as net income, excluding realized gains and losses
on investments, branch reorganization severance, facilities exit
(costs)/sublease income, income taxes and distributions on capital securities of
subsidiary trusts. Operating income is presented in a manner which is not
intended to conform with generally accepted accounting principles ("GAAP").
Management believes this presentation provides a meaningful understanding of the
core drivers of an insurance company's operations. Operating income combines
premiums earned, net investment income and other income and offsets these
amounts by losses, loss expenses and policy benefits, underwriting, acquisition
and operating expenses and interest expense. However, net realized gains on
investments, branch reorganization severance, facilities exit (costs)/sublease
income, income taxes and distributions on capital securities are significant
components of net income and should be considered in assessing USF&G's overall
financial performance. This operating income caption may not be comparable to
other similarly titled measures of the Corporation and should not be construed
as an alternative to income from continuing operations or cash flows from
operating, investing or financing activities as determined in accordance with
GAAP.
Property/casualty segment income for the third quarter and nine months ended
September 30, 1997 increased $45 million and $90 million, respectively, when
compared with the same periods of 1996. The increase is related primarily to
improved underwriting results, including decreased catastrophe losses, incurred
during the period, as well as changes in the allocation of corporate
nonunderwriting expenses. Life insurance segment results increased $4 million
and $10 million, respectively, for the third quarter and nine months ended
September 30, 1997 due to the combined effects of increased annuity sales and
improved investment spreads on annuity and universal life products. The loss
from parent and noninsurance operations increased during the third quarter and
first nine months of 1997 when compared with the same periods of 1996 due
primarily to changes in the allocation of corporate nonunderwriting expenses,
which had no effect on consolidated net income (refer to Section 3.1 of this
Analysis).
As of December 31, 1996, USF&G had fully recognized all of its deferred tax
assets. As a result, effective January 1997, the Corporation recognizes income
tax expense in its consolidated statements of operations. The financial
statement recognition of tax expense is not necessarily an appropriate indicator
of tax to be paid, however, as the Corporation still has income tax net
operating loss carryforwards available for both regular and alternative minimum
tax purposes.
USF&G's effective tax rate for the quarter and nine months ended September 30,
1997 was less than the statutory federal income tax rate due to permanent
book/tax differences which resulted primarily from investment income generated
by tax-exempt fixed maturity investments.
During the first nine months of 1996, a $12 million reduction of the facilities
exit costs reserve was included in net income related primarily to reduced
property tax assessments on the Corporation's former home office. Additionally,
USF&G recognized $2 million of sublease income related to the former home
office.
In December 1996 and January 1997, two business trusts wholly owned by USF&G
issued a total of $200 million of USF&G-obligated mandatorily redeemable
preferred capital securities. Accruals for distributions on these securities,
net of tax, totaled $8 million in the first nine months of 1997. Proceeds from
the issuance of the preferred capital securities were used to redeem the $4.10
Series A Convertible Exchangeable Preferred Stock ("Series A Preferred Stock"),
resulting in annual after-tax savings of over $5 million compared with the
dividends on the Series A Preferred Stock.
In July 1997, USF&G Capital III, a business trust wholly owned by USF&G, issued
a total of $100 million of USF&G-obligated mandatorily redeemable preferred
capital securities. Accruals for distributions on these securities, net of tax,
totaled $1 million for both the third quarter and first nine months of 1997,
respectively. Proceeds from this third issuance of preferred capital securities
were used to repay $60 million that was outstanding at the end of June 1997
against a standby credit facility.
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.
Further information regarding each group's business and strategy may be found in
the Strategic Overview section of Management's Discussion and Analysis of
Financial Condition and Results of Operations in USF&G's 1996 Annual Report to
Shareholders.
3. RESULTS OF OPERATIONS
3.1. Property/casualty insurance
Property/casualty insurance operations, which consist of CIG, FBIG, and the
Specialty Businesses, accounted for 90 percentof USF&G's revenues before net
realized gains in the first nine months of 1997 compared with 87 percent in the
same period of 1996, and 70 percent of its assets at September 30, 1997 and
December 31, 1996. Financial results for this segment were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
-------------------------------------
Net premiums written* $ 644 $687 $1,928 $2,022
Premiums earned* 631 651 1,938 1,919
Net underwriting loss (22) (58) (78) (134)
Operating income* 81 36 237 147
-------------------------------------
*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 GAAP,
were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1996 1997 1996
--------------------------------------
GAAP combined ratio 103.4% 108.9% 104.0% 107.0%
--------------------------------------
Premiums earned decreased $19 million in the third quarter of 1997, when
compared with the same period of 1996, primarily due to intensely competitive
domestic market conditions. USF&G's response to the competitive market is to
attempt to maintain disciplined pricing and underwriting standards, which has
resulted in declining premium trends particularly in standard commercial lines
of business. Management anticipates that competitive market conditions will
prevail for the foreseeable future. Operating income increased $45 million in
the third quarter of 1997 and $90 million in the first nine months of 1997 when
compared with the same periods of 1996, due primarily to improved underwriting
results and a decrease in other (nonunderwriting) expenses. The underwriting
improvement is primarily attributable to reduced occurrences in 1997 of
catastrophe losses and other severe weather related losses. Gross catastrophe
losses totaled $5 million and $24 million in the third quarter and first nine
months of 1997, respectively, compared with $47 million and $102 million in the
same periods of 1996, respectively. These losses, net of ceded reinsurance, were
$5 million and $23 million in the third quarter and first nine months of 1997,
respectively, compared with $45 million and $100 million in the same periods of
1996, respectively. The high level of catastrophe losses incurred in the first
nine months of 1996 was the result of severe winter storms and floods incurred
during the first quarter and Hurricane Fran in the third quarter.
