Exhibit 99.01
Travelers Group Inc.
INDEX TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
---------------------------------
Page No.
--------
Five Year Summary of Selected Supplemental Financial Data 2
Management's Discussion and Analysis of
Financial Condition and Results of Operations 3
Supplemental Financial Statements
Supplemental Consolidated Statement of Income for the year ended
December 31, 1996, 1995 and 1994 39
Supplemental Consolidated Statement of Financial Position at
December 31, 1996 and 1995 40
Supplemental Consolidated Statement of Changes in Stockholders'
Equity for the year ended December 31, 1996, 1995 and 1994 41
Supplemental Consolidated Statement of Cash Flows for the year ended
December 31, 1996, 1995 and 1994 42
Notes to Supplemental Consolidated Financial Statements 43
Schedules:
Schedule I - Condensed Financial Information of
Registrant (Parent Company only) 92
Independent Auditors' Report 96
1
Travelers Group Inc. and Subsidiaries
FIVE-YEAR SUMMARY OF SELECTED SUPPLEMENTAL FINANCIAL DATA
(In millions of dollars, except per share amounts)
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
Year Ended December 31, (1)
- ---------------------------
Total revenues $ 32,414 $ 27,287 $ 22,719 $ 16,964 $ 13,883
======== ======== ======== ======== ========
Income from continuing operations $ 3,282 $ 2,141 $ 747 $ 1,843 $ 1,335
Discontinued operations (334) 150 180 (28) (29)
Cumulative effect of accounting changes (2) -- -- -- (72) (28)
-------- -------- -------- -------- --------
Net income $ 2,948 $ 2,291 $ 927 $ 1,743 $ 1,278
======== ======== ======== ======== ========
Return on average common stockholders' equity (3) 18.0% 16.3% 6.6% 19.9% 17.2%
At December 31, (1)
- -------------------
Total assets $345,948 $302,344 $287,093 $286,125 $183,610
Long-term debt $ 24,696 $ 22,235 $ 22,277 $ 18,683 $ 12,484
Redeemable preferred securities $ 420 $ 560 $ 700 $ 700 $ 700
Redeemable preferred securities of subsidiary trusts $ 2,245 -- -- -- --
Stockholders' equity (4) $ 17,942 $ 15,853 $ 12,432 $ 13,872 $ 7,860
Per common share data (5):
- --------------------------
Income from continuing operations $ 2.74 $ 1.76 $ 0.52 $ 1.96 $ 1.45
Discontinued operations (0.29) 0.13 0.16 (0.03) (0.03)
Cumulative effect of accounting changes -- -- -- (0.08) (0.03)
-------- -------- -------- -------- --------
Net income $ 2.45 $ 1.89 $ 0.68 $ 1.85 $ 1.39
======== ======== ======== ======== ========
Cash dividends per common share (5) $ 0.300 $ 0.267 $ 0.192 $ 0.163 $ 0.121
Book value per common share (5) $ 14.74 $ 13.06 $ 10.03 $ 10.92 $ 8.74
Book value per common share, excluding
FAS No. 115 adjustment (4,5) $ 14.33 $ 12.39 $ 11.20
Other data:
- -----------
Average number of common shares
and equivalents (millions) (5) 1,138.5 1,132.7 1,147.1 901.5 864.0
Year-end common shares
outstanding (millions) (5) 1,141.2 1,129.1 1,128.9 1,168.8 852.1
Number of full-time employees 64,814 56,039 60,970 68,543 24,546
(1) All periods have been restated for the inclusion of Salomon Inc. The
results of Aetna P&C are included only from the date of acquisition, April
2, 1996. Results of operations prior to 1994 exclude the amounts of The
Travelers Corporation (old Travelers), except that results for 1993
include the Company's equity in earnings relating to the 27% interest
purchased in December 1992. Results of operations include the Shearson
Businesses from July 31, 1993, the date of acquisition (see Note 2 of
Notes to Supplemental Consolidated Financial Statements). Data relating to
financial position for 1992 exclude old Travelers and the Shearson
Businesses.
(2) Cumulative effect of accounting changes in 1993 represent a change in
accounting for postretirement benefits other than pensions and a change in
accounting for postemployment benefits. Cumulative effect of accounting
changes in 1992 represent a change in accounting for income taxes.
(3) The return on average common stockholders' equity is calculated using
income before the cumulative effect of accounting changes after deducting
preferred stock dividend requirements.
(4) Stockholders' equity at December 31, 1996 and 1995 reflects $469 million
and $756 million, respectively, of net unrealized gains on investment
securities and at December 31, 1994 reflects $1.3 billion of net
unrealized losses on investment securities, pursuant to the adoption of
FAS No. 115 "Accounting for Certain Investments in Debt and Equity
Securities" in 1994.
(5) During 1996 the Company's Board of Directors declared a three-for-two
stock split in January and a four-for-three stock split in October (both
payable in the form of stock dividends), which combined are the equivalent
of a two-for-one stock split. On October 22, 1997 the Company declared a
three-for-two stock split paid on November 19, 1997. All amounts presented
herein have been restated to reflect the stock splits.
2
Travelers Group Inc. and Subsidiaries
MANAGEMENT'S DISCUSSION and ANALYSIS of FINANCIAL CONDITION
and RESULTS of OPERATIONS
Consolidated Results of Operations
Year Ended December 31,
------------------------------
(In millions, except per share amounts) 1996 1995 1994
-------- -------- --------
Revenues $ 32,414 $ 27,287 $ 22,719
======== ======== ========
Income from continuing operations $ 3,282 $ 2,141 $ 747
Income (loss) from discontinued operations (334) 150 180
======== ======== ========
Net income $ 2,948 $ 2,291 $ 927
======== ======== ========
Income (loss) per share*:
Continuing operations $ 2.74 $ 1.76 $ 0.52
Discontinued operations (0.29) 0.13 0.16
======== ======== ========
Net income $ 2.45 $ 1.89 $ 0.68
======== ======== ========
Weighted average number of common shares
outstanding and common stock equivalents* 1,138.5 1,132.7 1,147.1
======== ======== ========
- ----------
* During 1996 the Company's Board of Directors declared a three-for-two
stock split in January and a four-for-three stock split in October (both
payable in the form of stock dividends), which combined are the equivalent
of a two-for-one stock split. On October 22, 1997 the Company declared a
three-for-two stock split paid on November 19, 1997. All amounts presented
herein have been restated to reflect the stock splits.
Merger with Salomon Inc
On November 28, 1997, a newly formed wholly owned subsidiary of Travelers Group
Inc. merged with and into Salomon Inc (Salomon) (the Merger). Under the terms of
the Merger, approximately 188 million shares of Travelers Group Inc. (TRV)
common stock were issued in exchange for all of the outstanding shares of
Salomon common stock, based on an exchange ratio of 1.695 shares of TRV common
stock for each share of Salomon common stock, for a total value of approximately
$9 billion. Each of Salomon's series of preferred stock outstanding was
exchanged for a corresponding series of TRV preferred stock having substantially
identical terms, except that the TRV preferred stock issued in conjunction with
the Merger has certain voting rights. Thereafter, Smith Barney Holdings Inc.
(Smith Barney), a wholly owned subsidiary of TRV, was merged with and into
Salomon to form Salomon Smith Barney Holdings Inc. (Salomon Smith Barney), which
is the primary vehicle through which TRV engages in investment banking,
proprietary trading, retail brokerage and asset management. The Merger was
treated as a tax-free exchange and accounted for under the pooling of interests
method.
As a result of the Merger, the Company expects to record an after-tax
restructuring charge of between $400 million and $500 million primarily for
severance and costs related to excess or unused office space and other
facilities.
Overview
Consolidated results of operations include the accounts of TRV and its
subsidiaries, including Salomon Inc and its subsidiaries (collectively, the
Company). As discussed in Note 2 of Notes to Supplemental Consolidated Financial
Statements, on April 2, 1996, Travelers Property Casualty Corp. (formerly
Travelers/Aetna Property Casualty Corp.) (TAP), an indirect majority-owned
subsidiary of TRV, acquired the domestic property and casualty insurance
3
subsidiaries of Aetna Services Inc. (formerly Aetna Life and Casualty Company)
(Aetna P&C) for approximately $4.16 billion in cash. This acquisition was
financed in part by the issuance by TAP of common stock resulting in a minority
interest in TAP of approximately 18%. The acquisition was accounted for under
the purchase method of accounting and, accordingly, the supplemental
consolidated financial statements include the results of Aetna P&C's operations
only from the date of acquisition. TAP also owns The Travelers Indemnity Company
(Travelers Indemnity). Travelers Indemnity along with Aetna P&C, are the primary
vehicles through which the Company engages in the property and casualty
insurance business.
Results of Operations
Income from continuing operations for the year ended December 31, 1996 was
$3.282 billion compared to $2.141 billion in 1995 and $747 million in 1994.
Included in income from continuing operations for the years ended December 31,
1996, 1995 and 1994 are net after-tax gains (losses) of $101 million, $74
million and $(91) million, respectively, as follows:
1996
- ----
o $346 million (after minority interest) charge for reserve adjustments and
restructuring costs related to the acquisition of Aetna P&C;
o $363 million gain from the sale of Class A Common Stock by TAP;
o $31 million gain from the sale of The Mortgage Corporation Limited;
o $26 million net gain from the disposition of investment advisory
affiliates; and
o $27 million (after minority interest) of reported investment portfolio
gains.
1995
- ----
o $13 million provision for loss on disposition of an affiliate; and
o $87 million of reported investment portfolio gains.
1994
- ----
o $189 million charge to correct general ledger balances at Salomon Smith
Barney;
o $102 million income tax benefit resulting from the reversal of reserves
established in prior years to cover potential tax liabilities;
o $79 million gain on the sales of subsidiaries and affiliates; and
o $83 million of reported investment portfolio losses.
Excluding these items, income from continuing operations for 1996 increased
$1.114 billion to $3.181 billion, or 54%, over 1995, primarily reflecting
improved performance at Salomon Smith Barney, the inclusion of the property and
casualty business acquired from Aetna Services Inc. and increased earnings in
the Life Insurance segment.
On the same basis, income from continuing operations for 1995 increased $1.229
billion to $2.067 billion, or 147%, over 1994, primarily reflecting improved
performance at Salomon Smith Barney.
The following discussion presents in more detail each segment's operating
performance.
4
Investment Services
Year Ended December 31,
-------------------------------------------------------------------------
1996 1995 1994
-------------------------------------------------------------------------
Net Income Net Income Net Income
(millions) Revenues (loss) Revenues (loss) Revenues (loss)
- ------------------------------------------------------------------------------------------------------------------------------------
Salomon Smith Barney (1)(2) $18,871 $ 1,871 $17,512 $ 1,112 $13,310 $ (20)
Mutual funds and asset management -- -- -- -- 156 32
- ------------------------------------------------------------------------------------------------------------------------------------
Total Investment Services $18,871 $ 1,871 $17,512 $ 1,112 $13,466 $ 12
====================================================================================================================================
(1) Net income for 1996 includes a $31 million after-tax gain on the sale of
The Mortgage Corporation Limited. Net income for 1994 income includes a
$21 million after-tax gain from the sale of the interest in HG Asia; a
$189 million after-tax charge to correct general ledger balances; and a
$102 million income tax benefit that resulted from the reversal of
reserves established in prior years to cover potential tax losses.
(2) Excludes results of Basis Petroleum which are classified as discontinued
operations.
In 1994 mutual funds and asset management sub-segment included the limited
partnership interest in RCM Capital Management, a California Limited Partnership
(RCM) and the operations of American Capital Management & Research, Inc.
(American Capital) through its date of sale in December 1994. RCM is reported as
part of Corporate and Other in 1995 and through its date of sale in 1996.
Salomon Smith Barney
Salomon Smith Barney's income was $1,871 million for the year ended December 31,
1996, an increase of 68% from $1,112 million for the year ended December 31,
1995. Salomon Smith Barney's 1996 income includes a $48 million pre tax gain
($31 million after-tax) on the sale of The Mortgage Corporation Limited. Salomon
Smith Barney's $20 million net loss in 1994 included pre tax charges of $303
million ($189 million after-tax) to correct general ledger balances and a $102
million income tax benefit that resulted from the reversal of reserves
established in prior years to cover potential tax liabilities.
Salomon Smith Barney Revenues
Year Ended December 31,
- --------------------------------------------------------------------------------
(millions) 1996 1995 1994
- --------------------------------------------------------------------------------
Commissions $ 2,612 $ 2,376 $ 2,171
Asset management and
administration fees 1,390 1,087 962
Investment banking 2,001 1,318 1,167
Principal transactions 3,027 2,140 420
Interest income, net* 1,488 1,645 1,357
Other income 178 149 121
================================================================================
Net revenues* $10,696 $ 8,715 $ 6,198
================================================================================
* Net of interest expense of $8,175 million, $8,797 million and $7,112
million in 1996, 1995 and 1994, respectively. Revenues included in the
supplemental consolidated statement of income are before deductions for
interest expense.
5
Revenues, net of interest expense increased $2 billion in 1996 over 1995 levels.
Salomon Smith Barney's 1996 results reflect improvements in most businesses,
including fixed income trading, investment banking, asset management and retail
sales. These improvements were partially offset by a decrease in revenues from
equities trading.
Commission revenues increased 10% in 1996 to $2.6 billion, from $2.4 billion in
1995 and $2.2 billion in 1994. The 1996 increase reflects growth in sales of
listed and over-the-counter (OTC) securities, as well as increased insurance and
annuity sales. The 1995 increase reflects growth in listed and OTC securities
and option activity, offset by declines in futures, mutual funds and insurance
activity.
Investment banking revenues increased 52% in 1996 to $2.0 billion from $1.3
billion in 1995 and $1.2 billion in 1994. The 1996 increase in revenues was
attributable to significant improvements in equity and debt underwriting,
combined with a higher level of advisory fees.
Principal transaction revenues from fixed income for the year increased 128% to
$2.0 billion in 1996 from $900 million in 1995, reflecting strong performances
in customer sales and trading, favorable market conditions, and excellent
results in proprietary trading. Fixed income revenues in 1994 were $132 million,
reflecting the impact of a lower volume of customer activity and trading losses
in certain products.
Principal transaction revenues from equities decreased 42% in 1996 to $576
million from $1.0 billion in 1995. Equity revenues were $357 million in 1994.
The decline in 1996 primarily reflects losses associated with long-term
proprietary equity strategies. Results for 1995 reflect strong performances in
both customer sales and trading and proprietary trading, while 1994 results
reflect modest losses from proprietary trading coupled with a lower level of
revenues from customer sales and trading.
Principal transaction revenues from physical commodities were $393 million in
1996, compared with $238 million in 1995 and $191 million in 1994.
1994 principal transaction revenues include a pre tax accounting charge of $303
million to correct general ledger balances of which $194 million is related to
London-based companies and $109 million arose from the completion of a detailed
review of Salomon's general ledger balances related to interest rate swaps.
Asset management and administration fees rose to $1.4 billion in 1996, up 28%
from $1.1 billion in 1995 and $1.0 billion in 1994. The increase is due to
growth in assets under management, as well as bringing in-house all of the
administrative functions for Smith Barney proprietary mutual funds and money
funds in the third quarter of 1995.
Assets Under Management
At December 31,
------------------
(billions) 1996 1995
- --------------------------------------------------------------------------------
Salomon Smith Barney $175.6 $145.0
Travelers Life and Annuity (1) 21.5 22.1
- --------------------------------------------------------------------------------
Total Assets Under Management $197.1 $167.1
================================================================================
(1) Part of the Life Insurance Services segment.
Net interest and dividends decreased 10% in 1996 to $1.5 billion from $1.6
billion in 1995. The decrease is primarily due to a decrease in net inventory
balances partially offset by increased margin lending to clients. In
6
1994, net interest and dividends were $1.4 billion. The increase in 1995 was
primarily due to an increase in net inventory balances, partially offset by
increased financing costs.
Gain on sale of subsidiaries and affiliates in 1996 includes a pre-tax gain of
$48 million related to the sale of the Company's indirect wholly-owned
subsidiary The Mortgage Corporation Limited, which originated and serviced
residential mortgages in the United Kingdom.
The increase in noninterest expenses in 1996 primarily reflects an increase in
production-related compensation and employee benefits expense, reflecting
Salomon Smith Barney's increased revenues. Compensation and employee-related
expenses as a percentage of revenues, net of interest expense was 52% in 1996,
compared with 56% in 1995 and 71% in 1994. The ratio of non-compensation
expenses to revenues, net of interest expense was 20% in 1996, 23% in 1995 and
32% in 1994. Salomon Smith Barney continues to maintain its focus on controlling
fixed expenses.
Asset Quality -- Salomon Smith Barney's assets at December 31, 1996 were
approximately $246.1 billion, consisting primarily of highly liquid marketable
securities and collateralized receivables. Approximately 51% of these assets
represent trading securities, commodities and derivatives used for proprietary
trading and to facilitate customer transactions. About 40% of these assets were
related to collateralized financing transactions where U.S. Government and
mortgage-backed securities are bought, borrowed, sold and lent in generally
offsetting amounts. A significant portion of the remainder of the assets
represented receivables from brokers, dealers, clearing organizations and
customers that relate to securities transactions in the process of being
settled. The carrying values of the majority of Salomon Smith Barney's
securities inventories are adjusted daily to reflect current prices. See Notes
1, 7, 8, 9 and 20 of Notes to Supplemental Consolidated Financial Statements for
a further description of these assets.
Smith Barney's assets are financed through a number of sources including long
and short-term credit facilities, the financing transactions described above and
payables to brokers, dealers and customers.
Outlook -- Salomon Smith Barney's business is significantly affected by the
levels of activity in the securities markets, which in turn are influenced by
the level and trend of interest rates, the general state of the economy and the
national and worldwide political environments, among other factors.
The following is a discussion of derivatives and risk management as they relate
to the operations of Salomon Smith Barney.
DERIVATIVE INSTRUMENTS
- --------------------------------------------------------------------------------
Derivatives are an integral element of the world's financial and commodity
markets. Globalization of economic activity has brought more market participants
in contact with foreign exchange and interest rate risk at a time when market
volatility has increased. Salomon Smith Barney has developed many techniques
using derivatives which enhance the efficiency of capital and trading risk
management.
