1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTER ENDED MARCH 31, 1998. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____. Commission File Number 1-6563 SAFECO CORPORATION (Exact name of registrant as specified in its charter) Washington 91-0742146 (State of Incorporation) (I.R.S. Employer I.D. No.) SAFECO PLAZA, Seattle, Washington 98185 (Address of principal executive offices) (206)545-5000 (Telephone) 141,187,820 shares of no PAR VALUE common stock were outstanding at March 31, 1998. Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]. 2 SAFECO CORPORATION - -------------------------------------------------------------------------------- TABLE OF CONTENTS AND SIGNATURES Part I - Financial Information* Page ---- Item 1. Financial Statements: Consolidated Balance Sheet, 3 March 31, 1998 and December 31, 1997 Statement of Consolidated Income and Retained Earnings 5 for the Three Months Ended March 31, 1998 and 1997 Statement of Consolidated Cash Flows 6 for the Three Months Ended March 31, 1998 and 1997 Statement of Consolidated Comprehensive Income 7 for the Three Months Ended March 31, 1998 and 1997 Item 2. Management's Discussion and Analysis 8 Part II - Other Information Item 6. Exhibits and Reports on Form 8-K 13 *The accompanying unaudited condensed financial statements have been prepared in accordance with the instructions to Form 10-Q. In the opinion of management, they include all adjustments (none of which were other than normal and recurring adjustments) which are necessary for a fair presentation of results for the interim periods. It is suggested that these condensed financial statements be read in conjunction with the financial statements and the notes thereto included in the Corporation's Form 10-K for the year ended December 31, 1997 which has previously been filed with the Commission. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SAFECO CORPORATION ------------------------------------ Registrant ROD A. PIERSON ------------------------------------ Rod A. Pierson Senior Vice President Dated May 13, 1998 and Chief Financial Officer H. PAUL LOWBER ------------------------------------ H. Paul Lowber Vice President, Controller and Dated May 13, 1998 and Chief Accounting Officer -2- 3 SAFECO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Millions) - -------------------------------------------------------------------------------- March 31 December 31 ASSETS 1998 1997 -------- ----------- ----------- Investments: Fixed Maturities Available-for-Sale, at Market Value (Amortized cost: 1998 - $16,710.2; 1997 -$16,086.8) $ 17,706.9 $ 17,143.2 Fixed Maturities Held-to-Maturity, at Amortized Cost (Market value: 1998 - $3,156.4; 1997 - $3,159.9) 2,716.7 2,708.6 Marketable Equity Securities, at Market Value (Cost: 1998 - $970.3; 1997 - $969.0) 2,073.7 1,879.7 Mortgage Loans 520.0 499.0 Real Estate (At cost less accumulated depreciation) 602.9 586.1 Policy Loans 85.5 85.3 Short-Term Investments 231.0 134.7 ----------- ----------- Total Investments 23,936.7 23,036.6 Cash 122.3 391.4 Accrued Investment Income 344.1 337.0 Finance Receivables 985.4 1,004.3 Premiums and Other Service Fees Receivable 970.5 953.9 Other Notes and Accounts Receivable 80.9 71.1 Reinsurance Recoverables 283.3 311.0 Deferred Policy Acquisition Costs 554.5 544.8 Land, Buildings and Equipment for Company Use (At cost less accumulated depreciation) 242.5 238.0 Goodwill 1,324.1 1,332.6 Other Assets 416.5 341.7 Separate Account Assets 1,082.0 905.4 ----------- ----------- TOTAL $ 30,342.8 $ 29,467.8 =========== =========== (continued) -3- 4 SAFECO CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (In Millions) (continued) - -------------------------------------------------------------------------------- March 31 December 31 LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997 -------------------------------------- ----------- ----------- Losses and Adjustment Expense $ 4,367.1 $ 4,352.2 Life Policy Liabilities 267.6 262.3 Unearned Premiums 1,725.2 1,713.7 Funds Held Under Deposit Contracts 