In 1997, the Corporation re-evaluated its methodology for allocating
nonunderwriting expenses originating from the corporate holding company to the
business segments. Prior to 1997, corporate nonunderwriting expenses were
allocated based primarily on written premiums, whereas in the current year,
corporate nonunderwriting expenses are no longer allocated to the business
segments as it was determined that there is insufficient correlation between
these expenses and the related business segment revenues generated. Management
believes the latter approach provides a more meaningful understanding of each
business segment's performance. This change in approach to corporate allocations
decreased the property/casualty segment's nonunderwriting expenses by $11
million and $33 million for the quarter and nine months ended September 30,
1997, respectively, but had no affect on consolidated net income.
CIG
The following table shows underwriting results for CIG.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
--------------------------------------
Gross voluntary premiums written $251 $267 $795 $803
Net premiums written 232 248 731 754
Underwriting loss (27) (36) (72) (48)
GAAP Underwriting Ratios:
Loss ratio 77.4% 80.7% 77.5% 73.9%
Expense ratio 34.2 33.8 32.8 32.7
Combined ratio 111.6 114.5 110.3 106.6
--------------------------------------
Gross voluntary premiums written in excess & surplus lines and specialty
segments combined, represented 37 percent of CIG's gross premiums in the first
nine months of 1997 and grew 26 percent in the first nine months of 1997 when
compared with the same period of 1996. These increases were largely offset by
declines in the standard middle market segments, primarily due to competitive
market conditions and USF& G's decision to de-emphasize the trucking line of
business.
In the first quarter of 1996, CIG recorded a $30 million reduction in workers'
compensation reserves as a result of the recognition of the effect on reserve
estimation models of the significant use of structured settlement annuities to
close medical claims. Excluding this one-time reserve adjustment, overall
underwriting results for the first nine months of 1997 were generally consistent
with 1996. Underwriting results for the third quarter of 1997 were consistent
with the corresponding period of the prior year excluding catastrophes. A trend
of deteriorating underwriting losses in the specialty trucking line contributed
to the increase in the loss ratio for the nine months ended September 30, 1997,
in comparison with the corresponding period of 1996. During the quarter ended
September 30, 1997, management decided to discontinue its discrete underwriting
emphasis of the trucking line which is expected to result in significantly
reduced premiums written for this line, but improved underwriting results. The
trucking line had approximately $71 million of gross premiums written and
approximately $25 million of underwriting losses through the first nine months
of 1997.
FBIG
The following table shows underwriting results for FBIG.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
-------------------------------------
Gross voluntary premiums written $ 243 $ 264 $ 738 $ 766
Net premiums written 233 259 655 751
Underwriting loss (12) (51) (53) (142)
GAAP Underwriting Ratios:
Loss ratio 75.3% 84.4% 75.9% 82.8%
Expense ratio 29.8 35.9 31.6 36.4
Combined ratio 105.1 120.3 107.5 119.2
--------------------------------------
FBIG gross voluntary premiums written decreased $21 million and $28 million in
the third quarter and first nine months of 1997, respectively, when compared
with the same periods of 1996. The decrease was primarily due to intense
competition in the personal lines and small commercial markets, as well as
management's actions to lower the commission rates on most personal lines and
some small commercial business, effective April 1, 1997. The decreases in net
premiums written in the third quarter and first nine months of 1997 were
primarily the result of a new personal lines quota share reinsurance treaty
(refer to Section 4.2 of this Analysis), as well as the decreases in gross
voluntary premiums written described above.
The loss ratio improved 9.1 points and 6.9 points in the third quarter and first
nine months of 1997, respectively, when compared with the same periods of 1996,
due primarily to the high level of catastrophe losses associated with Hurricane
Fran which were incurred in the third quarter of 1996, in addition to severe
winter storms and floods in the first quarter of 1996.
The expense ratio improved 6.1 points and 4.8 points in the third quarter and
first nine months of 1997, respectively, when compared with the same periods of
1996. The expense ratio improvement was primarily the result of lower commission
rates and continued expense management, and is expected to continue throughout
1997 as FBIG realizes the operating efficiencies resulting from the centralized
underwriting and policy processing in the Centers for Agency Services.
Specialty Businesses
USF&G's Specialty Businesses consist of Discover Re Managers, Inc. ("Discover
Re"), which provides insurance, reinsurance and related services to the
alternative risk transfer market, F&G Re, Inc. ("F&G Re"), which manages USF&G's
assumed reinsurance business, and the Surety Group.