DERIVATIVE INSTRUMENTS - OVERVIEW
Derivative instruments are contractual commitments or payment exchange
agreements between counterparties that "derive" their value from some underlying
asset, index, interest rate or exchange rate. The markets for these instruments
have grown tremendously over the past decade. A vast increase in the types of
derivative users and their motivations in using these products has resulted in
an expansion of geographic coverage, transaction volume and liquidity, and the
number of underlying products and instruments.
Derivatives have been used quite successfully by multinational corporations to
hedge foreign currency exposure, by financial institutions to manage gaps in
maturities between assets and liabilities, by investment companies to reduce
transaction costs and take positions in foreign markets without assuming
currency risk, and by non-financial companies to fix the prices of inputs into
the manufacturing process or prices of the products they sell. Derivatives
7
are also used by investors when, considering such factors as taxes, regulations,
capital, and liquidity, they provide the most efficient means of taking a
desired market position. These are just a few of the business objectives for
which derivatives are used. The list of objectives is large and continues to
grow rapidly.
Derivatives are accounted for and settled differently than cash instruments and
their use requires special management oversight. Such oversight should ensure
that management understands the transactions to which they commit their firms
and that the transactions are executed in accordance with sensible corporate
risk policies and procedures. Publications such as the Basle Committee on
Banking Supervision's July 1994 report, Risk Management Guidelines for
Derivatives; the International Organization of Securities Commissions' July 1994
report, Operational and Financial Risk Management Control Implications for
Over-The-Counter Derivatives Activities of Regulated Securities Firms; or the
Group of Thirty ("G-30") July 1993 report, Derivatives: Practices and
Principles, each provide an excellent framework for developing strong management
policies and procedures.
In 1994, Salomon adopted the G-30 report as its model for control of its OTC
derivatives activities. Subsequently, Salomon began working with five other U.S.
securities firms, forming the Derivatives Policy Group ("DPG"), to develop the
"Framework for Voluntary Oversight" of OTC derivatives activities of unregulated
affiliates of U.S. Securities and Exchange Commission ("SEC") registered broker
dealers. In March of 1995, the DPG agreed with the SEC to implement the
framework. The framework encompasses management controls, enhanced reporting,
evaluation of risk in relation to capital and counterparty relations.
Salomon's adoption of the DPG framework resulted in modifications and/or
enhancements to Salomon Smith Barney's existing control procedures, including
the establishment by the Board of Directors of an OTC Derivatives Activity and
Transaction Oversight Committee ("Authorizing Body"), a Board-reviewed firmwide
market risk limit, a quarterly SEC and CFTC reporting package, annual reviews of
internal risk management control objectives and reviews by Salomon's external
auditors (provided to the SEC and CFTC) of inventory pricing and modeling
procedures.
The Authorizing Body, which consists of senior risk managers and senior control
managers from Salomon's businesses, has established guidelines which include
Salomon's framework for independent market risk measurement and monitoring; the
scope of permitted activity for Salomon's OTC derivative activities both as
dealer and end user; and the establishment of requirements for the periodic
review of risks related to the credit, funding, legal and processing aspects of
its derivatives activities.
The reports provided to the SEC and CFTC by Salomon and other DPG participants
provide insight into the OTC derivative activities conducted by unregulated
affiliates of U.S. broker dealers. Information provided by Salomon on such
reports includes:
- firmwide current credit exposure to its top 20 current net exposure
counterparties,
- firmwide current exposures by counterparty credit rating,
- potential exposures by counterparty credit rating,
- net revenues derived from OTC derivative activities in unregulated
entities, and
- OTC derivatives business revenue sensitivity to certain market
movements.
Derivatives activities, like Salomon Smith Barney's other ongoing business
activities, give rise to market, credit, and operational risks. Market risk
represents the risk of loss from adverse market price movements. While market
risk relating to derivatives is clearly an important consideration for
intermediaries such as Salomon Smith Barney, such risk represents only a
component of overall market risk, which arises from activities in non-derivative
instruments as well. Consequently, the scope of Salomon Smith Barney's market
risk management procedures extends beyond derivatives to include all financial
instruments and commodities. Credit risk is the loss that Salomon Smith Barney
would incur if counterparties failed to perform pursuant to their contractual
obligations. While credit risk is not a principal consideration with respect to
exchange-traded instruments, it is a major factor with respect to
non-exchange-traded OTC instruments. Whenever possible, Salomon Smith Barney
uses industry
8
master netting agreements to reduce aggregate credit exposure. Swap and foreign
exchange agreements are documented utilizing counterparty master netting
agreements supplemented by trade confirmations. Over the past several years,
Salomon Smith Barney has enhanced the funding and risk management of its
derivatives activities through the increased use of bilateral security
agreements. Salomon Smith Barney, in particular, has been an industry leader in
promoting the use of this risk reduction technique. Based on notional amounts,
at December 31, 1996 and 1995, respectively, approximately 80% and 72% of
Salomon Smith Barney's swap portfolio was subject to the bilateral exchange of
collateral. This initiative, combined with the success of Salomon Swapco Inc,
Salomon Smith Barney's triple-A rated derivatives subsidiary, has greatly
strengthened the liquidity profile of Salomon Smith Barney's derivative trading
activities. See "Risk Management" for discussions of Salomon Smith Barney's
management of market, credit, and operational risks.
NATURE AND TERMS OF DERIVATIVE INSTRUMENTS
Salomon Smith Barney and its subsidiaries enter into various bilateral financial
contracts involving future settlement, which are based upon a predetermined
principal or par value (referred to as the "notional" amount). Such instruments
include swaps, swap options, caps and floors, futures contracts, forward
purchase and sale agreements, option contracts and warrants. Transactions are
conducted either through organized exchanges or OTC. For a discussion of the
nature and terms of these instruments see Note 20 to the supplemental
consolidated financial statements.
SALOMON SMITH BARNEY'S USE OF DERIVATIVE INSTRUMENTS
Salomon Smith Barney's use of derivatives can be broadly classified between
trading and non-trading activities. The vast majority of Salomon Smith Barney's
derivatives use is in its trading activities, which include market-making
activities for customers and the execution of proprietary trading strategies.
Salomon Smith Barney's derivative counterparties consist primarily of other
major derivative dealers, financial institutions, insurance companies, pension
funds and investment companies, and other corporations. The scope of permitted
derivatives activities both for trading and non-trading purposes for each of
Salomon Smith Barney's businesses is defined by the Authorizing Body.
Trading Activities
A fundamental activity of Salomon Smith Barney is to provide market liquidity to
its customers across a broad range of financial instruments, including
derivatives. Salomon Smith Barney also seeks to generate returns by executing
proprietary trading strategies which are generally longer term in nature. By
their very nature, proprietary trading activities represent the assumption of
risk. However, trading positions are constructed in a manner that seeks to
define and limit risk taking only to those risks that Salomon Smith Barney
intends to assume. The most significant derivatives-related activity conducted
by Salomon Smith Barney is in fixed-income derivatives, which includes interest
rate swaps, financial futures, swaps, swap options, and caps and floors. Other
derivative transactions, such as currency swaps, forwards and options as well as
derivatives linked to equities, are also regularly executed by Salomon Smith
Barney. Salomon Smith Barney generally earns a spread from market-making
transactions involving derivatives, as it generally does from its market-making
activities for non-derivative transactions. Salomon Smith Barney also utilizes
derivatives to manage the market risk inherent in the securities inventories and
derivative portfolios it maintains for market-making purposes as well as its
"book" of swap agreements and related transactions with customers. Salomon Smith
Barney conducts its commodities dealer activities in organized futures exchanges
as well as in OTC forward markets. Salomon Smith Barney executes transactions
involving commodities options, forwards and swaps, much in the same manner as it
does in the financial markets.
Non-Trading Activities
Salomon Smith Barney also makes significant use of financial derivatives for
non-trading, or end user, purposes. Such activities are significant, though not
nearly as extensive as its use of derivatives for trading purposes. As an end
user, these instruments provide Salomon Smith Barney with added flexibility in
the management of its capital and funding costs. Interest rate swaps are
utilized to effectively convert the majority of Salomon Smith Barney's
9
fixed-rate term debt, a portion of its short-term borrowings and its guaranteed
preferred beneficial interests in Company subordinated debt securities (TRUPS)
to variable-rate obligations. Cross-currency swaps and forward currency
contracts are utilized to effectively convert a portion of its non-U.S. dollar
denominated term debt to U.S. dollar denominated obligations and to minimize the
variability in equity and book value per share otherwise attributable to
exchange rate movements.
Notional Amounts
Notional amounts of derivatives are the underlying principal amounts used to
calculate contractual cash flows to be exchanged between derivatives
counterparties. The notional amounts presented in this report are only a rough
indicator of the volume of derivative instrument activity and are not indicative
of the level of market or credit risk assumed by Salomon Smith Barney through
their use.
ACCOUNTING FOR DERIVATIVES
The way in which Salomon Smith Barney reports derivative instruments in its
financial statements depends on both the type and purpose of the derivative
instruments. Derivative instruments used for trading purposes, including those
used to hedge trading positions, are marked to market value or, when market
prices are not readily available, fair value is determined on a comparable
basis, for example, by using matrix or model pricing. Changes in market price or
fair value are recognized currently in earnings in "Principal transactions." The
market or fair value of derivatives used for trading purposes is included in
"Contractual commitments" within either assets or liabilities, as appropriate,
in the supplemental consolidated statement of financial condition. Derivative
receivables and payables are netted by counterparty when a legal right of offset
exists under a legally enforceable master netting agreement. Derivative
receivables and payables are netted across products and against cash collateral
if such provisions are included in the master netting and cash collateral
agreements. The determination of market or fair value involves various factors,
including the potential impact on market prices of liquidating positions over a
reasonable time period, and counterparty credit quality. When marking derivative
positions to market, higher risk counterparties warrant a higher risk premium,
or yield to Salomon Smith Barney, which equates to a lower price. Credit-related
adjustments are applied in determining the carrying amount of Salomon Smith
Barney's derivatives portfolio. These adjustments consider, among other things,
concentrations of exposure, netting agreements, and expected defaults. In
specific situations in which individual counterparties experience financial
difficulties that compromise their ability to meet their contractual obligations
to Salomon Smith Barney, reserves are established to cover such exposure. As
part of its mark-to-market policy, Salomon Smith Barney provides for the future
operational costs of maintaining long-term derivatives.
Interest rate swaps, including cross-currency swaps, which are used to convert
Salomon Smith Barney's fixed rate term debt, short-term borrowings and TRUPS
obligations to variable rate obligations, are not marked to market. Instead, the
net inflows or outflows are recorded as adjustments to interest expense.
Non-U.S. dollar denominated debt issued by Salomon Smith Barney Holdings Inc.
(Parent Company) is translated to U.S. dollars at exchange rates prevailing at
the end of each reporting period. Except for debt specifically identified as a
hedge of an investment in a subsidiary with a functional currency other than the
U.S. dollar, the translation impact is included in income. Salomon Smith Barney
mitigates this exposure by entering into forward currency purchase and swap
agreements. The impact of marking such agreements to prevailing exchange rates
is also included in income. Salomon Smith Barney also enters into forward
currency sales contracts to hedge investments in subsidiaries with functional
currencies other than the U.S. dollar. The impact of marking such contracts to
prevailing exchange rates is included in "Cumulative translation adjustments" as
is the impact of translating the investments being hedged.
Additional Derivatives-Related Disclosures
o Note 1 - Summary of Significant Accounting Policies
o Note 5 - Principal Transaction Revenues
o Note 11 - Debt
o Note 20 - Trading Securities, Commodities, Derivatives and Related
Risks
10
11
RISK MANAGEMENT
---------------------------------
Effective management of the risks inherent in Salomon Smith Barney's businesses
is critical. The following section discusses the risks inherent in Salomon Smith
Barney's businesses, procedures in place to manage such risks, and initiatives
underway to continue to enhance Salomon Smith Barney's management of risk.
---------------------------------
MARKET RISK
Market risk represents the potential loss Salomon Smith Barney may incur as a
result of absolute and relative price movements in financial instruments,
commodities and contractual commitments, price volatility, changes in yield
curves, currency fluctuations and changes in market liquidity. Salomon Smith
Barney utilizes a mark-to-market accounting policy for a substantial majority of
items recorded on the balance sheet as well as off-balance-sheet derivatives.
When market prices are not readily available, fair value is determined on a
comparable basis, for example, by using matrix or model pricing. Prices are
adjusted, where appropriate, to address factors such as the market liquidity of
the instrument, aging or holding period of the instrument, and credit quality of
the counterparty. The market liquidity component considers the size of positions
relative to the market and would generally result in a markdown of a position as
its relative size is increased. Salomon Smith Barney considers this to be an
integral component of mark-to-market accounting. Salomon Smith Barney manages
market risk across both on- and off-balance sheet products. This, together with
Salomon Smith Barney's mark-to-market accounting policy, means that separate
discussion of market risk for individual products, including derivatives, is not
meaningful. The distinguishing risks relative to derivatives are credit risk and
funding (liquidity) risk, which is roughly equivalent to the risk of margin
calls. Each type of risk can be increased or decreased by market movements. See
"Risk Management - Credit Risk - Credit Exposure from Derivative Activities".
Within Salomon Smith Barney's trading businesses, sound management of market
risk has always been a critical consideration. The sections that follow discuss
organizational elements of market risk management, as well as specific risk
management tools and techniques. Salomon Smith Barney has sought to
institutionalize these elements across all its businesses. Efforts to further
strengthen Salomon Smith Barney's management of market risk are ongoing and the
enhancement of risk management systems and reporting, including the development
and utilization of quantitative tools, is of major importance. Nevertheless, the
basis for strong risk management is the expertise and judgment of Salomon Smith
Barney's trading professionals and senior management, and open lines of
communication.
Salomon Smith Barney's Risk Management Control Framework
Salomon Smith Barney's risk management control framework is based upon the
ongoing participation of senior management, business unit managers and the
coordinated efforts of various support units throughout the firm.
Salomon Smith Barney's risk management capabilities meet or exceed the risk
management requirements of major regulatory and reporting bodies such as the
Securities and Exchange Commission, Commodities Futures and Trading Commission,
and the Derivatives Policy Group's Framework for Voluntary Oversight of OTC
Derivatives Activity; Office of the Comptroller of the Currency; the Federal
Reserve Bank; the Securities and Futures Authority and the Group of Thirty.
These requirements include the establishment of appropriate market and credit
risk controls, policies and procedures; appropriate senior management risk
oversight with thorough risk analysis and reporting; and independent risk
management with capabilities to evaluate and monitor risk limits.
Inventory Control and Valuation
With regard to Salomon Smith Barney's inventory (financial instruments,
commodities and contractual commitments), the Co-Chairmen and Co-Chief Executive
Officers determine the appropriate risk profile of
12
Salomon Smith Barney with assistance from the Risk Management Committee. This
committee is comprised of senior business managers, the Chief Financial Officer
and the Chief Risk Officer and reviews and recommends appropriate levels of
risk, reviews risk capital allocations, balance sheet and regulatory capital
usage by business units and recommends overall risk policies and controls. Prior
to the Merger, this committee was comprised of the Vice Chairman of Salomon
Brothers, Salomon's Global Risk Manager, the Chairman and CEO of Salomon, the
Chairman and CEO of Salomon Brothers and the heads of the major risk-taking
business units. Lastly, an independent Global Risk Management Group provides
technical and quantitative analysis of the market risk associated with inventory
to the Co-Chairmen and Co-Chief Executive Officers and members of the Risk
Management Committee on a frequent basis.
Inventory is necessary for an active market maker, but can be a major source of
liquidity risk. Monitoring Salomon Smith Barney's inventory levels and
composition and oversight for inventory pricing is the responsibility of the
Global Risk Management Group and various support units, which monitor inventory
on a position by position level, and employs specific risk models to track
inventory exposure in credit markets, emerging markets and the mortgage market.
Salomon Smith Barney also provides for liquidity risk by imposing markdowns as
the age of the inventory increases. Inventory event risk, both for issuer credit
and emerging markets, is analyzed with the involvement of senior traders,
economists and credit department personnel. Market scenarios for the major
emerging markets are maintained and updated to reflect the event risk for the
emerging market inventory. In addition, Salomon Smith Barney, as a dealer of
securities in the global capital markets, has risk to issuers of fixed income
securities for the timely payment of principal and interest. Principal risk is
reviewed by the Global Risk Management Group, which identifies and reports major
risks undertaken by the trading businesses. The Credit Department (the
"Department") combines principal risk positions with credit risks resulting from
market and delivery risk to review aggregate exposures by counterparty, industry
and country.
Risk Limits
Salomon Smith Barney's trading businesses have implemented desk and business
unit limits on exposure to risk factors. These limits, which are intended to
enforce the discipline of communicating and gaining approval for higher risk
positions, are periodically reviewed by the Global Risk Management Group.
Individual desks may not exceed risk limits without the approval of the business
unit head. Business units may not exceed risk limits without the approval of the
appropriate members of the Global Risk Management Group.
Theoretical Revenue Reconciliation
The trading units of Salomon Smith Barney, the Global Risk Management Group and
various support units perform periodic revenue reconciliations, comparing actual
revenues with the revenue outcome that would have been expected based on risk
factor exposures. A discrepancy between the expected revenue impact for a given
market event and the actual revenues may indicate an unexplained dimension of
market risk. Comparing the two thus provides a fundamental check that risk
management is capturing all the material market risk factors and that the
sources of trading risk and trading revenue are consistent with the realized
revenue.