12,011.5 11,891.4 Debt: Commercial Paper 808.2 812.8 Credit Company Borrowings ($944.9 maturing within one year) 969.4 892.0 7.875% Notes Due 2005 200.0 200.0 6.875% Notes Due 2007 200.0 200.0 Other ($73.5 maturing within one year) 265.4 255.1 Other Liabilities 1,463.4 1,223.3 Income Taxes: Current 28.8 9.3 Deferred (Includes tax on unrealized appreciation of investment securities: 1998 - $722.5; 1997 - $675.6) 497.5 446.9 Separate Account Liabilities 1,082.0 905.4 ----------- ----------- Total Liabilities 23,886.1 23,164.4 ----------- ----------- Corporation-Obligated, Mandatorily Redeemable Capital Securities of Subsidiary Trust Holding Solely Junior Subordinated Debentures of the Corporation ("Capital Securities") 841.8 841.7 ----------- ----------- Preferred Stock, No Par Value: Shares Authorized: 10 Shares Issued and Outstanding: None -- -- Common Stock, No Par Value: Shares Authorized: 300 Shares Reserved for Options: (1998 - 7.7; 1997 - 7.9) Shares Issued and Outstanding: (1998 - 141.2; 1997 - 141.2) 912.7 909.3 Retained Earnings 3,361.3 3,299.1 Total Accumulated Other Comprehensive Income -- Unrealized Appreciation of Investment Securities, Net of Tax 1,340.9 1,253.3 ----------- ----------- Total Shareholders' Equity 5,614.9 5,461.7 ----------- ----------- TOTAL $ 30,342.8 $ 29,467.8 =========== =========== -4- 5 SAFECO CORPORATION AND SUBSIDIARIES STATEMENT OF CONSOLIDATED INCOME AND RETAINED EARNINGS (In Millions Except Per Share Amounts) - -------------------------------------------------------------------------------- Three Months Ended March 31 --------------------------- 1998 1997 ----------- ----------- REVENUES: Insurance: Property and Casualty Earned Premiums $ 1,029.4 $ 581.5 Life and Health Premiums and Other Revenues 86.8 66.6 ----------- ----------- Total 1,116.2 648.1 Real Estate 20.5 16.3 Finance 23.4 19.6 Asset Management 8.9 5.7 Other 14.3 12.6 Net Investment Income 374.5 291.0 Realized Investment Gain 27.9 21.7 ----------- ----------- Total 1,585.7 1,015.0 ----------- ----------- EXPENSES: Losses, Adjustment Expense and Policy Benefits 987.7 605.6 Commissions 185.4 109.1 Personnel Costs 107.2 73.1 Interest 39.0 18.5 Goodwill Amortization 13.2 1.5 Other 109.7 63.9 Amortization of Deferred Policy Acquisition Costs 201.1 110.5 Deferral of Policy Acquisition Costs (210.3) (111.9) ----------- ----------- Total 1,433.0 870.3 ----------- ----------- Income before Income Taxes 152.7 144.7 ----------- ----------- Provision for Income Taxes: Current 29.7 27.2 Deferred 0.2 5.9 ----------- ----------- Total 29.9 33.1 ----------- ----------- Income before Distributions on Capital Securities 122.8 111.6 Distributions on Capital Securities, Net of Tax (11.2) -- ----------- ----------- Net Income 111.6 111.6 Retained Earnings, Beginning of Period 3,299.1 3,042.2 Amortization of Underwriting Compensation on Capital Securities (0.1) -- Dividends Declared (45.2) (36.7) Common Stock Reacquired (4.1) (3.3) ----------- ----------- Retained Earnings, End of Period $ 3,361.3 $ 3,113.8 =========== =========== Net Income Per Share of Common Stock: Basic $ 0.79 $ 0.88 =========== =========== Diluted $ 0.79 $ 0.88 =========== =========== Dividends Paid to Common Shareholders $ 0.32 $ 0.29 =========== =========== Average Number of Shares Outstanding During the Period: Basic 141.2 126.3 =========== =========== Diluted 141.8 126.9 =========== =========== -5- 6 SAFECO CORPORATION AND SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS (In Millions) - -------------------------------------------------------------------------------- Three Months Ended March 31 ----------------------- 1998 1997 ---------- -------- OPERATING ACTIVITIES Insurance Premiums Received $ 1,079.0 $ 632.5 Dividends and Interest Received 359.7 277.6 Other Operating Receipts 53.7 46.0 Insurance Claims and Policy Benefits Paid (773.0) (557.1) Underwriting, Acquisition and Insurance Operating Costs Paid (466.1) (287.3) Interest Paid and Distributions on Capital Securities (67.9) (11.1) Other Operating Costs Paid (26.3) (27.5) Income