Discover Re
The following table shows underwriting results for Discover Re.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
--------------------------------------
Gross program premiums* $49 $32 $127 $100
Net premiums written 16 8 33 17
Service fees 4 3 12 9
Underwriting gain 1 1 3 2
GAAP Underwriting Ratios:
Loss ratio 77.9% 78.6% 74.1% 78.5%
Expense ratio 4.5 8.0 9.4 11.5
Combined ratio 82.4 86.6 83.5 90.0
--------------------------------------
*See Glossary of Terms
Growth in Discover Re's captive business was the primary driver of increases in
gross program premiums in the quarter and first nine months of 1997, when
compared with the same periods of the previous year. Management is increasing
its focus on captive business which, despite typically resulting in less
retained premium, is expected to generate significant fee income compared with
traditional alternative risk transfer products. For the nine months ended
September 30, 1997, captive business represented 46 percent of Discover Re's
gross program premiums, compared with 36 percent in the corresponding period of
1996.
F&G Re
The following table shows underwriting results for reinsurance assumed through
F&G Re.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
--------------------------------------
Net Premiums Written:
Traditional risk $ 71 $ 87 $210 $240
Finite risk 42 40 139 136
--------------------------------------
Total premiums written $113 $127 $349 $376
--------------------------------------
Underwriting gain $ 9 $ 13 $ 23 $ 41
--------------------------------------
GAAP Underwriting Ratios:
Loss ratio 58.6% 75.7% 67.1% 64.8%
Expense ratio 33.0 12.8 26.6 23.0
Combined ratio 91.6 88.5 93.7 87.8
--------------------------------------
F&G Re's net premiums written decreased $14 million and $27 million in the third
quarter and first nine months of 1997, respectively, when compared with the same
periods of 1996 as a result of competitive pricing pressures in the assumed
reinsurance market. Management's adherence to its underwriting discipline has
resulted in the sacrifice of some premium volume in favor of maintaining a
profitable book of business. These pricing and premium issues, as well as loss
experience, led to declines in underwriting profitability in the quarter and
first nine months of 1997, when compared with the same periods of 1996. This
intense pricing competition is expected to continue throughout 1997. The
increase in the expense ratio for the quarter and nine months ended September
30, 1997, when compared with the same periods of 1996, is primarily the result
of a higher percentage of proportional reinsurance business, which carries
higher commission rates than excess of loss reinsurance business. Additionally,
the third quarter 1996 loss ratio and expense ratio were impacted by the
novation of a reinsurance contract which resulted in an unusual fluctuation
between losses and expenses in that period.
Surety
The following table shows underwriting results for the Surety Group.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
--------------------------------------
Gross voluntary premiums written $60 $47 $185 $134
Net premiums written 50 45 160 124
Underwriting gain 7 15 21 13
GAAP Underwriting Ratios:
Loss ratio 33.3% 14.0% 34.2% 36.9%
Expense ratio 51.3 47.2 50.6 50.9
Combined ratio 84.6 61.2 84.8 87.8
-------------------------------------
Surety's gross premiums written increased 26 percent and 37 percent in the third
quarter and first nine months of 1997, respectively, when compared with the same
periods of 1996, due primarily to growth in international surety business.
International surety business consists primarily of Afianzadora Insurgentes,
S.A. de C.V. ("Afianzadora"), which USF&G acquired in December 1996. Afianzadora
represented 20 percent and 22 percent of total Surety gross premiums written in
the third quarter and first nine months of 1997, respectively.
Surety's underwriting results improved $8 million in the first nine months of
1997, when compared with the same period of the previous year, largely due to
the absence, in the 1997 period, of large contract surety losses which were
incurred during the first half of 1996.
Surety's underwriting gain for the third quarter of 1997 was in line with the
results in the first half of 1997, but deteriorated when compared with the third
quarter of 1996 due primarily to the abnormally low level of losses incurred in
the third quarter of 1996.
3.2. Life insurance
Life insurance operations (F&G Life) represented 10 percent of USF&G's revenues
before net realized gains for the first nine months of 1997 compared with 12
percent for the same period of 1996. F&G Life also represented 30 percent of the
assets at September 30, 1997 compared with 29 percent at December 31, 1996.
Financial highlights for F&G Life were as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
--------------------------------------
Sales $109 $123 $344 $288
Premiums earned 25 36 78 109
Net investment income 64 63 185 100
Operating income* 17 13 46 36
--------------------------------------
*See Glossary of Terms
F&G Life's premiums earned declined in the third quarter and first nine months
of 1997 when compared with the same periods of 1996 primarily due to a reduction
in sales of life contingent structured settlement annuities. Only structured
settlement annuities with life contingencies are recognized as premiums earned
under GAAP. Non-life contingent contracts are recorded directly in the balance
sheet on a deposit accounting basis, pursuant to SFAS No. 97. Structured
settlement annuities are sold primarily to the property/casualty segment to
settle insurance claims. The decline in sales of these annuities for the first
nine months of 1997 resulted from a higher-than-average level of structured
settlement annuities which the property/casualty segment purchased in prior
years as part of its efforts to settle older property/casualty claims. Net
investment income for the first nine months of 1997 when compared with the same
period of 1996 declined due to a lower asset base created by the transfer of
approximately $918 million of F&G Life's fixed maturities to an unaffiliated
life insurance company as part of a coinsurance transaction (refer to the
"Policy surrenders" discussion below). Despite the decrease in premiums earned
and net investment income, operating income for the quarter and nine months
ended September 30, 1997 increased when compared with the same periods of 1996,
primarily due to improved spread management on annuity and universal life
products.