Tools for Risk Management and Reporting
Salomon Smith Barney's global risk measurement begins with the identification of
relevant market risk factors. These core risk factors vary from market to
market, and region to region. For example, in fixed income markets, risk factors
include interest rates, yield curve slopes, credit spreads, and interest rate
volatility. In equity markets, risk factors include equity index exposure,
equity volatility and equity index spreads. In the foreign exchange market, risk
factors are exchange rates and exchange rate volatility. In the commodities
markets, risk factors include price levels, spreads and the volatility of
prices. Salomon Smith Barney identifies other factors specific to trading
strategies as well as risk factors significant to Salomon Smith Barney as a
whole, such as aggregate credit spread exposure, that may not be significant for
individual desks. Overall, more than one hundred risk factors are employed. Risk
factors are used in three types of analysis: stress analysis, value-at-risk
analysis and scenario analysis.
13
Stress Analysis Salomon Smith Barney performs stress analysis by repricing
inventory positions for specified upward and downward moves in risk factors, and
computing the revenue implications of these repricings. Stress analysis is a
useful tool for identifying exposures that appear to be relatively small in the
current environment but grow more than proportionately with changes in risk
factors. Such risk is typical of a number of derivative instruments, including
options sold, many mortgage derivatives and a number of structured products.
Stress analysis provides for the measurement of the potential impact of
extremely large moves in risk factors, which, though infrequent, can be expected
to occur from time to time.
Value-at-Risk Analysis. Under value-at-risk analysis, revenue implications are
computed for individual simulations, each based on a random outcome for the
individual risk factors. Value-at-risk is a summary statistic constructed by
performing thousands of simulations from which a probability distribution of
revenues is derived. It is of limited value for internal risk management in that
it does not give any indication of which individual exposures are problematic or
which of the many risk factor simulations are particularly worrisome. However,
it does provide a concise and simple measure of risk.
Scenario Analysis. Scenario analysis is a tool that generates forward-looking
"what-if" simulations for specified changes in market factors. For example, a
scenario analysis could simulate the impact of a dramatic tightening by the
Federal Reserve Board. The revenue implications of the specified scenario are
quantified not only for Salomon Smith Barney as a whole, but on a business unit
basis and on a geographic basis. The risk management system keeps track of many
scenarios developed by both members of the Group and Salomon Smith Barney's
economists and strategists.
CREDIT RISK
Credit risk represents the loss Salomon Smith Barney could incur if an issuer or
counterparty is unable or unwilling to perform on its commitments, including the
timely payment of principal and interest or settlement of swap and foreign
exchange transactions, repurchase agreements, securities purchases and sales,
and other contractual obligations. Salomon Smith Barney's credit risk management
process considers the many factors that influence the probability of a potential
loss, including, but not limited to, the issuer's or counterparty's financial
profile, its business prospects and reputation, the specific terms and duration
of the transactions, the exposure of the transactions to market risk,
macroeconomic developments and sovereign risk.
Origin of Credit Risk
In the normal course of its operations, Salomon Smith Barney and its
subsidiaries enter into various transactions which give rise to credit risk.
Credit risk is generally attributable to one or more of the following risks:
market, delivery and default of principal. Market and delivery risks create
credit risk with respect to transactions with counterparties. Default of
principal risk is the risk of nonpayment of the principal and interest of a
security.
The components of market risk such as absolute and relative price movements,
price volatility, changes in yield curves, currency fluctuations, and changes in
market liquidity, result in credit risk when a counterparty's obligation to
Salomon Smith Barney exceeds the obligation of Salomon Smith Barney to the
counterparty. Delivery risk arises from the requirement, in certain
circumstances, to release cash or securities before receiving payment. For both
market and delivery risk, the Credit Department sets credit limits or requires
specific approvals which anticipate the potential exposure of transactions.
14
Credit Risk Management at Salomon Smith Barney
The Chief Credit Officer, who is independent of any revenue-generating function,
manages the Department, whose professionals assess, approve, monitor, and
coordinate the extension of credit on a global basis. In considering such risk,
the Department evaluates the risk/return trade-offs as well as current and
potential credit exposures to a counterparty or to groups of counterparties that
are related because of industry, geographic, or economic characteristics. The
Department also has established various credit policies and control procedures
used singularly or in combination, depending upon the circumstances, including:
o establishment of internal guidelines monitored by the Chief Credit
Officer for maximum potential credit exposure to each counterparty
or each issuer and to each country;
o initial credit approval, whereby the approval of a designated member
of the Department is required before execution of a transaction that
does not meet defined parameters;
o credit limits, against which monitoring of transactions is performed
on a daily basis;
o specific clauses in legal agreements for collateral requirements,
cross-default, right of set-off, guarantees, event risk covenants
and two-way mark to market, among others;
o establishment of collateral standards for financing activities and
secured derivatives;
o quarterly analysis of potential exposure for DPG reporting to the
SEC and CFTC, see "Derivative Instruments - Overview;"
o periodic scenario analysis of subsets of the credit portfolio to
evaluate sensitivity to market variables;
o periodic assessment of sovereign risk through analysis of economic
and political developments; and
o periodic review of aged and large inventory positions with the
Global Risk Management Group and various support units.
Credit Risk Management of Commodities-Related Transactions
Phibro's credit department determines the credit limits for counterparties in
its commodities-related activities. Exposure reports, which contain detailed
information about cash flows with customers, goods in transit and forward
mark-to-market positions, are reviewed daily.
Credit Exposure from Derivatives Activities
The following table summarizes Salomon Smith Barney's credit exposure, net of
cash and securities collateral for swap agreements, swap options and caps and
floors and foreign exchange contracts and options at December 31, 1996. These
numbers do not present potential credit exposure that may result from factors
that influence market risk or from the passage of time. Severe changes in market
factors may cause credit exposure to increase suddenly and dramatically. Swap
agreements, swap options, caps and floors include transactions with both short-
and long-term periods of commitment.
15
Transactions with
over 3 years to
(billions) All transactions maturity 1996 average
- ----------------------------------------------------------------------------------------------------
Swaps, swap options, caps and floors:
Risk classes 1 and 2 $1.1 $ .8 $1.0
Risk class 3 1.2 .6 1.0
Risk classes 4 and 5 .7 .3 .8
Risk classes 6, 7 and 8 -- .1 .1
- ----------------------------------------------------------------------------------------------------
$3.0 $1.8 $2.9
- ----------------------------------------------------------------------------------------------------
Foreign exchange contracts and
options:
Risk classes 1 and 2 $ .8 -- $ .6
Risk class 3 .3 -- .3
Risk classes 4 and 5 .1 -- .1
- ----------------------------------------------------------------------------------------------------
$1.2 -- $1.0
- ----------------------------------------------------------------------------------------------------
To monitor credit risk, Salomon Smith Barney utilizes a series of eight internal
designations of counterparty credit quality. These designations are analogous to
external credit ratings whereby risk classes one through three are high quality
investment grades. Risk classes four and five include counterparties ranging
from the lowest investment grade to the highest non-investment grade. Risk
classed six, seven and eight represent higher risk counterparties.
With respect to sovereign risk related to derivatives, credit exposure at
December 31, 1996 was primarily to counterparties in the U.S. ($1.7 billion),
Germany ($.5 billion), Japan ($.4 billion), Great Britain ($.3 billion), Italy
($.2 billion) and Switzerland ($.2 billion).
OPERATIONAL RISK
As a major intermediary in financial and commodities markets, Salomon Smith
Barney is directly exposed to market risk and credit risk, which arise in the
normal course of its business activities. Slightly less direct, but of critical
importance, are risks pertaining to operational and back office support. This is
particularly the case in a rapidly changing and increasingly global environment
with increasing transaction volumes and an expansion in the number and
complexity of products in the marketplace. Such risks include:
o Operational/Settlement Risk - the risk of financial and opportunity
loss and legal liability attributable to operational problems, such
as inaccurate pricing of transactions, untimely trade execution,
clearance and/or settlement, or the inability to process large
volumes of transactions. Salomon Smith Barney is subject to
increased risks with respect to its trading activities in emerging
markets securities, where clearance, settlement, and custodial risks
are often greater than in more established markets.
o Technological Risk - the risk of loss attributable to technological
limitations or hardware failure that constrain Salomon Smith
Barney's ability to gather, process, and communicate information
efficiently and securely, without interruption, with customers,
among units within Salomon Smith Barney, and in the markets where
Salomon Smith Barney participates. In addition, Salomon Smith Barney
must enhance its systems to process dates starting with the year
2000 and to address the technological implications that will result
from regulatory and market changes, such as Europe's Economic and
Monetary Union.
o Legal/Documentation Risk - the risk of loss attributable to
deficiencies in the documentation of transactions (such as trade
confirmations) and customer relationships (such as master netting
agreements) or errors that result in noncompliance with applicable
legal and regulatory requirements.
16
o Financial Control Risk - the risk of loss attributable to
limitations in financial systems and controls; strong financial
systems and controls ensure that assets are safeguarded, that
transactions are executed in accordance with management's
authorization, and that financial information utilized by management
and communicated to external parties, including Salomon Smith
Barney's stockholder, creditors, and regulators, is free of material
errors.
As the above risks are largely interrelated, so are Salomon Smith Barney's
actions to mitigate and manage them. Salomon Smith Barney's Chief Administrative
Officer is responsible for, among other things, oversight of global operations
and technology. An essential element in mitigating the risks noted above is the
optimization of information technology and the ability to manage and implement
change. To be an effective competitor in an information-driven business of a
global nature requires the development of global systems and databases that
ensure increased and more timely access to reliable data.
Consumer Finance Services
Year Ended December 31,
------------------------------ ------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
Net Net Net
(millions) Revenues Income Revenues Income Revenues Income
- --------------------------------------------------------------------------------------------------------------------
Consumer Finance Services $1,411 $ 223 $1,354 $ 246 $1,239 $ 227
====================================================================================================================
Despite strong growth in receivables during the second half of 1996, net income
in 1996 was lower than 1995, as expected, driven by a higher provision for loan
losses reflecting industry trends associated with personal bankruptcies.
Consumer finance receivables rose to $8.071 billion at December 31, 1996, a 12%
increase from year-end 1995. This growth occurred primarily in real estate loan
and personal loan products generated by Commercial Credit's branch office
network and through Primerica Financial Services (PFS).
Consumer Finance net income in 1995 increased by 9% over 1994, primarily
reflecting a 7% increase in average receivables outstanding highlighted by an
11% increase in personal loan average receivables outstanding, which is the
highest margin product line.
While total interest margin increased from the 1995 period due to the increase
in the portfolio, average net interest margin declined 15 basis points in 1996
to 8.64% from 8.79% in 1995, reflecting a decline to 15.24% from 15.64% in the
average yield, partially offset by a decrease in cost of funds. The decline in
average yield was due to the run-off of older, higher yielding real estate
loans, growth in lower yielding higher quality first mortgage real estate loans
and higher levels of non-accruing personal loans. The average yield on
receivables outstanding was 15.41% in 1994, and average net interest margin was
8.76%.
Consumer Finance borrows from the corporate treasury operations of Commercial
Credit Company (CCC), a major holding company subsidiary of TRV that raises
funds externally. For fixed rate loan products, Consumer Finance is charged
agreed-upon rates that generally have been set within a narrow range and
approximated 7% in 1996, 1995 and 1994. For variable rate loan products,
Consumer Finance is charged rates based on prevailing short-term rates. CCC's
actual cost of funds may be higher or lower than rates charged to Consumer
Finance, with the difference reflected in the Corporate and Other segment.
Delinquencies in excess of 60 days rose to 2.38% at December 31, 1996 compared
to 2.14% at December 31, 1995, versus the historically low level of 1.88% in
1994. Correspondingly, the charge-off rate, which had been at record low levels
in 1994, moved higher in 1996 and 1995 -- reaching 2.91% in 1996 and 2.28% in
1995 versus
17
2.08% in 1994. This increase in delinquencies and charge-offs reflects a
continued high level of personal bankruptcies, a national trend that shows no
indication of reversing itself.
The allowance for credit losses as a percentage of net outstandings was 2.97% at
year-end 1996 compared to 2.66% at year-end 1995 and 2.64% at year-end 1994.
The total number of offices at year-end 1996 stood at 859, which includes the
addition of 10 offices from the first quarter 1996 acquisition of Hawaii-based
Servco Financial Corp. During the year the Company completed its conversion of
27 existing retail offices into $.M.A.R.T.SM Solution Centers -- devoted
exclusively to servicing the segment's growing business of underwriting real
estate loans for PFS.
As of, or for, the
Year Ended December 31,
-------------------------
1996 1995 1994
=========================
Allowance for credit losses as a %
of net outstandings 2.97% 2.66% 2.64%
Charge-off rate for the year 2.91% 2.28% 2.08%
60 + days past due on a contractual basis as a %
of gross consumer finance receivables at year-end 2.38% 2.14% 1.88%
Insurance subsidiaries of the Company provide credit life, health and property
insurance to Consumer Finance customers. Premiums earned were $155 million in
1996, $139 million in 1995 and $115 million in 1994. The increase in premiums
year-over-year is the result of growth in receivables and expanded availability
of certain products in additional states.
Asset Quality -- Consumer Finance assets totaled approximately $9.1 billion at
December 31, 1996, of which $7.9 billion, or 87%, represented the net consumer
finance receivables (including accrued interest and the allowance for credit
losses). These receivables were predominantly residential real estate-secured
loans and personal loans. Receivable quality depends on the likelihood of
repayment. The Company seeks to reduce its risks by focusing on individual
lending, making a greater number of smaller loans than would be practical in
commercial markets, and maintaining disciplined control over the underwriting
process. The Company has a geographically diverse portfolio as described in Note
10 of Notes to Supplemental Consolidated Financial Statements. The Company
believes that its loss reserves on the consumer finance receivables are
appropriate given current circumstances. If the charge-off and delinquency rates
continue to increase, the Company would anticipate increasing the loss reserves.
Of the remaining Consumer Finance assets, approximately $755 million were
investments of insurance subsidiaries, including $629 million of fixed income
securities and $69 million of short-term investments with a weighted average
quality rating of A1.
Outlook -- The Consumer Finance results during 1996 continued to be influenced
by a higher level of loan losses, as a result of a higher level of personal
bankruptcies. Also, near-term earnings for Consumer Finance are expected to be
affected by establishing reserves on new business and a higher level of
expenses, as the Company implements additional investments in marketing,
training and systems enhancements in order to capitalize on future growth
opportunities. Consumer Finance is also affected by the interest rate
environment and general economic conditions. Although the lower interest rate
environment, should it continue, is not expected to have a material effect on
Consumer Finance yields, it has resulted in modest downward pressure on interest
rates charged
18
on new receivables secured by real estate. For the Company overall, however,
these trends would be offset by the lower costs of funds in such an environment.
From time to time low interest rates combined with aggressive competitor pricing
may increase the likelihood of prepayments of mortgages loans. This impact has
been mitigated by a number of programs instituted by the Company including those
designed to attract first mortgage business. Continued low interest rates could
result in a reduction of the interest rates that CCC charges Consumer Finance on
borrowed funds.
Life Insurance Services
Year Ended December 31,
------------------------------ ------------------------------------
1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
Net Net Net
(millions) Revenues Income Revenues Income Revenues Income
- --------------------------------------------------------------------------------------------------------------------
Travelers Life and Annuity (1), (2) $2,339 $ 371 $2,502 $ 330 $2,198 $ 211
Primerica Financial Services (3) 1,426 282 1,356 251 1,290 210
- --------------------------------------------------------------------------------------------------------------------
Total Life Insurance Services $3,765 $ 653 $3,858 $ 581 $3,488 $ 421
====================================================================================================================
(1) Net income includes $11 million, $48 million and $1 million of reported
investment portfolio gains in 1996, 1995 and 1994, respectively.
(2) Excludes results of MetraHealth which are classified as discontinued
operations.
(3) Net income includes $9 million, $20 million and $7 million of reported
investment portfolio gains in 1996, 1995 and 1994, respectively, and in
1996 a portion of the gain ($4 million) from the disposition of RCM.
Travelers Life and Annuity
Travelers Life and Annuity consists of annuity, life and health products
marketed by The Travelers Insurance Company (TIC) under the Travelers name and
the individual accident and health operations of Transport Life (through
September 29, 1995 -- the date of spin-off). Among the range of products offered
are individual universal and term life and long-term care insurance, payout
annuities and fixed and variable deferred annuities to individuals and small
businesses and group pension deposit products, including guaranteed investment
contracts and annuities for employer-sponsored retirement and savings plans.
These products are primarily marketed through The Copeland Companies (Copeland),
an indirect wholly owned subsidiary of TIC, Smith Barney Financial Consultants
and a core group of approximately 500 independent agencies. The majority of the
annuity business and a substantial portion of the life business written by
Travelers Life and Annuity is accounted for as investment contracts, with the
result that the premium deposits collected are not included in revenues.
Earnings before portfolio gains increased 28% to $360 million in 1996, compared
to $282 million in 1995 and 34% from 1995 to 1994. Improved earnings during 1996
were largely driven by strong investment income, reflecting repositioning of the
investment portfolio over the past year. In addition, earnings benefited from
the reinvestment of the proceeds from the sale of the Company's interest in
MetraHealth in the 1995 fourth quarter, partially offset by the loss of earnings
from Transport Life, which was spun off to TRV stockholders in September 1995.
Also offsetting this increase were higher expenses, a portion of which relates
to higher corporate expense allocations of amounts previously absorbed in other
segments. Earnings growth attributable to strong sales of recently introduced
products -- including less capital-intensive variable life insurance and
annuities -- was partially offset by the gradual decline in the amount of higher
margin business written several years ago.
Improved sales through Copeland, Smith Barney Financial Consultants, and a
nationwide network of independent agents, reflect the ongoing effort to build
market share by strengthening relationships in key distribution channels. Future
sales should also benefit from Standard & Poor's recently announced upgrading of
The Travelers Insurance Company's claims paying ability to AA- ("Excellent").
19
Deferred annuity policyholder account balances and benefit reserves grew to
$13.2 billion at year-end 1996, up from $11.3 billion at year-end 1995 and $9.5
billion at year-end 1994. Net written premiums and deposits, which benefited in
1996 from a continuation of the strong fourth quarter 1995 Smith Barney
marketing initiative, were $1.991 billion in 1996 compared to $1.649 billion in
1995 and $1.262 billion in 1994 (excluding Transport Life).