Taxes Paid (3.6) (3.1) ---------- -------- Net Cash Provided by Operating Activities 155.5 70.0 ---------- -------- INVESTING ACTIVITIES Purchases of: Fixed Maturities Available-for-Sale (1,450.3) (538.9) Fixed Maturities Held-to-Maturity (0.3) (100.7) Equities (50.8) (10.3) Other Investments (46.1) (52.0) Maturities of Fixed Maturities Available-for-Sale 218.9 120.1 Maturities of Fixed Maturities Held-to-Maturity 0.6 0.4 Sales of: Fixed Maturities Available-for-Sale 816.6 248.7 Fixed Maturities Held-to-Maturity -- -- Equities 62.9 37.4 Other Investments 34.4 20.9 Net (Increase) Decrease in Short-Term Investments (72.0) 23.8 Finance Receivables Originated or Acquired (98.6) (115.9) Principal Payments Received on Finance Receivables 105.2 66.0 Other (18.9) (12.0) ---------- -------- Net Cash Used in Investing Activities (498.4) (312.5) ---------- -------- FINANCING ACTIVITIES Funds Received Under Deposit Contracts 310.1 402.6 Return of Funds Held Under Deposit Contracts (264.5) (199.3) Proceeds from Notes and Mortgage Borrowings 20.0 2.0 Repayment of Notes and Mortgage Borrowings (10.5) (1.7) Net Proceeds from Short-Term Borrowings 89.9 69.2 Common Stock Reacquired (4.8) (3.4) Dividends Paid to Stockholders (45.2) (36.6) Other (21.2) 3.0 ---------- -------- Net Cash Provided by Financing Activities 73.8 235.8 ---------- -------- Net Decrease in Cash (269.1) (6.7) Cash at the Beginning of Period 391.4 55.5 ---------- -------- Cash at the End of Period $ 122.3 $ 48.8 ========== ======== (continued) -6- 7 SAFECO CORPORATION AND SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS (In Millions) (continued) - -------------------------------------------------------------------------------- Three Months Ended March 31 --------------------- 1998 1997 -------- -------- Net Income $ 111.6 $ 111.6 -------- -------- Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Realized Investment Gain (27.9) (21.7) Amortization and Depreciation 39.3 16.9 Amortization of Fixed Maturity Investments (7.3) (9.0) Deferred Income Tax Expense 0.2 5.9 Interest Expense on Deposit Contracts 147.4 116.8 Other Adjustments 6.5 -- Changes in: Losses and Adjustment Expense 14.9 (63.9) Life Policy Liabilities 5.3 0.3 Unearned Premiums 11.5 1.4 Accrued Income Taxes 19.5 24.7 Accrued Interest on Accrual Bonds (14.9) (11.8) Accrued Investment Income (7.1) (10.2) Deferred Policy Acquisition Costs (8.9) (0.7) Other Assets and Liabilities (134.6) (90.3) -------- -------- Total Adjustments 43.9 (41.6) -------- -------- Net Cash Provided by Operating Activities $ 155.5 $ 70.0 ======== ======== SAFECO CORPORATION AND SUBSIDIARIES STATEMENT OF CONSOLIDATED COMPREHENSIVE INCOME (In Millions) - -------------------------------------------------------------------------------- Three Months Ended March 31 --------------------- 1998 1997 -------- -------- Net Income $ 111.6 $ 111.6 Other Comprehensive Income, Net of Taxes: Change in Unrealized Appreciation of Investment Securities 87.6 (179.2) -------- -------- Comprehensive Income (Loss) $ 199.2 $ (67.6) ======== ======== -7- 8 SAFECO CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS - -------------------------------------------------------------------------------- SAFECO Corporation - ------------------ Our net income for the first quarter was $111.6 million or $0.79 per share, compared with $0.88 per share for the first quarter of 1997. If we exclude realized gain from investments, our income was $0.66 per share, compared with $0.77 per share in 1997. The 1998 amounts include the results of American States Financial Corporation which was acquired on October 1, 1997. The acquisition has been treated as a purchase for accounting purposes; therefore, American States' operations are included in SAFECO's consolidated financial statements from October 1, 1997 forward. The following summarized financial information sets forth the contributions of each business segment to our consolidated income. Three Months Ended March 31 -------------------------- 1998 1997 --------- --------- (In Millions