Sales
The following table shows life insurance and annuity sales (premiums and
deposits) by distribution system and product type.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
--------------------------------------
Distribution System:
Brokerage $ 64 $ 84 $217 $157
National wholesaler 22 17 69 56
Direct structured settlements 22 21 50 63
Other 1 1 8 12
--------------------------------------
Total $109 $123 $344 $288
--------------------------------------
Product Type:
Single premium deferred annuities $ 57 $ 77 $201 $139
Tax sheltered annuities 20 17 64 55
Structured settlement annuities 22 21 50 63
Other annuities 5 6 16 21
Life insurance 5 2 13 10
--------------------------------------
Total $109 $123 $344 $288
--------------------------------------
F&G Life's sales declined 12 percent in the third quarter of 1997 when compared
with the same period of 1996 due to a decrease in single premium deferred
annuities ("SPDAs") which were sold through the brokerage channel. The
competitive interest rate environment in the last half of 1996 was favorable and
helped boost SPDA sales for the third quarter of 1996. Sales increased 19
percent in the first nine months of 1997 when compared with the same period of
1996. The growth in sales of SPDAs and tax sheltered annuities during the first
nine months of 1997 was primarily due to management's continued concentration on
the expansion of its new and existing products and distribution channels.
Despite this marketing emphasis, demand for its products is affected by
fluctuating interest rates and the relative attractiveness of alternative
investments, annuity or insurance products, as well as its credit ratings. Total
life insurance in force was $10.6 billion at September 30, 1997, compared with
$10.7 billion at December 31, 1996.
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.
In August 1996, F&G Life entered into a coinsurance contract with an
unaffiliated life insurance company whereby F&G Life ceded all of its remaining
block of SPDAs that were originally sold through stock brokerage firms (the
"broker SPDA block"). At the time of transaction, the broker SPDA block had a
current account value of approximately $964 million. The transaction removed
from F&G Life's direct obligations an underperforming block of business that had
significant exposure to changes in current interest rates and was subject to a
high surrender rate. As of September 30, 1997, surrender activity under the
coinsurance contract had reduced the broker SPDA block and the related
reinsurance receivable to $659 million.
Policy surrenders totaled $44 million and $125 million for the quarter and nine
months ended September 30, 1997, respectively, compared with $76 million and
$441 million for the same periods of 1996. Surrender activity has decreased
significantly due primarily to the coinsurance of the broker SPDA block. This
reduced level of surrenders is expected to continue throughout 1997.
4. RESERVES AND SURPLUS
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.
4.1. 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 incurred but not reported losses and also provide
for future development of case basis loss reserves. Total case and bulk reserves
for these mass torts, net of ceded reinsurance, comprised approximately ten
percent of total net property/casualty reserves for unpaid losses and loss
expenses at September 30, 1997 and December 31, 1996, respectively.
The following table sets 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, 1996 $ 40 $308 $135
Losses incurred 12 18 (4)
Claims paid (11) (18) (3)
-------------------------------------
Net reserves at September 30, 1997 $ 41 $308 $128
-------------------------------------
Management believes that USF&G's reserve position is adequate relative to its
exposure to mass torts. USF&G's customer base generally has not included 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.
4.2. Reinsurance
In the second quarter of 1997, United States Fidelity and Guaranty Company
("USF&G Company"), the principal property/casualty insurance subsidiary,
realigned its catastrophe reinsurance to reflect USF&G Company's strategic
initiatives in FBIG and CIG. USF&G Company secured a 60 percent quota share
treaty for its personal lines residential property business (homeowners and
dwelling/fire policies) which allows USF&G Company to limit its exposure to
historically volatile underwriting losses in these lines. To further protect
against catastrophe losses on the remainder of the FBIG residential property
business, USF&G Company obtained an aggregate excess of loss treaty providing
$15 million of coverage in excess of a $20 million annual aggregate deductible.
Effective July 1, 1997, USF&G Company expanded its property catastrophe
reinsurance coverage by reducing its retention from $75 million to $50 million
and increasing its reinsurance coverage limit from $175 million to $250 million,
providing USF&G Company protection against catastrophe losses in lines not
covered by personal lines quota share treaty.
The property catastrophe treaty provides the following coverage layers:
(in millions)
Losses and LAE Incurred Reinsurance
Above To and Including Coverage
- --------------------------------------------------------------
$ 50 $ 75 50%
75 250 90
250 300 50
- --------------------------------------------------------------
A property per risk treaty, which provides coverage of $97 million in excess of
USF&G Company's $3 million retention limit, and a Surety treaty, which provides
coverage of $65 million in excess of USF&G Company's $5 million retention limit,
are also in place.