Payout and group annuity account balances and reserves declined to $10.9 billion
at year-end 1996, compared to $12.0 billion at year-end 1995 and $13.6 billion
at year-end 1994, reflecting run-off of low margin guaranteed investment
contracts written in prior years. Net written premiums and deposits (excluding
those of affiliates) rose to $1.201 billion in 1996 from $1.085 billion in 1995
and $818 million in 1994.
Net written premiums and deposits for individual life insurance rose 17% in 1996
to $291.4 million from $249.3 million in 1995 and $282 million in 1994
(excluding Transport Life, which was spun off in September 1995). Life insurance
in force was $50.4 billion at December 31, 1996, up from $49.2 billion at
year-end 1995 and $48.4 billion at year-end 1994 (excluding Transport Life).
Net written premiums for the growing Long Term Care insurance line reached
$127.7 million for 1996 compared to $88.2 million in 1995 and $61.3 million in
1994.
Outlook -- Travelers Life and Annuity should benefit from growth in the aging
population who are becoming more focused on the need to accumulate adequate
savings for retirement, to protect these savings and to plan for the transfer of
wealth to the next generation. Travelers Life and Annuity is well-positioned to
take advantage of the favorable long-term demographic trends through its strong
financial position, widespread brand name recognition and broad array of
competitive life, annuity and long-term care insurance products sold through the
three established distribution channels.
However, competition in both product pricing and customer service is
intensifying. While there has been some consolidation within the industry, other
financial services organizations are increasingly involved in the sale and/or
distribution of insurance products. Deregulation of the banking industry,
including possible reform of restrictions on entry into the insurance business,
will likely accelerate this trend. Also, the annuities business is interest
sensitive, and swings in interest rates could influence sales and retention of
in force policies. In order to strengthen its competitive position, Travelers
Life and Annuity expects to maintain a current product portfolio, further
diversify its distribution channels, and retain its healthy financial position
through strong sales growth and maintenance of an efficient cost structure.
Primerica Financial Services
Earnings before portfolio gains and the gain on disposition of RCM increased 16%
over 1995 and 14% from 1995 to 1994. This growth reflects higher sales of mutual
funds and consumer loans as well as continued growth in life insurance in force
and improving life insurance margins.
New term life insurance sales were $52.0 billion in face amount for 1996,
compared to $53.0 billion in 1995, and $57.4 billion in 1994. The number of
policies issued was 247,600 in 1996, compared to 266,600 in 1995, and 299,400 in
1994, consistent with the industry-wide downturn in new life insurance sales for
these periods. During this time, PFS has focused upon the strategic expansion of
its business beyond life insurance and now offers a greater variety of financial
products and services, delivered through its sales force. Life insurance in
force at year-end 1996 reached $359.9 billion, up from $348.2 billion at
year-end 1995 and $335.0 billion at year-end 1994, and continued to reflect good
policy persistency.
PFS has traditionally offered mutual funds to customers as a means to invest the
relative savings realized through the purchase of term life insurance as
compared to traditional whole life insurance. Sales of mutual funds were $2.327
billion in 1996 compared to $1.551 billion in 1995 and $1.622 billion in 1994.
Approximately 37% of
20
initial U.S. sales in 1996 were from the Smith Barney products, predominantly
the Concert SeriesSM which PFS first introduced to its market in March 1996.
Loan receivables from the $.M.A.R.T. (real-estate loans) and $.A.F.E. (personal
loans) products of Consumer Finance, which are reflected in the assets of
Consumer Finance, continued to advance during the year and were $1.524 billion
at December 31, 1996 compared to $1.258 billion at December 31, 1995, and $1.107
billion at December 31, 1994. PFS's Secure property and casualty insurance
product (automobile and homeowners insurance) -- issued through Travelers
Property Casualty Corp. -- continues to experience healthy growth in
applications and policies and currently has been introduced in 37 states. More
than 6,300 agents are licensed to sell this product.
Outlook -- Over the last few years, programs including sales and product
training were begun that are designed to maintain high compliance standards,
increase the number of producing agents and customer contacts and, ultimately,
increase production levels. Additionally, increased effort has been made to
provide all PFS customers full access to all PFS marketed lines. Insurance in
force is continuing to grow and the number of producing agents is stable. A
continuation of these trends could positively influence future operations. PFS
continues to expand cross-selling with other Company subsidiaries of products
such as loans, mutual funds and, most recently, property and casualty insurance
(automobile and homeowners).
Property & Casualty Insurance Services
Year Ended December 31,
------------------------------ ------------------------------------
(millions) 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------
Net Net Net
Revenues Income Revenues Income Revenues Income
- --------------------------------------------------------------------------------------------------------------------
Commercial Lines (1) $5,528 $ 215 $3,063 $ 343 $3,058 $ 146
Personal Lines (2) 2,685 281 1,482 110 1,480 103
Financing Costs and Other 11 (87) -- -- -- --
Minority Interest -- (47) -- -- -- --
- --------------------------------------------------------------------------------------------------------------------
Total Property & Casualty Insurance
Services $8,224 $ 362 $4,545 $ 453 $4,538 $ 249
====================================================================================================================
(1) Net income includes $21 million and $36 million of reported investment
portfolio gains in 1996 and 1995, respectively, and $73 million of
reported investment portfolio losses in 1994 and $453 million of charges
in 1996 related to the acquisition of Aetna P&C.
(2) Net income includes $5 million of reported investment portfolio losses in
1996, $6 million of reported investment portfolio gains in 1995 and $18
million of reported investment portfolio losses in 1994. 1996 also
benefits from $31 million of adjustments related to the acquisition of
Aetna P&C. 1994 also includes a $19 million gain from the sale of Bankers
and Shippers Insurance Company.
Segment earnings include the property and casualty operations of Aetna P&C for
periods subsequent to April 2, 1996. Certain production statistics related to
Aetna P&C operations are provided for comparative purposes for periods prior to
April 2, 1996 and are not reflected in such prior period revenues or operating
results.
As previously indicated, TAP incurred charges during 1996 related to the
acquisition and integration of Aetna P&C. These charges resulted primarily from
anticipated costs of the merger and the application of Travelers strategies,
policies and practices to Aetna P&C reserves. The charges include:
o $229.1 million after tax and minority interest ($430 million before
tax and minority interest) in reserve increases, net of reinsurance,
related primarily to cumulative injury claims other than asbestos
(CIOTA);
21
o $44.8 million after tax and minority interest ($84 million before
tax and minority interest) in additional asbestos liabilities
pursuant to an existing settlement agreement with a customer of
Aetna P&C;
o a $32 million after tax and minority interest ($60 million before
tax and minority interest) charge related to premium collection
issues on loss sensitive programs, specifically large deductible
products;
o a $21.8 million after tax and minority interest ($41 million before
tax and minority interest) provision for uncollectibility of
reinsurance recoverables of Aetna P&C determined by applying the
Company's normal guidelines for estimating collectibility of such
accounts; and
o an $18.7 million after tax and minority interest ($35 million before
tax and minority interest) provision for lease and severance costs
of Travelers Indemnity related to the restructuring plan for the
merger.
Commercial Lines
Earnings before portfolio gains/losses and acquisition-related charges increased
111% to $647 million in 1996 from $307 million in 1995, primarily reflecting
income from the acquisition of Aetna P&C, the emerging benefits of expense
reduction initiatives associated with the integration of the two companies and
strong investment income. Earnings before portfolio gains/losses increased 40%
to $307 million in 1995 compared to $219 million in 1994. The improvement
relative to 1994 primarily resulted from an increase in net investment income
and improved loss trends in the workers' compensation line.
Commercial Lines net written premiums were $4.084 billion in 1996 (excluding a
one-time adjustment associated with a reinsurance transaction) compared to
$2.309 billion in 1995 and $2.391 billion in 1994. Premium equivalents for 1996
were $2.596 billion compared to $2.821 billion in 1995 and $2.990 billion in
1994. Premium equivalents, which are associated largely with National Accounts,
represent estimates of premiums that customers would have been charged under a
fully insured arrangement and do not represent actual premium revenues.
On a combined total basis including Aetna P&C (for periods prior to April 2,
1996 for comparative purposes only), Commercial Lines net written premiums for
1996 totaled $4.690 billion, compared to $5.144 billion for 1995 and $5.481
billion in 1994. These decreases reflect the highly competitive marketplace and
the Company's selective underwriting. On the same combined total basis, premium
equivalents for 1996 totaled $2.712 billion, compared to $3.458 billion in 1995.
The decrease in premium equivalents reflects a depopulation of involuntary pools
as the loss experience of workers' compensation improves and insureds move to
voluntary markets, the Company's selective renewal activity to address the
competitive pricing environment and its continued success in lowering workers'
compensation losses of customers. Premium equivalents of $2.990 billion for 1994
does not include Aetna P&C. (Historically, Aetna P&C did not track premium
equivalents and such amounts are not available for 1994).
A significant component of Commercial Lines is National Accounts, which works
with national brokers and regional agents providing insurance coverages and
services, primarily workers' compensation, mainly to large corporations.
National Accounts also includes the alternative market business which covers
primarily workers' compensation products and services. National Accounts' net
written premiums for 1996 (excluding a one-time adjustment associated with a
reinsurance transaction) were $803 million compared to $703 million in 1995 and
$835 million in 1994. The 1996 increase reflects the acquisition of Aetna P&C,
partially offset by the Company's selective renewal activity and the highly
competitive marketplace. The 1995 decline reflects selective renewal activity in
response to the competitive pricing environment and the highly competitive
marketplace. National Account premium equivalents were $2.526 billion in 1996
compared to $2.779 billion in 1995 and $2.959 billion in 1994. The decrease in
premium equivalents in 1996 and 1995 reflects a depopulation of involuntary
pools as the loss experience of workers' compensation improves and insureds move
to voluntary markets, the Company's
22
selective renewal activity in response to the competitive pricing environment
and its continued success in lowering workers' compensation losses of customers.
On a combined total basis including Aetna P&C (for periods prior to April 2,
1996 for comparative purposes only), National Accounts net written premiums of
$874 million in 1996 decreased $318 million from 1995. Net written premiums of
$1.192 billion in 1995 decreased $312 million from 1994. The 1996 and 1995
decreases reflect the Company's selective renewal activity and the highly
competitive marketplace. On the same combined total basis, National Accounts
premium equivalents of $2.625 billion for 1996 were $733 million below 1995. The
decrease in premium equivalents in 1996 reflects a depopulation of involuntary
pools as the loss experience of workers' compensation improves and insureds move
to voluntary markets, the Company's selective renewal activity to address the
competitive pricing environment and its continued success in lowering workers'
compensation losses of customers.
For 1996 National Accounts new business, including both premiums and premium
equivalents, was $389 million compared to $444 million in 1995 and $325 million
in 1994. This decrease, despite the Aetna acquisition, is due to the highly
competitive marketplace. The National Accounts business retention ratio dropped
to 82% in 1996 from 84% in 1995 and 88% in 1994. The new business and retention
ratio declines in 1996 reflect the Company's selective renewal activity and the
highly competitive marketplace.
Commercial Accounts serves mid-sized businesses through a network of independent
agents and brokers. Commercial Accounts' net written premiums were $1.485
billion in 1996 compared to $730 million in 1995 and $791 million in 1994. The
increase in 1996 compared to 1995 reflects the acquisition of Aetna P&C,
marginally offset by the highly competitive market, where Commercial Accounts
has continued to be more selective in renewal activity. Programs designed to
leverage underwriting experience in specific industries have demonstrated
continued growth. Commercial Accounts premium equivalents were $69 million in
1996 compared to $41 million in 1995 and $31 million in 1994.
On a combined total basis including Aetna P&C (for periods prior to April 2,
1996 for comparative purposes only), Commercial Accounts net written premiums of
$1.725 billion for 1996 were $137 million below 1995 premium levels, which were
$266 million below 1994 premium levels. The decrease in 1996 and 1995 in net
written premiums is due to the highly competitive marketplace, the Company's
selective underwriting and the continued softness in guaranteed cost products.
The decrease in 1995 compared to 1994 in net written premiums was partly offset
by the continued growth in Commercial Accounts' industry-specific programs and
in retrospectively rated policies and other loss-responsive products. On the
same combined total basis, Commercial Accounts premium equivalents of $87
million in 1996 were $13 million below 1995 due to the competitive marketplace.
During 1996, new business in Commercial Accounts was $360 million compared to
$269 million in 1995 and $207 million in 1994. The 1996 increase in new
businesses is due to the acquisition of Aetna P&C. The Commercial Accounts
business retention ratio was 72% in 1996 compared to 73% in 1995 and 79% in
1994. These retention ratios reflect Commercial Accounts selective underwriting
policy. Commercial Accounts continues to focus on industry specific programs
which meet strict underwriting guidelines.
Select Accounts serves small businesses through a network of independent agents.
Select Accounts net written premiums were $1.191 billion in 1996 compared to
$542 million in 1995 and $466 million in 1994. The increase in 1996 reflects the
acquisition of Aetna P&C.
On a combined total basis including Aetna P&C (for periods prior to April 2,
1996 for comparative purposes only), Select Accounts net written premiums of
$1.412 billion for 1996 were $54 million lower than 1995. This decrease reflects
the highly competitive marketplace and the Company's selective underwriting.
Select Accounts
23
net written premiums of $1.466 billion for 1995 were $173 million above 1994
premium levels, due primarily to an increase in new business.
New premium business in Select Accounts was $276 million in 1996 compared to
$131 million in 1995 and $112 million in 1994. The 1996 increase in new premium
business is due to the acquisition of Aetna P&C. The Select Accounts business
retention ratio was 78% in 1996 compared to 75% in 1995 and 73% in 1994. The
increase in the 1996 business retention ratio reflects the industry and product
line expertise of the combined company.
Specialty Accounts markets products to national, midsize and small customers and
distributes them through both wholesale brokers and retail agents and brokers
throughout the United States. Specialty Accounts net written premiums were $605
million in 1996 compared to $334 million in 1995 and $299 million in 1994. The
growth in 1996 is primarily attributable to the acquisition of the Aetna P&C
Bond business, the net written premiums of which were $210 million since the
date of acquisition.
On a combined total basis including Aetna P&C (for periods prior to April 2,
1996 for comparative purposes only), Specialty Accounts net written premiums for
1996 were $679 million compared to $624 million in 1995, and was $556 million in
1994. The 1996 increase compared to 1995 is due to increases in directors' and
officers' liability insurance and errors and omissions coverages.
Catastrophe losses, net of tax and reinsurance, were $31 million in 1996
compared to $7 million in 1995 and $30 million in 1994. Catastrophe losses in
1996 were primarily due to Hurricane Fran and December storms on the West Coast.
The 1994 catastrophe losses were due to winter storms in the first quarter of
1994.
The statutory combined ratio for Commercial Lines for 1996 was 128.1% compared
to 105.0% in 1995 and 124.7% in 1994. The GAAP combined ratio for Commercial
Lines for 1996 was 125.4% compared to 102.2% in 1995 and 107.9% in 1994.
GAAP combined ratios for Commercial Lines differ from statutory combined ratios
primarily due to differences in reporting of revenues and expenses related to
service business, including servicing of residual market pools and deductible
policies. In addition, in 1996, GAAP combined ratios for Commercial Lines differ
from statutory combined ratios due to certain purchase accounting adjustments
recorded in connection with the Aetna P&C acquisition resulting in a charge to
statutory expenses, but not GAAP expenses.
The increase in the 1996 statutory and GAAP combined ratios for Commercial Lines
compared to 1995 was primarily attributable to the charges taken in 1996 related
to the acquisition and integration of Aetna P&C. Excluding these amounts, the
statutory and GAAP combined ratios before policyholder dividends for 1996 would
have been 109.3% and 109.6%, respectively. The increase in the 1996 statutory
and GAAP combined ratios excluding acquisition-related charges compared to the
1995 statutory and GAAP combined ratios is primarily due to the inclusion in
1996 of Aetna P&C's results. Aetna P&C historically has had a higher
underwriting expense ratio, partially offset by a lower loss and LAE ratio, that
reflects the mix of business including the favorable effect of the lower loss
and LAE ratio of the Bond business. The 1994 statutory combined ratio includes a
statutory charge of $225 million for reserve increases for environmental claims
and for a reduction of ceded reinsurance balances. Excluding this charge, the
statutory combined ratio for 1994 was 114.2%. The improvement in the 1995
combined ratios compared to the adjusted 1994 combined ratios was due to the
first quarter 1994 catastrophe losses and favorable loss development in certain
workers' compensation lines and residual markets in 1995.
Personal Lines
Earnings before portfolio gains/losses and acquisition-related adjustments
increased 145% to $255 million in 1996 from $104 million in 1995, primarily
reflecting the post-acquisition results of operations of Aetna P&C,
approximately $70 million of favorable prior year loss development in personal
automobile bodily injury lines, the continued benefit of expense reduction
initiatives and higher net investment income. Earnings before portfolio
24
gains/losses were $104 million in 1995 compared to $102 million in 1994. Expense
reduction initiatives and higher net investment income contributed to the
increase in earnings in 1995 relative to 1994, largely offset by benefits from
favorable prior year loss reserve development in 1994 in the personal automobile
line of business. In addition, 1994 benefited from a one-time contribution of $9
million from the favorable resolution of the New Jersey Market Transition
Facility (MTF) deficit as well as earnings from Bankers and Shippers Insurance
Company (Bankers and Shippers) which was sold in October 1994.
Net written premiums for 1996 were $2.359 billion, compared to $1.298 billion in
1995 and $1.433 billion in 1994. The 1996 increase compared to 1995 primarily
reflects the acquisition of Aetna P&C and, to a lesser extent, growth in target
markets, partially offset by reductions due to catastrophe management
strategies. The 1995 decline of $135 million compared to 1994 was attributable
to the sale of Bankers and Shippers in October 1994. Excluding Bankers and
Shippers business, net written premiums for 1995 were up approximately 8% from
1994, reflecting reduced reinsurance ceded and targeted growth in sales through
independent agents.
On a combined total basis including Aetna P&C (for periods prior to April 2,
1996 for comparative purposes only), Personal Lines net written premiums for
1996 totaled $2.675 billion, up $132 million from $2.543 billion in 1995. This
increase on a combined basis reflects continued growth in targeted automobile
and homeowners markets, partially offset by reductions due to catastrophe
management strategies.