Except Per Share Amounts) Income (Loss) before Realized Gain and Income Taxes: Property and Casualty Insurance: Underwriting Gain (Loss) $ (10.9) $ 7.3 Net Investment Income 118.1 70.4 Goodwill Amortization (10.7) -- --------- --------- Total Property and Casualty 96.5 77.7 Life and Health Insurance 36.4 37.2 Real Estate 1.2 2.8 Credit 5.5 4.5 Asset Management 2.0 1.0 Corporate (16.8) (0.2) --------- --------- Total 124.8 123.0 Realized Investment Gain before Tax 27.9 21.7 --------- --------- Income before Income Taxes 152.7 144.7 --------- --------- Provision for Income Taxes on: Income before Realized Gain 20.4 26.2 Realized Investment Gain 9.5 6.9 --------- --------- Total 29.9 33.1 --------- --------- Income before Distributions on Capital Securities 122.8 111.6 Distributions on Capital Securities, Net of Tax (11.2) -- --------- --------- Net Income $ 111.6 $ 111.6 ========= ========= Net Income Per Share of Common Stock: Income before Realized Gain $ .66 $ .77 Realized Gain .13 .11 --------- --------- Net Income $ .79 $ .88 ========= ========= -8- 9 SAFECO CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - -------------------------------------------------------------------------------- Property and Casualty Insurance Property and casualty operations for the first quarter of 1998 produced pretax income of $96.5 million before realized gain from investments, compared with $77.7 million a year ago. The company had a $10.9 million underwriting loss during the first quarter of 1998, compared with a profit of $7.3 million a year ago. The underwriting results for the first quarter of 1998 and the first quarter of 1997 are detailed further in the chart below. The combined loss and expense ratio was 101.1 for the first quarter, compared with 98.7 for the first quarter last year. Investment income was $118.1 million for the first quarter of 1998. Underwriting Results (In Millions) First Qtr. 1998 First Qtr. 1997 --------------- --------------- SAFECO Personal auto $ 5.8 $ 4.2 Homeowners 2.2 (11.2) Other personal lines 1.1 3.7 Commercial (11.4) 6.1 Surety 6.9 4.5 Other (0.1) -- American States Business insurance (15.2) -- Personal lines (0.2) -- ------- ------- Total ($ 10.9) $ 7.3 ======= ======= SAFECO Personal auto, our largest line, reported an underwriting profit of $5.8 million for the first quarter, compared with a profit of $4.2 million in the first quarter a year ago. The number of vehicles insured at the end of March was 8% higher than a year ago. Average loss costs continued to decrease during the first quarter due to a decline in both the frequency and severity of bodily injury claims. Homeowners had an underwriting profit of $2.2 million for the first quarter, compared with a loss of $11.2 million for the first quarter of 1997. Catastrophe losses for this line were $6 million during the quarter, compared with $14 million for the first quarter last year. Higher prices, increased deductibles and initiatives to improve insurance to value have also contributed to the improvement in results. Other personal lines, which provide coverage for earthquake, dwelling fire, inland marine, and boats, produced an underwriting profit of $1.1 million for the quarter, compared with $3.7 million for the same quarter last year. Commercial reported an underwriting loss of $11.4 million for the first quarter, operating at a combined ratio of 107.4. This compares with a loss of $9.2 million last quarter (combined ratio of 106.1) and a profit of $6.1 million in the first quarter last year (combined ratio of 95.9). Increased price competition, particularly for workers' compensation, has had an adverse impact on results. Surety produced a profit of $6.9 million, compared with a profit of $4.5 million in the first quarter last year. Premiums written during the first three months, excluding American States, increased 9% over a year ago with personal lines up 8% and commercial lines up 12%. American States American States Business Insurance reported an underwriting loss of $15.2 million for the first