4.3. Liquidity restrictions
There are certain restrictions on payments of dividends by insurance
subsidiaries that may limit USF&G Corporation's ability to receive funds from
its subsidiaries. Under the Maryland Insurance Code, Maryland insurance
subsidiaries, such as 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 1997, would be deemed extraordinary dividends
and subject to the thirty-day notice period. The application of the thirty-day
notice requirement is not expected to materially affect the liquidity of USF&G
Corporation.
Through November 11, 1997, USF&G Company paid dividends totaling $136 million to
USF&G Corporation. Any further dividends in 1997 are subject to the application
of the thirty-day notice requirement.
5. INVESTMENTS
USF&G's investment mix continues to reflect a concentration in high-quality,
fixed-income securities. Long-term fixed maturities comprised 81 percent of
total investments at September 30, 1997 and December 31, 1996. Total investments
have increased primarily due to an increase in the fixed maturity portfolio,
including an increase in unrealized gains on the portfolio. The following table
shows the distribution of USF&G's investment portfolio.
September 30, December 31,
(in millions) 1997 1996
----------------------------
Total investments $10,459 $10,076
----------------------------
Fixed maturities 81% 81%
Common and preferred stocks 1 --
Short-term investments 4 5
Mortgage loans and real estate 9 10
Other invested assets 5 4
----------------------------
Total 100% 100%
----------------------------
5.1. NET INVESTMENT INCOME
The following table shows the components of net investment income.
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
--------------------------------------
Net investment income from:
Taxable fixed maturities $ 138 $ 153 $ 415 $ 481
Tax-exempt fixed maturities 12 1 29 2
Common and preferred stocks -- -- -- 2
Short-term investments 7 7 23 15
Mortgage loans and real estate 15 15 49 35
Other investment income, net of
interest expense on funds held 1 5 8 14
--------------------------------------
Total investment income 173 181 524 549
--------------------------------------
Investment expenses (4) (4) (11) (12)
--------------------------------------
Net investment income $ 169 $ 177 $ 513 $ 537
--------------------------------------
Average annualized yields:
Total investments 6.8% 7.0% 7.0% 6.9%
Fixed maturities 7.3 7.3 7.3 7.3
--------------------------------------
Net investment income for the nine months ended September 30, 1997, decreased
$24 million, or four percent, when compared with the same period of 1996. Income
from fixed maturities declined $39 million in the first nine months of 1997
primarily as a result of the decline in F&G Life's fixed maturities portfolio
due to the transfer of fixed maturities to an unaffiliated life insurance
company under the terms of a coinsurance contract (refer to Section 3.2 of this
Analysis), as well as to the higher proportion of investments in tax-exempt
fixed maturities which result in lower pre-tax returns. The increase in interest
income from short-term investments year-to-date is a result of varying
short-term interest rates, changes in asset balances, and the inclusion of $2
million and $7 million for the third quarter and first nine months of 1997,
respectively, related to Afianzadora, which USF&G acquired in December 1996.
Investment income on mortgage loans and real estate for 1997 reflects the
strategy of reducing equity real estate holdings and reinvesting into commercial
mortgage loans collateralized by income-producing real estate. Other investment
income includes $4 million and $5 million in the third quarter of 1997 and 1996,
respectively, and $13 million and $14 million for the nine months ended
September 30, 1997 and 1996, 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 is interest credited to
funds held on assumed reinsurance contracts of $6 million and $4 million for the
third quarter of 1997 and 1996, respectively, and $16 million and $15 million
for the nine months ended September 30, 1997 and 1996, respectively.
5.2. Net realized gains on investments
The components of net realized gains include the following:
Three Months Ended Nine Months Ended
September 30, September 30,
(in millions) 1997 1996 1997 1996
--------------------------------------
Net Gains (Losses) on Sales:
Fixed maturities $ 2 $ (1) $(8) $ (2)
Mortgage loans and real estate 5 -- 9 4
Other -- 5 11 15
--------------------------------------
Total net gains on sales 7 4 12 17
Impairments (7) -- (8) (1)
--------------------------------------
Net realized gains on investments $-- $ 4 $ 4 $ 16
--------------------------------------
Realized losses on fixed maturities in 1997 relate to the sale of taxable bonds
in order to reinvest the proceeds in tax-exempt bonds. Realized gains on
mortgage loans and real estate for the quarter and nine months ended September
30, 1997, are a result of the sale of equity real estate investments. Other
realized gains in 1997 and 1996 primarily relate to USF&G's share of gains from
its equity in certain venture capital-type limited partnerships. Impairments
relate to specific assets and are realized when the decline in fair value is
deemed other than temporary, or when the fair value is significantly less than
book value and it is probable that the investment will be sold before any
recovery in value can occur.