Catastrophe losses, net of taxes and reinsurance, were $58 million in 1996
compared to $12 million in 1995 and $26 million in 1994. Catastrophe losses in
1996 were primarily due to Hurricane Fran, as well as severe first quarter
winter storms and second quarter hail and wind storms. Catastrophe losses in
1994 were primarily due to the severe winter storms in the Northeast during the
first quarter.
The statutory combined ratio for Personal Lines in 1996 was 97.6% compared to
104.4% in 1995 and 100.4% in 1994. The GAAP combined ratio for Personal Lines in
1996 was 94.9% compared to 103.6% in 1995 and 100.5% in 1994.
In 1996, GAAP combined ratios for Personal Lines differ from statutory combined
ratios primarily due to certain purchase accounting adjustments recorded in
connection with the Aetna P&C acquisition resulting in a charge to statutory
expenses, but not GAAP expenses.
The 1996 statutory and GAAP combined ratios for Personal Lines include a benefit
resulting from the Company's review of reserves associated with the acquisition
of Aetna P&C. Excluding this item, the 1996 statutory and GAAP combined ratios
were 100.1% and 97.4%, respectively. The decrease in the 1996 statutory and GAAP
combined ratios excluding this item is predominantly due to the favorable prior
year loss development, primarily in the automobile bodily injury line, partially
offset by higher catastrophe losses. The lower ratio in 1994 compared to 1995
was primarily due to the benefit of favorable loss reserve development and the
favorable resolution of the MTF deficit in 1994.
Financing Costs and Other
The primary component for 1996 was interest expense of $77 million after tax,
reflecting financing costs associated with the acquisition of Aetna P&C.
Outlook -- Property & Casualty
A variety of factors continue to affect the property and casualty insurance
market and the Company's core business outlook, including the competitive
pressures affecting pricing and profitability, inflation in the cost of medical
care, litigation and losses from involuntary markets.
Commercial Lines will continue to focus on its core product lines and markets,
with particular emphasis on both product and industry specialization. This
includes specific industry program marketing efforts in Commercial
25
Accounts and product offerings in Specialty Accounts. In most of Commercial
Lines, pricing did not improve in 1996. For Commercial Accounts and Select
Accounts, the soft underwriting cycle continues to pressure the pricing of
guaranteed cost products, as pricing trends have not kept pace with loss cost
inflation in recent years. The Company's focus is to retain existing profitable
business and obtain new accounts where it can maintain its selective
underwriting policy. National Accounts premiums are primarily loss sensitive and
therefore less affected by these pricing pressures. The market for National
Accounts guaranteed cost products is very competitive and has resulted in a
decline in the Company's new business. The Company will continue to adhere to
strict guidelines to maintain high quality underwriting. The Company's adherence
to its selective underwriting criteria has had an adverse effect on premium
levels during the last two years and, if the competitive pressures on pricing do
not improve in 1997, it may continue to affect future premium levels
unfavorably. The Company believes that the competitive pricing environment for
Commercial Lines is not likely to improve in 1997.
Personal Lines strategy includes the control of operating expenses to improve
competitiveness and profitability, growth in sales through independent agents in
target markets, expansion of alternative marketing channels to broaden the
distribution of Personal Lines products, and a reduction of exposure to
catastrophe losses. In order to reduce its exposure to catastrophe losses, the
Company has limited the writing of new homeowners business and selectively
non-renewed existing homeowners business in certain markets, tightened
underwriting standards and implemented price increases in certain
hurricane-prone areas, subject to restrictions imposed by insurance regulatory
authorities, and introduced new policy forms in certain markets to limit the
Company's exposure to earthquake losses.
The property and casualty insurance industry in the United States continues to
consolidate. The Company's strategic objectives are to enhance its position as a
consistently profitable market leader and to become a low-cost provider of
property and casualty insurance in the United States, as the industry
consolidates.
In relation to the Company's objective of being a low-cost provider of property
and casualty insurance, cost reductions and enhanced productivity efforts are
expected to continue. These efforts include reducing overhead expenses,
integrating Aetna P&C to make it more consistent with the decentralized,
streamlined structure of the Company, and eliminating redundant expenses between
the two companies. The Company is approximately two-thirds of the way toward its
objective of achieving $300 million in annual cost savings in the first two
years after the Aetna P&C acquisition.
Environmental Claims
The Company continues to receive claims alleging liability exposures arising out
of insureds' alleged disposition of toxic substances. These claims when
submitted rarely indicate the monetary amount being sought by the claimant from
the insured and the Company does not keep track of the monetary amount being
sought in those few claims which indicated such a monetary amount. The Company's
review and investigation of such claims includes an assessment of the probable
liability, available coverage, judicial interpretations and historical value of
similar claims. In addition, the unique facts presented in each claim are
evaluated individually and collectively. Due consideration is given to the many
variables presented in each claim, such as: the nature of the alleged activities
of the insured at each site; the allegations of environmental damage at each
site; the number of sites; the total number of potentially responsible parties
at each site; the nature of environmental harm and the corresponding remedy at a
site; the nature of government enforcement activities at each site; the
ownership and general use of each site; the overall nature of the insurance
relationship between the Company and the insured; the identification of other
insurers; the potential coverage available, if any; the number of years of
coverage, if any; the obligation to provide a defense to insureds, if any; and
the applicable law in each jurisdiction.
The Company's reserves for environmental claims are not established on a
claim-by-claim basis. An aggregate bulk reserve is carried for all of the
Company's environmental claims that are in the dispute process until the dispute
is resolved. This bulk reserve is established and adjusted based upon the
aggregate volume of in-process environmental claims and the Company's experience
in resolving such claims. At December 31, 1996,
26
approximately 12% of the net environmental loss reserve (i.e., approximately
$146 million) consists of case reserve for resolved claims. The balance,
approximately 88% of the net aggregate reserve (i.e. approximately $1.096
billion), is carried in a bulk reserve and includes incurred but not yet
reported environmental claims for which the Company has not received any
specific claims.
The Company's reserving methodology is preferable to one based on "identified
claims" since the resolution of environmental exposures by the Company generally
occurs on an insured-by-insured basis as opposed to a claim-by-claim basis. The
nature of the resolution is through coverage litigation, which often pertains to
more than one claim, as well as through a settlement with an insured. Generally,
the settlement between the Company and the insured extinguishes any obligation
the Company may have under any policy issued to the insured for past, present
and future environmental liabilities. This form of settlement is commonly
referred to as a "buy-back" of policies for future environmental liability.
Additional provisions of these agreements include the appropriate indemnities
and hold harmless provisions to protect the Company. The Company's general
purpose in executing such agreements is to reduce its potential environmental
exposure and eliminate both the risks presented by coverage litigation with the
insured and the cost of such litigation.
The reserving methodology includes an analysis by the Company of the exposure
presented by each insured and the anticipated cost of resolution, if any, for
each insured. This analysis is completed by the Company on a quarterly basis. In
the course of its analysis, an assessment of the probable liability, available
coverage, judicial interpretations and historical value of similar exposures is
considered by the Company. In addition, due considerations given to the many
variables presented, such as the nature of the alleged activities of the insured
at each site; the allegations of environmental damage at each site; the number
of sites; the total number of potentially responsible parties at each site; the
total number of potentially responsible parties at each site; the nature of
environmental harm and the corresponding remedy at a site; the ownership and
general use of each site; the overall nature of the insurance relationship
between the Company and the insured; the identification of other insurers; the
potential coverage available, if any, including the number of years of coverage,
if any; and the applicable law in each jurisdiction. Analysis of these and other
factors, including the potential for future claims, results in the establishment
of the bulk reserve.
The following table displays activity for environmental losses and loss expenses
and reserves for the three years ended December 31, 1996.
Environmental Losses
(millions) 1996 1995 1994
------- ------- -------
Beginning reserves:
Direct $ 454 $ 482 $ 504
Ceded (50) (11) (13)
------- ------- -------
Net 404 471 491
Acquisition of Aetna P&C:
Direct 968 -- --
Ceded (39) -- --
Incurred losses and loss expenses:
Direct 114 117 54
Ceded (52) (61) (5)
Losses paid:
Direct 167 145 76
Ceded (14) (22) (7)
------- ------- -------
27
Ending reserves:
Direct 1,369 454 482
Ceded (127) (50) (11)
------- ------- -------
Net $ 1,242 $ 404 $ 471
======= ======= =======
The duration of the Company's investigation and review of such claims and the
extent of time necessary to determine an appropriate estimate, if any, of the
value of the claim to the Company, varies significantly and is dependent upon a
number of factors. These factors include, but are not limited to, the
cooperation of the insured in providing claim information, the pace of
underlying litigation or claim processes, the pace of coverage litigation
between the insured and the Company and the willingness of the insured and the
Company to negotiate, if appropriate, a resolution of any dispute between them
pertaining to such claims. Since the foregoing factors vary from claim to claim
and insured by insured, the Company cannot provide a meaningful average of the
duration of an environmental claim. However, based upon the Company's experience
in resolving such claims, the duration may vary from months to several years.
The industry does not have a standard method of calculating claim activity for
environmental losses. Generally for environmental claims, Travelers Indemnity
and its subsidiaries (Travelers P&C) establishes a claim file for each insured
on a per site, per claimant basis. If there is more than one claimant such as a
federal and a state agency, this method will result in two claims being set up
for a policyholder at that one site. Similarly, if one hundred claimants file a
lawsuit against ten policyholders alleging injury as a result of the discharge
of wastes or pollutants, one thousand claims would be established. Travelers P&C
adheres to this method of calculating claim activity on all
environmental-related claims, whether such claims are tendered on primary,
excess or umbrella policies.
As of December 31, 1996, Travelers P&C had approximately 30,800 pending
environmental-related claims tendered by 664 active policyholders. The pending
environmental-related claims represent federal or state EPA-type claims as well
as plaintiffs' claims alleging bodily injury and property damage due to the
discharge of waste or pollutants. In 1996, the pending inventory increased by
approximately 20,000 claims as a result of several lawsuits being filed in the
states of Louisiana and Texas. These lawsuits filed against one or more
policyholders of Travelers P&C allege that the plaintiffs were injured or
damaged as a result of either alleged waste disposal or the alleged release of
deleterious substances from ongoing business operations, which have taken place
near the plaintiffs' residences. Claims of this nature have historically been
considered in the level of environmental reserves. To date, in total Travelers
P&C has resolved environmental-related claims on behalf of 1,628 policyholders.
The Company is preparing a claims system conversion which when completed will
apply Travelers P&C's method of establishing claim files to Aetna P&C's
environmental-related claims. The Company anticipates that this process should
be completed in 1997. As of December 31, 1996, Aetna P&C had pending
environmental-related claims tendered by approximately 948 active policyholders.
Approximately 129 of these 948 active policyholders are also included in the 664
active Travelers P&C policyholders. Aetna P&C's policyholders, like those of
Travelers P&C, have tendered both EPA-type claims and individual claims alleging
injury or damage as a result of the discharge of wastes or pollutants. To date,
Aetna P&C has resolved environmental-related claims on behalf of 1,870
policyholders.
To date, the Company generally has been successful in resolving its coverage
litigation and continues to reduce its potential exposure through favorable
settlements with certain insureds. These settlement agreements with certain
insureds are based on the variables presented in each piece of coverage
litigation. Generally the settlement dollars paid in disputed coverage claims
are a percentage of the total coverage sought by such insureds. Based upon the
Company's reserving methodology and the experience of its historical resolution
of environmental exposures, it believes that the environmental reserve provision
is appropriate. As of December 31, 1996, the Company, for
28
approximately $1 billion, has resolved the environmental liabilities presented
by 3,498 of the 4,981 policyholders who have tendered environmental claims to
the Company. This resolution comprises 70% of the policyholders who have
tendered such claims. The Company has reserves of approximately $950 million
included in its bulk reserves relating to the remaining 1,483 policyholders (30%
of the total) with unresolved environmental claims, as well as for any other
policyholder which may tender an environmental claim in the future.
Asbestos Claims
In the area of asbestos claims, the Company believes that the property and
casualty insurance industry has suffered from judicial interpretations that have
attempted to maximize insurance availability from both a coverage and liability
standpoint far beyond the intent of the contracting parties. These policies
generally were issued prior to the 1980s. The Company continues to receive
asbestos claims alleging insureds' liability from claimants' asbestos-related
injuries. These claims, when submitted, rarely indicate the monetary amount
being sought by the claimant from the insured and the Company does not keep
track of the monetary amount being sought in those few claims which indicated
such a monetary amount. Originally the cases involved mainly plant workers and
traditional asbestos manufacturers and distributors. However, in the mid-1980s,
a new group of plaintiffs, whose exposure to asbestos was less direct and whose
injuries were often speculative, began to file lawsuits in increasing numbers
against the traditional defendants as well as peripheral defendants who had
produced products that may have contained small amounts of some form of
encapsulated asbestos. These claims continue to arise and on an individual basis
generally involve smaller companies with smaller limits of potential coverage.
Also, there has emerged a group of non-product claims by plaintiffs, mostly
independent labor union workers, mainly against companies, alleging exposure to
asbestos while working at these companies' premises. In addition, various
insurers, including the Company, remain defendants in an action brought in
Philadelphia regarding potential consolidation and resolution of future asbestos
bodily injury claims.
In summary, various classes of asbestos defendants, such as major product
manufacturers, peripheral and regional product defendants as well as premises
owners, are tendering asbestos-related claims to the industry. Because each
insured presents different liability and coverage issues, the Company evaluates
those issues on an insured-by-insured basis.
The Company's evaluations have not resulted in any meaningful data from which an
average asbestos defense or indemnity payment may be determined. The varying
defense and indemnity payments made by the Company on behalf of its insureds
also have precluded the Company from deriving any meaningful data by which it
can predict whether its defense and indemnity payments for asbestos claims (on
average or in the aggregate) will remain the same or change in the future. Based
upon the Company's experience with asbestos claims, the duration period of an
asbestos claim from the date of submission to resolution is approximately two
years.
At December 31, 1996, approximately 25% of the net aggregate reserve (i.e.,
approximately $263 million) is for pending asbestos claims. The balance,
approximately 75% (i.e., approximately $810 million) of the net asbestos
reserves represents incurred but not yet reported losses for which the Company
has not received any specific claims.
The following table displays activity for asbestos losses and loss expenses and
reserves for the three years ended December 31, 1996. In general, the Company
posts case reserves for pending asbestos claims within approximately 30 business
days of receipt of such claims.
29
Asbestos Losses
(millions) 1996 1995 1994
------- ------- -------
Beginning reserves:
Direct $ 695 $ 702 $ 775
Ceded (293) (319) (381)
------- ------- -------
Net 402 383 394
Acquisition of Aetna P&C:
Direct 801 -- --
Ceded (121) -- --
Incurred losses and loss expenses:
Direct 120 109 67
Ceded (35) (66) (16)
Losses paid:
Direct 173 116 140
Ceded (79) (92) (78)
------- ------- -------
Ending reserves:
Direct 1,443 695 702
Ceded (370) (293) (319)
------- ------- -------
Net $ 1,073 $ 402 $ 383
======= ======= =======
The largest reinsurer of the Company's asbestos risks is Lloyd's of London
(Lloyd's). In 1996, Lloyd's restructured its operations with respect to claims
for years prior to 1993. At December 31, 1996, the Company was in arbitration
with underwriters at Lloyd's in New York State to enforce reinsurance contracts
with respect to recoveries for certain asbestos claims. The dispute involved the
ability of the Company to aggregate asbestos claims under a market agreement
between Lloyd's and the Company or under the applicable reinsurance treaties. In
the fourth quarter of 1997, the Company finalized an agreement to settle this
arbitration with underwriters at Lloyd's. The outcome of this agreement will
have no impact on earnings.
Uncertainty Regarding Adequacy of Environmental and Asbestos Reserves
It is difficult to estimate the reserves for environmental and asbestos-related
claims due to the vagaries of court coverage decisions, plaintiffs' expanded
theories of liability, the risks inherent in major litigation and other
uncertainties. Conventional actuarial techniques are not used to estimate such
reserves.
For environmental claims, the Company estimates its financial exposure and
establishes reserves based upon an analysis of its historical claim experience
and the facts of the individual underlying claims. The unique facts presented in
each claim are evaluated individually and collectively. Due consideration is
given to the many variables presented in each claim, as discussed above.
The following factors are evaluated in projecting the ultimate reserve for
asbestos-related claims: available insurance coverage; limits and deductibles;
an analysis of each policyholder's potential liability; jurisdictional
involvement; past and projected future claim activity; past settlement values of
similar claims; allocated claim adjustment expense; potential role of other
insurance, and applicable coverage defenses, if any. Once the gross
30
ultimate exposure for indemnity and allocated claim adjustment expense is
determined for a policyholder by policy year, a ceded projection is calculated
based on any applicable facultative and treaty reinsurance. In addition, a
similar review is conducted for asbestos property damage claims. However, due to
the relatively minor claim volume, these reserves have remained at a constant
level.
As a result of these processes and procedures, the reserves carried for
environmental and asbestos claims at December 31, 1996 are the Company's best
estimate of ultimate claims and claim adjustment expenses based upon known facts
and current law. However, the environment surrounding the final resolution of
these claims continues to change. Currently, it is not possible to predict
changes in the legal and legislative environment and their impact on the future
development of asbestos and environmental claims. Such development will be
affected by future court decisions and interpretations and changes in Superfund
and other legislation. Because of these future unknowns, additional liabilities
may arise for amounts in excess of the current reserves. These additional
amounts, or a range of these additional amounts, cannot now be reasonably
estimated, and could result in a liability exceeding reserves by an amount that
would be material to the Company's operating results in a future period.
However, the Company believes that is not likely that these claims will have a
material adverse effect on the Company's financial condition or liquidity.