quarter, operating at a combined ratio of 106.7. Weather-related losses were $19 million in the first quarter. Premiums written by American States were down 2% from the first quarter a year ago. -9- 10 SAFECO CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - -------------------------------------------------------------------------------- Life and Health Insurance Our life and health insurance operations produced a pretax profit, before realized gain from investments, of $36.4 million for first quarter of 1998. This compares with $37.2 million for the same period last year. Earnings for the annuity lines were $16.3 million, compared with $13.9 million reported for the first quarter of 1997. Annuity assets now total $11.9 billion, up from the $10.8 billion at the end of 1997. These increases are primarily due to the acquisition of WM Life Insurance Company. Group insurance experienced a loss of $1.4 million for the first quarter of 1998, compared with a profit of $4.3 million for the first quarter of 1997. Adverse experience in medical aggregate stop loss coverages is the main contributor to the loss during the quarter. Individual life earnings were $2.5 million, compared with less than $1 million for the same period last year. This increase is the result of the acquisition of American States Life Insurance Company. On March 10, 1998 Standard & Poor's issued revised ratings for SAFECO Life Insurance Company, lowering its claims-paying ability rating to AA- from AA. The revised ratings are lower due to SAFECO's acquisition of American States and the related financings, yet remain strong -- reflecting SAFECO Life's good market position and operating performance, and excellent liquidity. Real Estate SAFECO Properties' pretax income was $1.2 million for the first quarter of 1998, compared with $2.8 million in 1997. This decrease is attributed to the expensing of carrying costs on a regional shopping center that is being renovated and the start-up costs and additional depreciation charges related to our newly opened Redmond Town Center project in Redmond, Washington. Although SAFECO Properties has a significant portfolio of enclosed malls, community retail centers and office properties, this business no longer provides a good strategic fit for SAFECO. The acquisition of American States has focused our strategies on providing insurance and financial products through the independent agency distribution system. Therefore, on February 5, 1998, we announced that SAFECO Properties, Inc., is for sale, and Salomon Smith Barney has been retained to assist in this process. We anticipate that a sale will be closed in the second half of this year. -10- 11 SAFECO CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - -------------------------------------------------------------------------------- Credit SAFECO Credit Company produced a first quarter pretax profit of $5.5 million for 1998, compared with $4.5 million in 1997. The results reflect portfolio growth, low write-off and delinquency experience, and a decreasing operating expense ratio. SAFECO Credit's summarized financial information is as follows (in millions): March 31 December 31 1998 1997 ---------- ---------- Finance Receivables $ 985.4 $ 1,004.3 Other Assets 252.0 273.9 ---------- ---------- Total Assets $ 1,237.4 $ 1,278.2 ========== ========== Credit Company Borrowings $ 969.4 $ 892.0 Other Liabilities 147.7 268.5 ---------- ---------- Total Liabilities $ 1,117.1 $ 1,160.5 ========== ========== Three Months Ended March 31 ------------------------------ 1998 1997 ---------- ---------- Revenues $ 26.0 $ 21.9 Expenses 20.5 17.4 ---------- ---------- Income before Income Taxes 5.5 4.5 Provision for Income Taxes 2.0 1.5 ---------- ---------- Net Income $ 3.5 $ 3.0 ========== ========== Asset Management The pretax profit from asset management activities for the first quarter of 1998 was $2.0 million, compared with $1.0 million in the first quarter last year. Our operating profit (excluding gains and interest income) was $1.3 million versus $0.7 million