5.3. Unrealized gains (losses)
The components of the changes in unrealized gains (losses) were as follows:
September 30, December 31,
(in millions) 1997 1996 Change
------------------------------------
Fixed maturities available for sale $ 233 $ 98 $135
Deferred policy acquisition costs* (37) (19) (18)
Common and preferred stocks (4) -- (4)
Foreign currency and other 13 16 (3)
------------------------------------
Total unrealized gains 205 95 110
Deferred tax on net unrealized gains (72) (33) (39)
------------------------------------
Total unrealized gains, net of tax $ 133 $ 62 $ 71
------------------------------------
*See Glossary of Terms
Fixed maturity investments classified as "available for sale" are recorded at
market value, with the corresponding unrealized gains reported as a component of
shareholders' equity. Fluctuations in the unrealized gains and losses on fixed
maturities are primarily a result of fluctuating interest rates. The change in
unrealized gains on other investments primarily relates to USF&G's share of
unrealized gains from its equity interests in certain venture capital-type
limited partnerships.
5.4. Fixed maturity investments
The table below details the composition of the fixed maturity portfolio.
September 30, December 31,
(in millions) 1997 % 1996 %
-----------------------------
Corporate and other investment grade bonds $4,180 51% $4,673 58%
Mortgage-backed securities 1,432 17 1,464 18
Asset-backed securities 683 8 731 9
U.S. Government bonds 378 5 334 4
High-yield bonds* 606 7 548 7
Tax-exempt bonds 966 12 316 4
-----------------------------
Total fixed maturities at amortized cost 8,245 100 8,066 100
Total market value of fixed maturities 8,478 8,164
-----------------------------
Net unrealized gains $ 233 $ 98
-----------------------------
Percent market-to-amortized cost 103% 101%
-----------------------------
*See Glossary of Terms
While subject to prepayment risk, credit risk related to USF&G's mortgage-backed
securities portfolio at September 30, 1997, is believed to be minimal since 99
percent of such securities have "AAA" ratings or are collateralized by
obligations of the U.S. Government or its agencies. The net proceeds from sales,
maturities and prepayments in 1997 were predominately invested in
investment-grade taxable and tax-exempt bonds. As USF&G's income tax position
changed as a result of profitability and the depletion of its income tax net
operating loss carryforwards, the focus has turned toward investing available
cashflows into a higher proportion of tax-exempt securities in order to maximize
after-tax investment income. Investment-grade bonds, including debt obligations
of the U.S. Government and its agencies, comprised 93 percent of the portfolio
at September 30, 1997 and December 31, 1996. The following table shows the
credit quality of the long-term fixed maturity portfolio at September 30, 1997.
Percent
Market-to-
Amortized Market Amortized
(in millions) Cost Percent Value Cost
---------------------------------------
U.S. Government and
U.S.Government Agencies $1,789 22% $1,824 102%
AAA 1,564 19 1,605 103
AA 1,133 14 1,163 103
A 1,973 24 2,026 103
BBB 1,181 14 1,223 104
BB 245 3 257 105
B 360 4 379 105
CCC and lower -- -- 1 NM
--------------------------------------
Total $8,245 100% $8,478 103%
--------------------------------------
The information on credit quality in the preceding table 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 September 30, 1997, USF&G's five
largest investments in high-yield bonds totaled $65 million in amortized cost
and had a market value of $66 million. USF&G's largest single high-yield bond
exposure represented five percent of the high-yield portfolio and less than one
percent of the total fixed maturity portfolio.
5.5. Real Estate
The table below shows the components of USF&G's real estate portfolio.
September 30, December 31,
(in millions) 1997 1996
----------------------------
Mortgage loans $582 $406
Equity real estate 404 554
----------------------------
Total $986 $960
----------------------------
The increase in the real estate portfolio was primarily due to new mortgage loan
originations offset by the sale of equity real estate, including eleven
operating properties. Mortgage loan originations in the first nine months of
1997 consisted of fixed rate loans collateralized primarily by apartment and
office properties. This activity is consistent with USF&G's continuing 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.
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 were 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 $14.9 billion at September 30, 1997, compared with $14.4
billion at December 31, 1996. The increase is primarily attributable to a $314
million increase in the portfolio of fixed maturity investments classified as
available for sale, primarily due to the investment of cash flow, as well as
declining interest rates which caused an increase in bond prices (refer to
Section 5.3 of this Analysis). Additionally, accounts, notes and other
receivables increased approximately $158 million due primarily to the
seasonality of the property/casulaty segment's premium writing cycle.
6.2. Liabilities
USF&G's liabilities totaled $12.8 billion at September 30, 1997, compared to
$12.3 billion at December 31, 1996, due to an increase of approximately $234
million and $104 million in unpaid losses, loss expenses and policy benefits and
other liabilities, respectively. Unpaid losses, loss expenses and policy
benefits increased essentially due to increased sales of SPDA's and the related
annuity deposit liability. The increase in other liabilities is largely due to
F&G Life's securities lending program.
6.3. Shareholder's equity
USF&G's shareholder's equity totaled $1.9 billion at September 30, 1997,
compared with $2.0 billion at December 31, 1996. The decrease is primarily the
result of the redemption of $200 million, or the entire outstanding balance, of
the Series A Preferred Stock. Redemptions of the Series A Preferred Stock were
funded by proceeds from the December 1996 and January 1997 issuances of $200
million of USF&G-obligated mandatorily redeemable preferred capital securities
of subsidiary trusts holding solely junior subordinated deferrable interest
debentures of USF&G. Net income of $140 million partly offset the decrease in
shareholder's equity.