Cumulative Injury Other Than Asbestos (CIOTA) Claims
CIOTA claims are generally submitted to the Company under general liability
policies and often involve an allegation by a claimant against an insured that
the claimant has suffered injuries as a result of long-term or continuous
exposure to potentially harmful products or substances. Such potentially harmful
products or substances include, but are not limited to, lead paint, pesticides,
pharmaceutical products, silicone-based personal products, solvents and other
deleterious substances.
Due to claimants' allegations of long-term bodily injury in CIOTA claims,
numerous complex issues regarding such claims are presented. The claimant's
theories of liability must be evaluated, evidence pertaining to a causal link
between injury and exposure to a substance must be reviewed, the potential role
of other causes of injury must be analyzed, the liability of other defendants
must be explored, and assessment of a claimant's damages must be made and the
law of the jurisdiction must be applied. In addition, the Company must review
the number of policies issued by the Company to the insured and whether such
policies are triggered by the allegations, the terms and limits of liability of
such policies, the obligations of other insurers to respond to the claim, and
the applicable law in each jurisdiction.
To the extent disputes exist between the Company and a policyholder regarding
the coverage available for CIOTA claims, the Company resolves the disputes,
where feasible, through settlements with the policyholder or through coverage
litigation. Generally, the terms of a settlement agreement set forth the nature
of the Company's participation in resolving CIOTA claims and the scope of
coverage to be provided by the Company and contain the appropriate indemnities
and hold harmless provisions to protect the Company. These settlements generally
eliminate uncertainties for the Company regarding the risks extinguished,
including the risk that losses would be greater than anticipated due to evolving
theories of tort liability or unfavorable coverage determinations. The Company's
approach also has the effect of determining losses at a date earlier than would
have occurred in the absence of such settlement agreements. On the other hand,
in cases where future developments are favorable to insurers, this approach
could have the effect of resolving claims for amounts in excess of those that
would ultimately have been paid had the claims not been settled in this manner.
No inference should be drawn that because of the Company's method of dealing
with CIOTA claims, its reserves for such claims are more conservatively stated
than those of other insurers.
Aetna P&C did not distinguish CIOTA from other general liability claims or treat
CIOTA claims as a special class of claims. In addition, there were substantial
differences in claims approach and resolution between the Company and Aetna P&C
regarding CIOTA claims.
During the second quarter, the Company completed its review of Aetna P&C's
exposure to CIOTA claims in order to determine an appropriate level of reserves
using the Company's approach as described above. Based on the results of
31
that review, the Company's general liability insurance reserves were increased
$360 million, net of reinsurance ($192 million after tax and minority interest).
At December 31, 1996, approximately 19% of the net aggregate reserve (i.e.,
approximately $215 million) is for pending CIOTA claims. The balance,
approximately 81% (i.e., approximately $899 million) of the net CIOTA reserves
represents incurred but not yet reported losses for which the Company has not
received any specific claims.
The following table displays activity for CIOTA losses and loss expenses and
reserves for the three years ended December 31, 1996. In general, the Company
posts case reserves for pending CIOTA claims within approximately 30 business
days of receipt of such claims.
CIOTA Losses
(millions) 1996 1995 1994
------- ------- -------
Beginning reserves:
Direct $ 374 $ 375 $ 377
Ceded -- -- --
------- ------- -------
Net 374 375 377
Acquisition of Aetna P&C:
Direct 709 -- --
Ceded (293) -- --
Incurred losses and loss expenses:
Direct 565 21 16
Ceded (155) -- --
Losses paid:
Direct 88 22 18
Ceded (2) -- --
------- ------- -------
Ending reserves:
Direct 1,560 374 375
Ceded (446) -- --
------- ------- -------
Net $ 1,114 $ 374 $ 375
======= ======= =======
Outlook - Industry
Changes in the general interest rate environment affect the return received by
the insurance subsidiaries on newly invested and reinvested funds. While a
rising interest rate environment enhances the returns available, it reduces the
market value of existing fixed maturity investments and the availability of
gains on disposition. A decline in interest rates reduces the returns available
on investment of funds but could create the opportunity for realized investment
gains on disposition of fixed maturity investments.
As required by various state laws and regulations, the Company's insurance
subsidiaries are subject to assessments from state-administered guaranty
associations, second injury funds and similar associations. Management believes
that such assessments will not have a material impact on the Company's results
of operations, financial condition or liquidity.
Certain social, economic and political issues have led to an increased number of
legislative and regulatory proposals aimed at addressing the cost and
availability of certain types of insurance. While most of these provisions have
failed to become law, these initiatives may continue as legislators and
regulators try to respond to
32
public availability and affordability concerns and the resulting laws, if any,
could adversely affect the Company's ability to write business with appropriate
returns.
The National Association of Insurance Commissioners (NAIC) adopted risk-based
capital (RBC) requirements for life insurance companies and for property and
casualty insurance companies. The RBC requirements are to be used as early
warning tools by the NAIC and states to identify companies that merit further
regulatory action. The formulas have not been designed to differentiate among
adequately capitalized companies that operate with levels of capital higher than
RBC requirements. Therefore, it is inappropriate and ineffective to use the
formulas to rate or to rank such companies. At December 31, 1996 and 1995, all
of the Company's life and property & casualty companies had adjusted capital in
excess of amounts requiring any regulatory action.
Asset Quality - The investment portfolio of the insurance services segments
which include both Life Insurance and Property & Casualty Insurance totaled
approximately $55 billion, representing 61% of total insurance services' assets
of approximately $90 billion. Because the primary purpose of the investment
portfolio is to fund future policyholder benefits and claims payments, the
Company employs a conservative investment philosophy. The fixed maturity
portfolio totaled $43 billion, comprised of $36 billion of publicly traded fixed
maturities and $7 billion of private fixed maturities. The weighted average
quality ratings of the segment's publicly traded fixed maturity portfolio and
private fixed maturity portfolio at December 31, 1996 were Aa3 and Baa1,
respectively. Included in the fixed maturity portfolio was approximately $1.7
billion of below investment grade securities. Investments in venture capital
investments, highly leveraged transactions, and specialized lendings were not
material in the aggregate.
The insurance services segment makes investments in collateralized mortgage
obligations (CMOs). Such CMOs typically have high credit quality, offer good
liquidity, and provide a significant advantage in yield and total return
compared to U.S. Treasury securities. The investment strategy of the Insurance
Services segment is to purchase CMO tranches that are protected against
prepayment risk, including planned amortization class (PAC) tranches. Prepayment
protected tranches are preferred because they provide stable cash flows in a
variety of scenarios. The segment does invest in other types of CMO tranches if
a careful assessment indicates a favorable risk/return tradeoff; however, it
does not purchase residual interests in CMOs.
At December 31, 1996, the segment held CMOs with a market value of $4.6 billion.
Approximately 84% of CMO holdings are fully collateralized by GNMA, FNMA or
FHLMC securities, and the balance is fully collateralized by portfolios of
individual mortgage loans. In addition, the segment held $3.7 billion of GNMA,
FNMA or FHLMC mortgage-backed pass-through securities. Virtually all of these
securities are rated AAA.
At December 31, 1996, real estate and mortgage loan investments totaled $4.5
billion. Most of these investments are included in the investment portfolio of
the insurance companies. The Company is continuing its strategy to dispose of
these real estate assets and some of the mortgage loans and to reinvest the
proceeds to obtain current market yields.
At December 31, mortgage loan and real estate portfolios consisted of the
following:
(millions) 1996 1995
------ ------
Current mortgage loans $3,721 $3,796
Underperforming mortgage loans 91 252
------ ------
Total mortgage loans 3,812 4,048
------ ------
Real estate held for sale 695 321
------ ------
Total mortgage loans and real estate $4,507 $4,369
====== ======
33
Mortgage loans and real estate held for sale at December 31, 1996 include $811
million and $136 million, respectively, from the Aetna P&C acquisition.
Underperforming mortgage loans include delinquent loans, loans in the process of
foreclosure and loans modified at interest rates below market terms. The new
terms typically defer a portion of contract interest payments to varying future
periods. The accrual of interest is suspended on all restructured loans, and
interest income is reported only as payment is received. Of the total real
estate held for sale, $134 million is underperforming.
For further information relating to investments, see Note 6 of Notes to
Supplemental Consolidated Financial Statements.
Corporate and Other
Year Ended December 31,
---------------------------------------------------------------------
1996 1995 1994
---------------------------------------------------------------------
Net Net Net
Income Income Income
(millions) Revenues (Expense) Revenues (Expense) Revenues (Expense)
- ----------------------------------------------------------------------------------------------------------------------
Net expenses (1) $(211) $(238) $(201)
Net gain (loss) on sale of
stock of subsidiaries and
affiliates 384 (13) 39
- ----------------------------------------------------------------------------------------------------------------------
Total Corporate and Other $ 143 $ 173 $ 18 $(251) $ (12) $(162)
======================================================================================================================
(1) Includes $9 million and $23 million, respectively, of reported investment
portfolio losses in 1996 and 1995.
Corporate and Other consists of corporate staff and treasury operations, certain
corporate income and expenses that have not been allocated to the operating
subsidiaries, and certain intersegment eliminations.
The decrease in net expenses (before reported portfolio losses) in 1996 over
1995 is primarily attributable to lower staff expenses in the corporate segment
including the allocation of additional expenses to other operating segments
offset by increased interest costs associated with higher debt levels in 1996.
The increase in net expenses (before reported portfolio losses) in 1995 over
1994 is primarily attributable to increased interest costs borne at the
corporate level resulting from higher average short-term borrowing rates in 1995
when compared to 1994 as well as a shift in debt mix to higher levels of senior
long-term debt over the course of 1995.
Discontinued Operations
Year Ended December 31,
----------------------------------
(millions) 1996 1995 1994
----------------------------------
Net Income Net Income Net Income
(loss) (loss) (loss)
- --------------------------------------------------------------------------------
Operations $ (75) $ 20 $ 171
34
Gain (loss) on disposition (259) 130 9
- --------------------------------------------------------------------------------
Total Discontinued Operations $(334) $ 150 $ 180
================================================================================
As discussed in Note 3 of Notes to Supplemental Consolidated Financial
Statements, Basis Petroleum, Inc.(Basis), which was sold to Valero Energy
Corporation (Valero), as well as the life and health insurance businesses sold
to Metropolitan Life Insurance Company (MetLife) or contributed to The
MetraHealth Companies, Inc. (MetraHealth) have been classified as discontinued
operations. In 1995, the Company's results reflect the medical business not yet
transferred, plus its equity interest in the earnings of MetraHealth.
The Company's 1996 loss on disposition of $259 million represents the $290
million after tax loss on the sale of Basis to Valero, partially offset by a $31
million after tax gain resulting from a contingency payment received from United
HealthCare Corporation related to the 1995 sale of MetraHealth (see below).
Gain on disposition in 1995 represents a gain of $20 million from the sale in
January of the Company's group life insurance business to MetLife, and a gain of
$110 million (not including a contingency payment based on 1995 results which
was received by the Company in 1996) from the sale in October of the Company's
interest in MetraHealth to United HealthCare Corporation. During 1996 the
Company received the contingency payment recognizing an after tax gain of $31
million. Gain on disposition in 1994 represents the gain from the sale in
December of the group dental insurance business to MetLife.
Liquidity and Capital Resources
TRV services its obligations primarily with dividends and other advances that it
receives from subsidiaries. The subsidiaries' dividend paying abilities are
limited by certain covenant restrictions in credit agreements and/or by
regulatory requirements. TRV believes it will have sufficient funds to meet
current and future commitments. Each of TRV's major operating subsidiaries
finances its operations on a stand-alone basis consistent with its
capitalization and ratings.
Travelers Group Inc. (TRV)
TRV issues commercial paper directly to investors and maintains unused credit
availability under committed revolving credit agreements at least equal to the
amount of commercial paper outstanding. TRV, CCC and TIC have an agreement with
a syndicate of banks to provide $1.0 billion of revolving credit, to be
allocated to any of TRV, CCC or TIC. The participation of TIC in this agreement
is limited to $250 million. The revolving credit facility consists of a
five-year revolving credit facility which expires in June 2001. At December 31,
1996, $250 million was allocated to TRV, $650 million was allocated to CCC, and
$100 million to TIC. At December 31, 1996 there were no borrowings outstanding
under this facility. Under this facility the Company is required to maintain a
certain level of consolidated stockholders' equity (as defined in the
agreement). The Company exceeded this requirement by approximately $4.3 billion
at December 31, 1996.
As of December 31, 1996, TRV had unused credit availability of $250 million
under the five-year revolving credit facility. TRV may borrow under its
revolving credit facilities at various interest rate options and compensates the
banks for the facilities through commitment fees.
In February 1996, the Company issued 10.0 million depositary shares, each
representing one-twentieth of a share of 8.40% Cumulative Preferred Stock,
Series K (Series K Preferred). The Series K Preferred has cumulative dividends
payable quarterly and a liquidation preference of $500 per share ($25 per
depositary share) plus any accrued and unpaid dividends. On or after March 31,
2001, the Company may, at its option, redeem the Series K Preferred, in whole or
in part, at any time at a redemption price of $500 per share ($25 per depositary
share) plus dividends accrued and unpaid to the redemption date.
35
In October 1996, Travelers Capital I, a subsidiary trust of TRV, issued $400
million of 8.00% Trust Preferred Securities in a public offering. These Trust
Preferred Securities, which are fully and unconditionally guaranteed by TRV,
have a liquidation value of $25 per Trust Preferred Security and are mandatorily
redeemable under certain circumstances.
In December 1996, Travelers Capital II, a subsidiary trust of TRV, issued $400
million of 7 3/4% Trust Preferred Securities in a public offering and Travelers
Capital III, a subsidiary trust of TRV, issued $200 million of 7 5/8% Trust
Preferred Securities in a public offering. These Trust Preferred Securities,
which are fully and unconditionally guaranteed by TRV, have a liquidation value
of $1,000 per Trust Preferred Security and are mandatorily redeemable under
certain circumstances.
Commercial Credit Company (CCC)
CCC also issues commercial paper directly to investors and maintains unused
credit availability under committed revolving credit agreements at least equal
to the amount of commercial paper outstanding. As of December 31, 1996, CCC had
unused credit availability of $2.150 billion under five-year revolving credit
facilities, including the $650 million referred to above. CCC may borrow under
its revolving credit facilities at various interest rate options and compensates
the banks for the facilities through commitment fees.
CCC is limited by covenants in its revolving credit agreements as to the amount
of dividends and advances that may be made to TRV or its affiliated companies.
At December 31, 1996, CCC would have been able to remit $308 million to its
parent under its most restrictive covenants.
Travelers Property Casualty Corp. (TAP)
On April 2, 1996, Travelers Property Casualty Corp. (TAP), an indirect
majority-owned subsidiary of the Company, purchased from Aetna Services Inc. all
of the outstanding capital stock of The Aetna Casualty and Surety Company (ACSC)
and The Standard Fire Insurance Company (SFIC) (collectively, Aetna P&C) for
approximately $4.16 billion in cash. TAP also owns Travelers Indemnity.
Travelers Indemnity along with Aetna P&C are the primary vehicles through which
the Company engages in the property and casualty insurance business. See Note 2
of Notes to Consolidated Financial Statements regarding the financing of the
Aetna P&C purchase.
In addition to financing the Aetna P&C purchase, in September 1996 TAP sold in a
public offering $200 million of 6 3/4% Notes due September 1, 1999 and in
October an additional $200 million of 6 1/4% Notes due October 1, 1999 and in
November an additional $150 million of 6 3/4% Notes due November 15, 2006.
As discussed in Note 2 of Notes to Supplemental Consolidated Financial
Statements, during the first quarter of 1996 TAP entered into a five-year
revolving credit facility in the amount of $2.65 billion with a syndicate of
banks. The Credit Facility was used to finance in part the purchase of Aetna
P&C. All borrowings under the Credit Facility have been repaid in full. The
Credit Facility was subsequently amended to extend the maturity to December 2001
and reduce the amount available to $500 million, none of which is currently
utilized. Under the Credit Facility TAP is required to maintain a certain level
of consolidated stockholders' equity (as defined in the agreement). At December
31, 1996, this requirement was exceeded by approximately $2.8 billion.
TAP also issues commercial paper directly to investors and maintains unused
credit availability under the committed revolving credit agreement at least
equal to the amount of commercial paper outstanding.
TAP's insurance subsidiaries are subject to various regulatory restrictions that
limit the maximum amount of dividends available to be paid to their parent
without prior approval of insurance regulatory authorities. Dividend payments to
TAP from its insurance subsidiaries are limited to $647 million in 1997 without
prior approval of the Connecticut Insurance Department.
36
Salomon Smith Barney Holdings Inc. (Salomon Smith Barney)
Salomon Smith Barney's total assets were $246 billion at December 31, 1996, up
from $229 billion at year-end 1995. Due to the nature of Salomon Smith Barney's
trading activities, including its matched book activities, it is not uncommon
for the Company's asset levels to fluctuate from period to period. A "matched
book" transaction involves a security purchased under an agreement to resell
(i.e., reverse repurchase transaction) and simultaneously sold under an
agreement to repurchase (i.e., repurchase transaction). Salomon Smith Barney's
balance sheet is highly liquid, with the vast majority of its assets consisting
of marketable securities and collateralized short-term financing agreements
arising from securities transactions. The highly liquid nature of these assets
provides the Company with flexibility in financing and managing its business.
Salomon Smith Barney monitors and evaluates the adequacy of its capital and
borrowing base on a daily basis in order to allow for flexibility in its
funding, to maintain liquidity, and to ensure that its capital base supports the
regulatory capital requirements of its subsidiaries.
Salomon Smith Barney funds its operations through the use of secured and
unsecured short-term borrowings, long-term borrowings and TRUPS. Secured
short-term financing, including repurchase agreements and secured loans, is the
Company's principal funding source. Such borrowings totaled $105.1 billion at
December 31, 1996. Unsecured short-term borrowings provide a source of
short-term liquidity and are also utilized as an alternative to secured
financing when they represent a cheaper funding source. Sources of short-term
unsecured borrowings include commercial paper, unsecured bank borrowings and
letters of credit, deposit liabilities, promissory notes and corporate loans.
Short-term unsecured borrowing totaled $7.7 billion at December 31, 1996.