last year. These improved results were due to increased assets under management, which now total $6.5 billion versus $3.7 billion last year, a rise of 76%. Strong performance by our mutual funds and expanded distribution continue to drive increases in sales of our asset management products. Investment Portfolios The market value of our consolidated bond portfolio was $1.4 billion in excess of amortized cost at March 31, 1998, down slightly from $1.5 billion at December 31, 1997. The market value of our equity securities portfolio was $1.1 billion in excess of cost at March 31, 1998, up from $0.9 billion at December 31, 1997. Subsequent Event - Storms During April various parts of the country experienced significant adverse weather events, particularly the states of Kentucky, Georgia, Alabama and Tennessee. On May 5, 1998 SAFECO announced that it expects approximately $25 million in claims from these events. The losses will be recorded in the second quarter. Stock Purchase Program In February 1996, the Board of Directors approved the continuation of the stock purchase program and reauthorized a total accumulation of up to two million shares, about 2% of our issued shares. At April 24, 1998, 490,000 shares have been purchased. -11- 12 SAFECO CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS (Continued) - -------------------------------------------------------------------------------- Other -- Footnotes The following additional footnote disclosure relates to new accounting standards. Nature of Operations and Summary of Significant Accounting Policies -- New Accounting Standards In June of 1997, the Financial Accounting Standards Board (FASB) issued Statement 130, "Reporting Comprehensive Income." Statement 130 is effective for fiscal years beginning after December 15, 1997 and SAFECO adopted it in the first quarter of 1998. The Statement has no effect on net income but requires the reporting of "comprehensive income," which includes net income and certain items currently reported in shareholders' equity. See the "Statement of Consolidated Comprehensive Income" on page 7 of this report. The FASB issued Statement 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" in February 1998. Statement 132 revises employers' disclosures about pension and other postretirement benefit plans. This statement is effective for financial statements for periods beginning after December 15, 1997, and SAFECO will provide the disclosures in its 1998 annual report. This statement has no effect on net income. -12- 13 SAFECO CORPORATION Part II - Other Information - -------------------------------------------------------------------------------- Item 6. Exhibits and Reports on Form 8-K (a) Exhibits: Exhibit 10* - Executive Severance Agreement between SAFECO Corporation, SAFECO Life Insurance Company and Randall H. Talbot dated February 7, 1998. Exhibit 27 - Financial Data Schedule. (This exhibit is included only in the electronic EDGAR filing version of this 10-Q. The Financial Data Schedule is not a separate financial statement but a schedule that summarizes certain standard financial information extracted directly from the financial statements in this filing.) (b) Reports on Form 8-K The Registrant filed two Forms 8-Ks during the quarter ended March 31, 1998. The Registrant filed an 8-K dated January 6, 1998, under Item 5 (Other Items), related to the extension of the exchange period to December 19, 1997 during which holders of its 6 7/8% Notes due July 15, 2007 and SAFECO Capital Trust's 8.072% Capital Securities could exchange such securities for like securities that have been registered pursuant to the Securities Act of 1933, as amended. The Registrant filed an 8-K dated February 5, 1998, under Item 5, announcing that it was putting its real estate subsidiary, SAFECO Properties, Inc., up for sale. *A copy of this exhibit is available without charge by making a written request to: Rod A. Pierson Senior Vice President and Chief Financial Officer SAFECO Corporation SAFECO Plaza Seattle, Washington 98185 -13-