During 1996, USF&G announced a plan to repurchase up to 13.3 million shares of
the Corporation's common stock and common stock equivalents. As of December 31,
1996, 8.6 million shares had been repurchased. The program was completed during
the first half of 1997 with the purchase of an additional 4.7 million shares. It
is uncertain at this time if, or to what extent, USF&G will expand the
repurchase program beyond those shares already reacquired, except that the board
of directors has authorized repurchases reasonably designed to offset the impact
of share issuance pursuant to director and employee incentive compensation
programs. Management and the Board of Directors will continue to evaluate share
repurchases as an alternative use of excess capital and cash flow, depending on
other investment opportunities.
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 provided by operations of $128 million for the first nine
months of 1997, compared with $266 million for the same period of 1996.
Approximately $93 million of this decrease is in the life insurance segment and
relates to the decrease in sales of products with life contingencies as well as
the decrease in investment income resulting from the transfer of investments as
part of the coinsurance contract (refer to Section 3.2 of this Analysis).
The remaining decline in operating cash flow is generally consistent with the
decreases in the property/casulaty segment's net premiums written, including
cessions under the personal lines quota share reinsurance treaty. However, the
coinsurance transaction also reduced F&G Life's exposure to cash outflows for
surrender activity. Consequently, deposits and withdrawals of universal life and
investment contracts had net cash inflows of $215 million in the first nine
months of 1997, which for GAAP purposes are classified as financing activities,
compared with net cash outflows of $194 million in the first nine months of
1996.
7.2. Credit facilities
At September 30, 1997, USF&G maintained a $250 million committed, standby credit
facility with a group of foreign and domestic banks. Borrowings outstanding
under the credit facility totaled $20 million at September 30, 1997, which was
repaid in mid-October 1997. There were no borrowings against the facility 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 these covenants at September 30, 1997 and December 31,
1996.
In addition, at September 30, 1997, USF&G maintained a $150 million
multi-currency credit facility. There were no borrowings on this credit facility
as of September 30, 1997.
8. 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.
Bulk reserves: Reserves for incurred but not reported ("IBNR") losses and for
future development of case basis loss reserves. Bulk reserves are derived using
statistical projections of ultimate incurred losses. All of the losses for which
such reserves are established have occurrence dates prior to the respective
balance sheet reporting date.
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 policy acquisition costs: Commissions and other selling expenses that
vary with and are primarily related to the production of business. These
acquisition costs are deferred and amortized over the period that premium is
earned.
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.
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 credit ratings 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.
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.
Net premiums written: Premiums retained by an insurer, after the assumption and
cession of reinsurance.
Operating income: Net income excluding realized gains and losses on investments,
branch reorganization severance, facilities exit (costs)/sublease income, income
taxes and distributions on capital securities of subsidiary trusts. Operating
income is presented in a manner which is not intended to conform with GAAP.
Management believes this presentation provides a meaningful understanding of the
core drivers of an insurance company's operations. Operating income combines
premiums earned, net investment income and other income and offsets these
amounts by losses, loss expenses and policy benefits, underwriting, acquisition
and operating expenses and interest expense. However, net realized gains on
investments, branch reorganization severance, facilities exit (costs)/sublease
income, income taxes and distributions on capital securities are significant
components of net income and should be considered in assessing USF&G's overall
financial performance. This operating income caption may not be comparable to
other similarly titled measures of the Corporation and should not be construed
as an alternative to income from continuing operations or cash flows from
operating, investing or financing activities as determined in accordance with
GAAP.
Policyholders' surplus: The net assets of an insurer as reported to regulatory
agencies based on accounting practices prescribed or permitted by the National
Association of Insurance Commissioners.
Premiums earned: The portion of premiums written applicable to the expired
period of policies.
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.
Specialty segments: Market segments within CIG which operate separate business
resource platforms individually dedicated to specific target customer groups in
specialized businesses such as financial institutions, technology, governmental
entities, large real estate, and directors & officers.
Structured settlement annuity: An immediate annuity sold to property/casualty
companies to fund the settlement ofinsurance 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 accumulated cash values to which interest is credited.
USF&G CORPORATION Part II - Other Information
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11
Computation of earnings per share.
Exhibit 12
Computation of ratio of consolidated earnings to fixed charges, distributions on
capital securities and preferred stock dividends.
Exhibit 15
Letter regarding unaudited interim financial information.
(b) Reports on Form 8-K
There were no reports on Form 8-K filed during the third quarter of 1997.