Salomon Smith Barney and Phibro Inc. have committed uncollateralized revolving
lines of credit totaling $1.5 and $.5 billion, respectively. In addition,
Salomon Brothers Inc, a wholly owned subsidiary of Salomon Smith Barney, has a
$2.1 billion committed secured standby bank credit facility for financing
securities positions which enables it to borrow on a secured basis using a
variety of financial instruments as collateral and Salomon Brothers
International Limited, a wholly owned subsidiary of Salomon Smith Barney, has a
committed securities repurchase facility in the amount of $1 billion. At
December 31, 1996 there were no outstanding borrowings under these facilities.
Salomon Smith Barney also has substantial borrowing arrangements consisting of
facilities that it has been advised are available, but where no contractual
lending obligation exists. These arrangements are reviewed on an ongoing basis
to ensure flexibility in meeting short-term requirements.
Unsecured term debt is a significant component of Salomon Smith Barney's
long-term capital. Long-term debt totaled $15.7 billion at December 31, 1996,
compared with $14.9 billion at December 31, 1995. Salomon Smith Barney utilizes
interest rate swaps to convert the majority of its fixed rate long-term debt
used to fund inventory-related working capital requirements into variable rate
obligations. Long-term debt issuances denominated in currencies other than the
U.S. dollar which are not used to finance assets in the same currency are
effectively converted to U.S. dollar obligations through the use of
cross-currency swaps and forward currency contracts. The average remaining
maturity of Salomon Smith Barney long-term debt was 3.6 years at December 31,
1996 and 3.4 years at December 31, 1995. See Note 11 to the supplemental
consolidated financial statements for additional information regarding debt and
an analysis of the impact of interest rate swaps on debt.
In July 1996, Salomon Smith Barney issued $345 million of TRUPS which pay
interest at an annual rate of 9 1/2%. Salomon Smith Barney has entered into an
interest rate swap agreement to effectively convert the fixed rate obligations
on the TRUPS to variable rate obligations. For a detailed description of these
securities see Note 15 to the supplemental consolidated financial statements.
Salomon Smith Barney's borrowing relationships are with a broad range of banks,
financial institutions and other firms from which it draws funds. The volume of
borrowings generally fluctuates in response to changes in the level of the
Company's financial instruments, commodities and contractual commitments,
customer balances, the amount of reverse repurchase transactions outstanding and
securities borrowed transactions. As Salomon Smith Barney's activities increase,
borrowings generally increase to fund the additional activities. Availability of
financing can vary depending upon market conditions, credit ratings, and the
overall availability of credit to the securities
37
industry. Salomon Smith Barney seeks to expand and diversify its funding mix as
well as its creditor sources. Concentration levels for these sources,
particularly for short-term lenders, are closely monitored both in terms of
single investor limits and daily maturities.
Salomon Smith Barney monitors liquidity by tracking asset levels, collateral and
funding availability to maintain flexibility to meet its financial commitments.
As a policy, Salomon Smith Barney attempts to maintain sufficient capital and
funding sources in order to have the capacity to finance itself on a fully
collateralized basis in the event that access to unsecured financing was
impaired. Salomon Smith Barney's liquidity management process includes a
contingency funding plan designed to ensure adequate liquidity even if access to
unsecured funding sources is severely restricted or unavailable. This plan is
reviewed periodically to keep the funding options current and in line with
market conditions. The management of this plan includes an analysis which is
utilized to determine ability to withstand varying levels of stress, which could
impact its liquidation horizons and required margins. In addition, the Company
monitors its leverage and capital ratios on a daily basis.
The Travelers Insurance Company (TIC)
At December 31, 1996, TIC had $21.9 billion of life and annuity product deposit
funds and reserves. Of that total, $11.6 billion is not subject to discretionary
withdrawal based on contract terms. The remaining $10.3 billion is for life and
annuity products that are subject to discretionary withdrawal by the
contractholder. Included in the amount that is subject to discretionary
withdrawal are $1.7 billion of liabilities that are surrenderable with market
value adjustments. Also included are an additional $5.4 billion of the life
insurance and individual annuity liabilities which are subject to discretionary
withdrawals, and have an average surrender charge of 5.0%. In the payout phase,
these funds are credited at significantly reduced interest rates. The remaining
$3.2 billion of liabilities are surrenderable without charge. More than 11% of
these relate to individual life products. These risks would have to be
underwritten again if transferred to another carrier, which is considered a
significant deterrent against withdrawal by long-term policyholders. Insurance
liabilities that are surrendered or withdrawn are reduced by outstanding policy
loans and related accrued interest prior to payout.
Scheduled maturities of guaranteed investment contracts (GICs) in 1997, 1998,
1999, 2000 and 2001 are $1.4 billion, $482 million, $459 million, $218 million
and $66 million, respectively. At December 31, 1996, the interest rates credited
on GICs had a weighted average rate of 6.25%.
TIC issues commercial paper to investors and maintains unused committed,
revolving credit facilities at least equal to the amount of commercial paper
outstanding. As of December 31, 1996, TIC had unused credit availability of $100
million under the joint five-year revolving credit facility referred to above.
TIC is subject to various regulatory restrictions that limit the maximum amount
of dividends available to its parent without prior approval of the Connecticut
Insurance Department. A maximum of $507 million of statutory surplus is
available in 1997 for such dividends without Department approval.
Deferred Income Taxes
The Company has a net deferred tax asset which relates to temporary differences
that are expected to reverse as net ordinary deductions. The Company will have
to generate approximately $6.3 billion of taxable income, before the reversal of
the temporary differences, primarily over the next 10 to 15 years, to realize
the remainder of the deferred tax asset. Management expects to realize the
remainder of the deferred tax asset based upon its expectation of future taxable
income, after the reversal of these deductible temporary differences, of at
least $2.8 billion annually.
Future Application of Accounting Standards
See Note 1 of Notes to Supplemental Consolidated Financial Statements for future
application of accounting standards.
38
Travelers Group Inc. and Subsidiaries
Supplemental Consolidated Statement of Income
(In millions of dollars, except per share amounts)
Year Ended December 31, 1996 1995 1994
- ---------------------------------------------------------------------------------------------------
Revenues
Insurance premiums $ 7,633 $ 4,977 $ 5,144
Commissions and fees 4,637 3,713 3,384
Interest and dividends 13,286 13,045 10,771
Finance related interest and other charges 1,163 1,119 1,030
Principal transactions 3,027 2,140 420
Asset management and administration fees 1,390 1,087 1,031
Other income 1,278 1,206 939
- ---------------------------------------------------------------------------------------------------
Total revenues 32,414 27,287 22,719
- ---------------------------------------------------------------------------------------------------
Expenses
Policyholder benefits and claims 7,366 5,017 5,227
Non-insurance compensation and benefits 5,804 5,149 4,692
Insurance underwriting, acquisition and operating 3,013 1,912 1,867
Interest 8,927 9,378 7,626
Provision for consumer finance credit losses 260 171 152
Other operating 2,481 2,320 2,356
- ---------------------------------------------------------------------------------------------------
Total expenses 27,851 23,947 21,920
- ---------------------------------------------------------------------------------------------------
Gain (loss) on sale of subsidiaries and affiliates 445 (20) 226
- ---------------------------------------------------------------------------------------------------
Income before income taxes and minority interest 5,008 3,320 1,025
Provision for income taxes 1,679 1,179 278
Minority interest, net of income taxes 47 -- --
- ---------------------------------------------------------------------------------------------------
Income from continuing operations 3,282 2,141 747
- ---------------------------------------------------------------------------------------------------
Discontinued operations, net of income taxes:
Income (loss) from operations net of tax expense (benefit)
of $(48), $(18) and $94 (75) 20 171
Gain (loss) on disposition net of tax expense (benefit) of
$(198), $66 and $19 (259) 130 9
- ---------------------------------------------------------------------------------------------------
Income (loss) from discontinued operations (334) 150 180
- ---------------------------------------------------------------------------------------------------
Net income $ 2,948 $ 2,291 $ 927
===================================================================================================
Net income (loss) per share of common stock
and common stock equivalents:
Continuing operations $ 2.74 $ 1.76 $ 0.52
Discontinued operations (0.29) 0.13 0.16
- ---------------------------------------------------------------------------------------------------
Net income per share of common stock
and common stock equivalents $ 2.45 $ 1.89 $ 0.68
===================================================================================================
Weighted average number of common shares outstanding
and common stock equivalents (in millions) 1,138.5 1,132.7 1,147.1
===================================================================================================
See Notes to Supplemental Consolidated Financial Statements.
39
Travelers Group Inc. and Subsidiaries
Supplemental Consolidated Statement of Financial Position
(In millions of dollars)
December 31, 1996 1995
- ------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents
(including $1,446 and $1,347 segregated under federal and other
brokerage regulations or deposited with clearing organizations) $ 3,260 $ 3,491
Investments and real estate held for sale:
Fixed maturities, primarily available for sale at market value 43,998 30,712
Equity securities, at market value 1,157 856
Mortgage loans 3,812 4,048
Real estate held for sale 459 321
Policy loans 1,910 1,888
Short-term and other 5,173 3,140
- ------------------------------------------------------------------------------------------------------------------
Total investments and real estate held for sale 56,509 40,965
- ------------------------------------------------------------------------------------------------------------------
Securities borrowed or purchased under agreements to resell 97,985 85,026
Brokerage receivables 11,592 10,312
Trading securities and commodities owned, at market value 126,568 121,802
Net consumer finance receivables 7,885 7,092
Reinsurance recoverables 10,234 6,461
Value of insurance in force and deferred policy acquisition costs 2,563 2,172
Cost of acquired businesses in excess of net assets 3,060 2,060
Separate and variable accounts 9,023 6,949
Other receivables 4,869 3,564
Other assets 12,400 12,450
- ------------------------------------------------------------------------------------------------------------------
Total assets $ 345,948 $ 302,344
==================================================================================================================
Liabilities
Investment banking and brokerage borrowings $ 10,020 $ 11,249
Short-term borrowings 1,557 1,468
Long-term debt 24,696 22,235
Securities loaned or sold under agreements to repurchase 103,572 113,470
Brokerage payables 10,019 12,157
Trading securities and commodities sold not yet purchased, at market value 92,032 62,240
Contractholder funds 13,621 14,535
Insurance policy and claims reserves 43,944 26,920
Separate and variable accounts 8,949 6,916
Accounts payable and other liabilities 16,802 14,573
- ------------------------------------------------------------------------------------------------------------------
Total liabilities 325,212 285,763
- ------------------------------------------------------------------------------------------------------------------
ESOP preferred stock - Series C (net of note guarantee of $35 and $67) 129 168
- ------------------------------------------------------------------------------------------------------------------
Redeemable preferred stock - Series I 420 560
- ------------------------------------------------------------------------------------------------------------------
TRV-obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debt securities of TRV 1,000 --
- ------------------------------------------------------------------------------------------------------------------
TAP-obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debt securities of TAP 900 --
- ------------------------------------------------------------------------------------------------------------------
Salomon Smith Barney-obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely junior subordinated debt securities of Salomon Smith Barney 345 --
- ------------------------------------------------------------------------------------------------------------------
Stockholders' equity
Preferred stock ($1.00 par value; authorized shares: 30 million), at aggregate
liquidation value 1,125 1,112
Common stock ($.01 par value; authorized shares: 1.5 billion;
issued shares: 1996 - 1,384,707,342 and 1995 - 1,368,269,744) 14 14
Additional paid-in capital 7,806 7,227
Retained earnings 12,934 10,504
Treasury stock, at cost (1996 - 243,500,547 shares and 1995 - 239,158,362 shares) (4,123) (3,470)
Unrealized gain (loss) on investment securities 469 756
Other, principally unearned compensation (283) (290)
- ------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 17,942 15,853
- ------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $ 345,948 $ 302,344
==================================================================================================================
See Notes to Supplemental Consolidated Financial Statements
40
Travelers Group Inc. and Subsidiaries
Supplemental Consolidated Statement of Changes in Stockholders' Equity
(In millions of dollars)
Amounts Shares (in thousands)
------------------------------------ ------------------------------------
Year Ended December 31, 1996 1995 1994 1996 1995 1994
------------------------------------ ------------------------------------
Preferred stock at aggregate liquidation value
Balance, beginning of year $ 1,112 $ 1,112 $ 1,112 11,825 11,825 11,825
Issuance of Series K preferred stock 250 -- -- 500 -- --
Redemption of Salomon Series C preferred stock (112) -- -- (225) -- --
Conversion of Series B preferred stock to common stock (125) -- -- (2,500) -- --
- -------------------------------------------------------------------------------------------- ------------------------------------
Balance, end of year 1,125 1,112 1,112 9,600 11,825 11,825
============================================================================================ ====================================
Common stock and additional paid-in capital
Balance, beginning of year 7,241 7,107 7,021 1,368,269 1,368,299 1,368,397
Conversion of Series B and Series I preferred stock
to common stock 265 -- -- 16,448 -- --
Issuance of shares pursuant to employee benefit plans 355 126 85 -- -- --
Other (41) 8 1 (10) (30) (98)
- -------------------------------------------------------------------------------------------- ------------------------------------
Balance, end of year 7,820 7,241 7,107 1,384,707 1,368,269 1,368,299
- -------------------------------------------------------------------------------------------- ------------------------------------
Retained earnings
Balance, beginning of year 10,504 8,880 8,348
Net income 2,948 2,291 927
Common dividends (355) (323) (247)
Preferred dividends (163) (155) (148)
Distribution of Transport Holdings Inc. shares -- (189) --
- --------------------------------------------------------------------------------------------
Balance, end of year 12,934 10,504 8,880
- --------------------------------------------------------------------------------------------
Treasury stock, at cost
Balance, beginning of year (3,470) (3,207) (2,535) (239,158) (239,412) (199,657)
Issuance of shares pursuant to employee benefit plans,
net of shares tendered for payment of option
exercise price and withholding taxes (11) 157 111 23,862 27,866 15,954
Treasury stock acquired (642) (418) (795) (28,204) (27,612) (56,442)
Other -- (2) 12 -- -- 733
- -------------------------------------------------------------------------------------------- ------------------------------------
Balance, end of year (4,123) (3,470) (3,207) (243,500) (239,158) (239,412)
- -------------------------------------------------------------------------------------------- ------------------------------------
Unrealized gain (loss) on investment securities
Balance, beginning of year 756 (1,319) 30
Net change in unrealized gains and losses on investment
securities, net of tax (287) 2,075 (1,349)
- --------------------------------------------------------------------------------------------
Balance, end of year 469 756 (1,319)
- --------------------------------------------------------------------------------------------
Other, principally unearned compensation
Balance, beginning of year (290) (141) (104)
Net issuance of restricted stock (305) (221) (190)
Restricted stock amortization 206 175 136
Adjustment for minimum pension liability, net of tax 114 (114) --
Net translation adjustments, net of tax (8) 11 17
- --------------------------------------------------------------------------------------------
Balance, end of year (283) (290) (141)
- --------------------------------------------------------------------------------------------
Total common stockholders' equity and common shares
outstanding 16,817 14,741 11,320 1,141,207 1,129,111 1,128,887
============================================================================================ ====================================
Total stockholders' equity $ 17,942 $ 15,853 $ 12,432
============================================================================================
See Notes to Supplemental Consolidated Financial Statements.
41
Travelers Group Inc. and Subsidiaries
Supplemental Consolidated Statement of Cash Flows
(In millions of dollars)
Year Ended December 31, 1996 1995 1994
- ----------------------------------------------------------------------------------------------------
Cash flows from operating activities
Income from continuing operations $ 3,282 $ 2,141 $ 747
Adjustments to reconcile income from continuing operations
to net cash provided by (used in) operating activities:
Amortization of deferred policy acquisition costs and value
of insurance in force 1,192 803 812
Additions to deferred policy acquisition costs (1,388) (858) (994)
Depreciation and amortization 430 416 386
Deferred tax provision (benefit) 29 (341) (568)
Provision for consumer finance credit losses 260 171 152
Changes in:
Trading securities and commodities, net 25,026 (24,032) 25,705
Securities borrowed, loaned and repurchase agreements, net (22,857) 20,949 (28,633)
Brokerage receivables net of brokerage payables (3,418) 2,879 2,414
Insurance policy and claims reserves (309) 686 350
Other, net 274 (37) (2,144)
Net cash flows provided by (used in) operating activities
of discontinued operations (41) (410) 223
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in) operating activities 2,480 2,367 (1,550)
- ----------------------------------------------------------------------------------------------------
Cash flows from investing activities
Consumer loans originated or purchased (3,410) (2,748) (2,789)
Consumer loans repaid or sold 2,534 2,245 2,094
Purchases of fixed maturities and equity securities (29,246) (18,123) (9,057)
Proceeds from sales of investments and real estate:
Fixed maturities available for sale and equity securities 23,471 12,864 4,149
Mortgage loans 200 739 402
Real estate and real estate joint ventures 257 256 955
Proceeds from maturities of investments:
Fixed maturities 3,586 2,723 3,319
Mortgage loans 1,050 693 1,301
Other investments, primarily short-term, net (325) (408) (58)
Assets securing collateralized mortgage obligations 480 721 930
Contingent consideration payment for the Shearson Businesses (110) (76) (69)
Business acquisition (4,160) -- --
Business divestments 338 -- 679
Other, net (365) (538) (390)
Net cash flows provided by (used in) investing activities
of discontinued operations 83 1,621 (197)
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities (5,617) (31) 1,269
- ----------------------------------------------------------------------------------------------------
Cash flows from financing activities
Dividends paid (518) (478) (395)
Subsidiary's sale of Class A common stock 1,453 -- --
Issuance of preferred stock 250 -- --
Issuance of redeemable preferred stock of subsidiaries 2,245 -- --
Redemption of preferred stock (112) -- --
Redemption of redeemable preferred stock -- (140) --
Treasury stock acquired (642) (420) (795)
Stock tendered for payment of withholding taxes (201) (94) (42)
Issuance of long-term debt 7,648 6,322 7,650
Payments and redemptions of long-term debt (4,886) (6,347) (4,314)
Net change in short-term borrowings (including investment
banking and brokerage borrowings) (1,140) (801) (2,113)
Collateralized mortgage obligations (403) (704) (945)
Contractholder fund deposits 2,493 2,707 1,958
Contractholder fund withdrawals (3,262) (3,755) (3,358)
Other, net (19) 99 43
Net cash flows provided by financing activities
of discontinued operations -- -- 84
- ----------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities 2,906 (3,611) (2,227)
- ----------------------------------------------------------------------------------------------------
Change in cash and cash equivalents (231) (1,275) (2,508)
Cash and cash equivalents at beginning of period 3,491 4,766 7,274
- ----------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of period $ 3,260 $ 3,491 $ 4,766
====================================================================================================
Supplemental disclosure of cash flow information:
====================================================================================================
Cash paid during the period for income taxes $ 1,553 $ 923 $ 787
====================================================================================================
Interest expense recorded for financial statement purposes did not differ
materially from the amount of interest paid.