USF&G CORPORATION Exhibit 11 - Computation of Earnings Per Share (Unaudited)
Three Months Ended September 30,
(in millions except per share data) 1997 1996
---------------------------------
Net Income Available to Common Stock
Primary:
Net income $ 48 $ 35
Less preferred stock dividend requirements -- (5)
---------------------------------
Net income available to common stock $ 48 $ 30
---------------------------------
Fully diluted:
Net income $ 48 $ 35
Less preferred stock dividend requirements -- (5)
Add interest expense on zero coupon
convertible notes 1 --
---------------------------------
Net income available to common stock $ 49 $ 30
---------------------------------
Weighted-Average Shares Outstanding
Primary:
Common shares 110,898,412 117,451,252
Common stock equivalents 3,732,206 --
---------------------------------
Total primary shares 114,630,618 117,451,252
---------------------------------
Fully diluted:
Common shares 110,898,412 117,451,252
Common stock equivalents 3,732,206 --
Assumed conversion of preferred stock -- --
Assumed conversion of zero coupon
convertible notes 5,181,588 --
---------------------------------
Total fully diluted shares 119,812,206 117,451,252
---------------------------------
Earnings Per Share
Primary $ .41 $ .26
Fully diluted .40 .26
---------------------------------
USF&G CORPORATION Exhibit 11 - Computation of Earnings Per Share (Unaudited)
Nine Months Ended September 30,
(in millions except per share data) 1997 1996
---------------------------------
Net Income Available to Common Stock
Primary:
Net income $ 140 $ 159
Less preferred stock dividend requirements (2) (14)
---------------------------------
Net income available to common stock $ 138 $ 145
---------------------------------
Fully diluted:
Net income $ 140 $ 159
Less preferred stock dividend requirements (2) (12)
Add interest expense on zero coupon
convertible notes 2 3
---------------------------------
Net income available to common stock $ 140 $ 150
---------------------------------
Weighted-Average Shares Outstanding
Primary:
Common shares 111,679,284 118,753,266
Common stock equivalents 3,505,967 --
---------------------------------
Total primary shares 115,185,251 118,753,266
---------------------------------
Fully diluted:
Common shares 111,679,284 118,753,266
Common stock equivalents 3,769,814 2,308,106
Assumed conversion of preferred stock -- 2,536,315
Assumed conversion of zero coupon
convertible notes 5,181,588 5,986,552
---------------------------------
Total fully diluted shares 120,630,686 129,584,239
---------------------------------
Earnings Per Share
Primary $ 1.20 $ 1.21
Fully diluted 1.16 1.16
---------------------------------
USF&G CORPORATION Exhibit 12 - Computation of Ratio of Fixed Charges,
Distributions on Capital Securities and Preferred Stock
Dividends (Unaudited)
Nine Months Ended
September 30,
(in millions) 1997 1996
-------------------
Fixed charges
Interest expense $ 26 $ 30
Portion of rents representative of interest 7 11
-------------------
Total fixed charges 33 41
Distributions on capital securities 15 --
Preferred stock dividend requirements (A) 2 14
-------------------
Combined Fixed Charges, Distributions on Capital
Securities and Preferred Stock Dividends $ 50 $ 55
-------------------
Consolidated Earnings Available
Income from operations before income taxes and
distributions on capital securities $210 $159
Adjustment:
Fixed charges 33 41
-------------------
Consolidated earnings available for fixed charges,
distributions on capital securities and
preferred stock dividends $243 $200
-------------------
Ratio of Consolidated Earnings to Fixed Charges 7.3 4.8
Ratio of Consolidated Earnings to Combined Fixed Charges,
Distributions on Capital Securities and
Preferred Stock Dividends 4.9 3.6
-------------------
(A) Preferred stock dividend requirements of $2 million and $14 million in 1997
and 1996, respectively, divided by 100% less the effective income tax rate of
28.8% in 1997 and 0.2% in 1996.
USF&G CORPORATION Exhibit 15 - Letter Regarding Unaudited Interim
Financial Information
We are aware of the incorporation by reference in the Registration Statement
Numbers 33-20449, 33-9405, 33-33271, 33-21132, 33-51859, 33-65471 and 333-13685
on Form S-3 and Numbers 2-72026, 2-61626, 2-98232, 33-16111, 33-38113, 33-35095,
33-43132, 33-45664,33-45665, 33-61965, 33-55667, 33-55669, 33-55671, 33-59535,
33-64839 and 333-04359 on Form S-8 of USF&G Corporation, of our report relating
to the unaudited condensed consolidated interim financial statements of USF&G
Corporation which is included in this Quarterly Report (Form 10-Q) for the
quarter ended September 30, 1997.
Pursuant to Rule 436(c) of the Securities Act of 1933, our report is not a part
of the registration statements prepared or certified by accountants within the
meaning of Section 7 or 11 of the Securities Act of 1933.
ERNST & YOUNG LLP
Baltimore, Maryland
November 11, 1997
USF&G CORPORATION Signature
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
USF&G Corporation
By /s/ DAN L. HALE
--------------------------------------
Dan L. Hale
Executive Vice President and
Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)
Dated at Baltimore, Maryland
November 11, 1997
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
EXHIBITS TO QUARTERLY REPORT ON FORM 10-Q
USF&G CORPORATION
For the Quarter Ended Commission File Number
September 30, 1997 1-8233
A copy of all other of the Corporation's Exhibits to the September 30, 1997
Form 10-Q report not included herein may be obtained without charge upon
written request to John F. Hoffen, Jr., corporate secretary, at the
corporate headquarters:
6225 Centennial Way
Baltimore, Maryland 21209