See Notes to Supplemental Consolidated Financial Statements.
42
Travelers Group Inc. and Subsidiaries
Notes to Supplemental Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Basis of Presentation
Merger with Salomon Inc. On November 28, 1997, a newly formed wholly owned
subsidiary of Travelers Group Inc. merged with and into Salomon Inc
(Salomon) (the Merger). Under the terms of the Merger, approximately 188
million shares of Travelers Group Inc. (TRV) common stock were issued in
exchange for all of the outstanding shares of Salomon common stock, based
on an exchange ratio of 1.695 shares of TRV common stock for each share of
Salomon common stock, for a total value of approximately $9 billion. Each
of Salomon's series of preferred stock outstanding was exchanged for a
corresponding series of TRV preferred stock having substantially identical
terms, except that the TRV preferred stock issued in conjunction with the
Merger has certain voting rights (see Note 15). Thereafter, Smith Barney
Holdings Inc. (Smith Barney), a wholly owned subsidiary of TRV, was merged
with and into Salomon to form Salomon Smith Barney Holdings Inc. (Salomon
Smith Barney), which is the primary vehicle through which TRV engages in
investment banking, proprietary trading, retail brokerage and asset
management. The Merger was treated as a tax-free exchange.
The supplemental consolidated financial statements give retroactive effect
to the Merger in a transaction accounted for as a pooling of interests.
The pooling of interests method of accounting requires the restatement of
all periods presented as if TRV and Salomon had always been combined.
Generally accepted accounting principles proscribe giving effect to a
consummated business combination accounted for by the pooling of interests
method in financial statements that do not include the date of
consummation. The supplemental consolidated financial statements do not
extend through the date of consummation. However, they will become the
historical consolidated financial statements of TRV and its subsidiaries
(collectively, the Company) after financial statements covering the date
of consummation of the business combination are issued. The supplemental
consolidated statement of changes in stockholders' equity reflects the
accounts of the Company as if the additional preferred and common stock
had been issued during all periods presented. The supplemental
consolidated financial statements, including the notes thereto, should be
read in conjunction with the consolidated financial statements of
Travelers Group Inc. and Salomon Inc, included in their respective Annual
Reports on Form 10-K for the fiscal year ended December 31, 1996.
Certain reclassifications have been recorded to conform the accounting
policies of Salomon Inc and Smith Barney Holdings Inc.
Principles of Consolidation. The supplemental consolidated financial
statements include the accounts of Travelers Group Inc. and its
subsidiaries, including Salomon and its subsidiaries.
On April 2, 1996, Travelers Property Casualty Corp. (formerly
Travelers/Aetna Property Casualty Corp.) (TAP), an indirect majority-owned
subsidiary of the Company, purchased from Aetna Services Inc. (formerly
Aetna Life and Casualty Company) (Aetna), all of the outstanding capital
stock of The Aetna Casualty and Surety Company (ACSC) and The Standard
Fire Insurance Company (SFIC) (collectively, Aetna P&C) for approximately
$4.16 billion in cash. The acquisition was accounted for under the
purchase method of accounting and, accordingly, the supplemental
consolidated financial statements include the results of Aetna P&C's
operations only from the date of acquisition. TAP also owns The Travelers
Indemnity Company (Travelers Indemnity). Travelers Indemnity along with
Aetna P&C are the primary vehicles through which the Company engages in
the property and casualty insurance business.
Unconsolidated entities in which the Company has at least a 20% interest
are accounted for on the equity method. The minority interest in 1996
represents the interest in TAP held by the private and public investors.
(See Note 2.) Significant intercompany transactions and balances have been
eliminated.
43
Notes to Supplemental Consolidated Financial Statements (continued)
Assets and liabilities denominated in non-U.S. dollar currencies are
translated into U.S. dollar equivalents using year-end spot foreign
exchange rates. Revenues and expenses are translated monthly at amounts
which approximate weighted average exchange rates, with resulting gains
and losses included in income. The effects of translating the statements
of financial condition of non-U.S. subsidiaries with functional currencies
other than the U.S. dollar are recorded, in stockholders' equity net of
related hedge gains and losses and income taxes. Hedges of such exposure
include designated issues of non-U.S. dollar debt and, to a lesser extent,
forward currency contracts.
The preparation of the supplemental consolidated financial statements
requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the supplemental consolidated
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Accounting Changes
FAS 121. Effective January 1, 1996, the Company adopted Statement of
Financial Accounting Standards (FAS) No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of." This statement establishes accounting standards for the impairment of
long-lived assets and certain identifiable intangibles to be disposed of.
This statement requires a write down to fair value when long-lived assets
to be held and used are impaired. The statement also requires that
long-lived assets to be disposed of (e.g. real estate held for sale) be
carried at the lower of cost or fair value less cost to sell, and does not
allow such assets to be depreciated. The adoption of this standard did not
have a material impact on results of operations, financial condition or
liquidity.
FAS 123. In October 1995, the Financial Accounting Standards Board (FASB)
issued FAS No. 123, "Accounting for Stock-Based Compensation." FAS No. 123
establishes financial accounting and reporting standards for stock-based
employee compensation plans as well as transactions in which an entity
issues its equity instruments to acquire goods or services from
non-employees. This statement defines a fair value-based method of
accounting for employee stock options or similar equity instruments, and
encourages all entities to adopt this method of accounting for all
employee stock compensation plans. However, it also allows an entity to
continue to measure compensation cost for those plans using the intrinsic
value-based method of accounting prescribed by Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees" (Opinion 25).
Entities electing to remain with the accounting method prescribed in
Opinion 25 must make pro forma disclosures of net income and earnings per
share, as if the fair value-based method of accounting defined by FAS No.
123 had been applied. FAS No. 123 is applicable to fiscal years beginning
after December 15, 1995. The Company has elected to continue to account
for its stock-based compensation plans using the accounting method
prescribed by Opinion 25 and has included in the Notes to Supplemental
Consolidated Financial Statements the pro forma disclosures required by
FAS No. 123. (See Note 16.)
Accounting Policies
Cash and cash equivalents include cash on hand, cash segregated under
federal and brokerage regulations, cash deposited with clearing
organizations and short-term highly liquid investments with maturities of
three months or less when purchased, other than those held for sale in the
ordinary course of business. These short-term investments are carried at
cost plus accrued interest, which approximates market value.
Investments are owned principally by the insurance subsidiaries. Fixed
maturities include bonds, notes and redeemable preferred stocks. Equity
securities include common and non-redeemable preferred stocks. Fixed
maturities classified as "held to maturity" represent securities that the
Company has both the ability and the intent to hold until maturity and are
carried at amortized cost. Fixed maturity securities classified as
"available for sale" and equity securities are carried at market values
that are based primarily on quoted market prices or if quoted market
prices are not available, discounted expected cash flows using market
rates commensurate with the credit quality and maturity of the investment.
The difference between amortized cost and market values of such securities
net of applicable income taxes is reflected as a component of
stockholders' equity. Real estate held for sale is
44
Notes to Supplemental Consolidated Financial Statements (continued)
carried at the lower of cost or fair value less estimated costs to sell.
Fair value was established at the time of foreclosure by internal analysis
or external appraisers, using discounted cash flow analyses and other
acceptable techniques. Thereafter, an allowance for losses on real estate
held for sale is established if the carrying value of the property exceeds
its current fair value less estimated costs to sell. There was no such
allowance at December 31, 1996 or 1995. Mortgage loans are carried at
amortized cost. A mortgage loan is considered impaired when it is probable
that the Company will be unable to collect principal and interest amounts
due. For mortgage loans that are determined to be impaired, a reserve is
established for the difference between the amortized cost and fair value
of the underlying collateral. In estimating fair value, the Company uses
interest rates reflecting the higher returns required in the current real
estate financing market. Impaired loans were not significant at December
31, 1996 and 1995. Policy loans are carried at unpaid balances which do
not exceed the net cash surrender value of the related insurance policies.
Short-term investments, consisting primarily of money market instruments
and other debt issues purchased with a maturity of less than one year, are
carried at cost plus accrued interest which approximates market. Realized
gains and losses on sales of investments and unrealized losses considered
to be other than temporary, determined on a specific identification basis,
are included in other income.
Accrual of income is suspended on fixed maturities or mortgage loans that
are in default, or on which it is likely that future interest payments
will not be made as scheduled. Interest income on investments in default
is recognized only as payment is received. Investments included in the
Supplemental Consolidated Statement of Financial Position that were
non-income producing for the preceding 12 months were not significant.
The cost of acquired businesses in excess of net assets (goodwill) is
being amortized on a straight-line basis principally over a 40-year
period. The carrying amount is regularly reviewed for indicators of
impairment in value, which in the view of management are other than
temporary. Impairments are recognized in operating results if a permanent
diminution in value is deemed to have occurred.
Income taxes. TRV and its wholly owned domestic non-life insurance
subsidiaries (excluding Salomon Inc and its wholly owned domestic
subsidiaries) file a consolidated federal income tax return. All but one
of the life insurance subsidiaries are included in their own consolidated
federal income tax return. Salomon Inc and its wholly owned domestic
subsidiaries file their own consolidated federal income tax return.
Deferred income taxes result from temporary differences between the tax
basis of assets and liabilities and their recorded amounts for financial
reporting purposes.
Subsidiary stock issuance. The Company recognizes gains (losses) on sales
of stock by subsidiaries. For the year ended December 31, 1996, included
in net income is a gain of $363 million from the sale by TAP of 18% of its
common stock.
Earnings per common share is computed after recognition of preferred stock
dividend requirements and is based on the weighted average number of
shares outstanding during the period after consideration of the dilutive
effect of common stock warrants and stock options and the incremental
shares assumed issued under the Capital Accumulation Plan and other
restricted stock plans. Fully diluted earnings per common share, assuming
conversion of all outstanding convertible preferred stock, notes,
debentures and the maximum dilutive effect of common stock equivalents,
has not been presented because the effects are not material. The fully
diluted earnings per common share computation for the years ended December
31, 1996, 1995 and 1994 would entail adding the additional common stock
equivalents (11 million, 16 million and 5 million shares, respectively)
and the assumed conversion of the convertible preferred stock and
convertible notes (32 million, 52 million and 10 million shares,
respectively) to the number of shares included in the earnings per common
share calculation (resulting in a total of 1.181 billion, 1.200 billion
and 1.162 billion shares, respectively) and the elimination of the
convertible preferred stock dividends ($47 million, $70 million and $7
million, respectively).
During 1996 the Company's Board of Directors declared a three-for-two
stock split in January and a four-for-three stock split in October (both
payable in the form of stock dividends), which combined are the equivalent
of a
45
Notes to Supplemental Consolidated Financial Statements (continued)
two-for-one stock split. On October 22, 1997 the Company declared a
three-for-two stock split paid on November 19, 1997 in the form of a 50%
stock dividend to stockholders of record on November 3, 1997. All amounts
presented herein have been restated to reflect the stock splits.
Future Application of Accounting Standards
In June 1996, the FASB issued FAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." FAS No.
125 provides accounting and reporting standards for transfers and
servicing of financial assets and extinguishments of liabilities. These
standards are based on consistent application of a financial-components
approach that focuses on control. Under that approach, after a transfer of
financial assets, an entity recognizes the financial and servicing assets
it controls and the liabilities it has incurred, derecognizes financial
assets when control has been surrendered and derecognizes liabilities when
extinguished. FAS No. 125 provides consistent standards for distinguishing
transfers of financial assets that are sales from transfers that are
secured borrowings. The requirements of FAS No. 125 are effective for
transfers and servicing of financial assets and extinguishments of
liabilities occurring after December 31, 1996, and are to be applied
prospectively. However, in December 1996 the FASB issued FAS No. 127,
"Deferral of the Effective Date of Certain Provisions of FASB Statement
No. 125" which delays until January 1, 1998 the effective date for certain
provisions. Earlier or retroactive application is not permitted. The
adoption of the provisions of this statement effective January 1, 1997 did
not have a material impact on results of operations, financial condition
or liquidity and the Company is currently evaluating the impact of the
provisions whose effective date has been delayed until January 1, 1998.
In February 1997, the FASB issued Statement of Financial Accounting
Standards No. 128, "Earnings per Share" (FAS No. 128). This Statement
establishes standards for computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock. This
Statement simplifies the standards for computing earnings per share
previously found in Accounting Principles Board Opinion No. 15, "Earnings
per Share" (Opinion 15), and makes them comparable to international EPS
standards. It replaces the presentation of primary EPS with a presentation
of basic EPS. It also requires dual presentation of basic and diluted EPS
on the face of the income statement for all entities with complex capital
structures and requires a reconciliation of the numerator and denominator
of the basic EPS computation to the numerator and denominator of the
diluted EPS computation.
Basic EPS excludes dilution and is computed by dividing income available
to common stockholders by the weighted average number of shares
outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock
were exercised.
FAS No. 128 supersedes Opinion 15 and related accounting interpretations
and is effective for financial statements issued for periods ending after
December 15, 1997, including interim periods; earlier application is not
permitted. However, an entity is permitted to disclose pro forma amounts
computed using this Statement in the notes to the financial statements in
periods prior to required adoption.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" (FAS No. 130). FAS No. 130
establishes standards for the reporting and display of comprehensive
income and its components in a full set of general-purpose financial
statements. All items that are required to be recognized under accounting
standards as components of comprehensive income are to be reported in a
financial statement that is displayed with the same prominence as other
financial statements. This Statement stipulates that comprehensive income
reflect the change in equity of an enterprise during a period from
transactions and other events and circumstances from nonowner sources.
Comprehensive income will thus represent the sum of net income and other
comprehensive income, although FAS No. 130 does not require the use of the
terms comprehensive income or other comprehensive income. The accumulated
balance of other comprehensive income is required to be displayed
separately from retained earnings and additional paid-in capital in the
statement of financial position. This Statement is effective for fiscal
years beginning after December 15, 1997. The Company
46
Notes to Supplemental Consolidated Financial Statements (continued)
anticipates that the adoption of FAS No. 130 will result primarily in
reporting unrealized gains and losses on investments in debt and equity
securities in comprehensive income.
In June 1997, the FASB also issued Statement of Financial Accounting
Standards No. 131, "Disclosures about Segments of an Enterprise and
Related Information" (FAS No. 131). FAS No. 131 establishes standards for
the way that public enterprises report information about operating
segments in annual financial statements and requires that selected
information about those operating segments be reported in interim
financial statements. This Statement supersedes Statement of Financial
Accounting Standards No. 14, "Financial Reporting for Segments of a
Business Enterprise". FAS No. 131 requires that all public enterprises
report financial and descriptive information about their reportable
operating segments. Operating segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how
to allocate resources and in assessing performance. This Statement is
effective for fiscal years beginning after December 15, 1997. The
Company's reportable operating segments are not expected to change as a
result of the adoption of FAS No. 131.
INVESTMENT SERVICES
Commissions, underwriting and principal transaction revenues and related
expenses are recognized in income on a trade date basis. Customer security
transactions are recorded on a settlement date basis.
Asset management and administration fees are recorded as income for the
period in which the services are performed.
Trading securities, commodities and derivatives used for trading purposes
are recorded at either market value or, when market prices are not readily
available, fair value, which is determined under an alternative approach,
such as matrix or model pricing. Fair value includes related accrued
interest or dividends. The determination of market or fair value considers
various factors, including: closing exchange or over-the-counter market
price quotations; time value and volatility factors underlying options,
warrants and derivatives; price activity for equivalent or synthetic
instruments in markets located in different time zones; counterparty
credit quality; and the potential impact on market prices or fair value of
liquidating the Company's positions in an orderly manner over a reasonable
period of time under current market conditions.
Commodities include physical quantities of commodities involving future
settlement or delivery and related gains or losses are reported as
"Principal transactions."
The majority of the Company's trading securities, commodities and
derivatives are recorded on a trade date basis. Recording the remaining
instruments on a trade date basis would not materially affect these
supplemental consolidated financial statements.
47
Notes to Supplemental Consolidated Financial Statements (continued)
Derivatives used for trading purposes include interest rate, currency and
commodity swap agreements, swap options, caps and floors, options,
warrants and financial and commodity futures and forward contracts. The
market values (unrealized gains and losses) associated with derivatives
are reported net by counterparty, provided a legally enforceable master
netting agreement exists, and are netted across products and against cash
collateral when such provisions are stated in the master netting
agreement. Derivatives in a net receivable position, as well as options
owned and warrants held, are reported as assets in "Trading securities and
commodities owned." Similarly, derivatives in a net payable position, as
well as options written and warrants issued, are reported as liabilities
in "Trading securities and commodities sold not yet purchased." This
category also includes the Company's long-term obligations that have
principal repayments directly linked to equity securities of unaffiliated
issuers for which the Company holds in inventory a note exchangeable for
the same equity securities. Cash collateral received in connection with
interest rate swaps totaled $250 million and $447 million at December 31,
1996 and 1995, respectively and cash collateral paid totaled $1,637
million and $1,337 million, respectively. Revenues generated from
derivative instruments used for trading purposes are reported as
"Principal transactions" and include realized gains and losses as well as
unrealized gains and losses resulting from changes in the market or fair
value of such instruments.
Derivatives used for non-trading purposes which are designated as hedges
must be effective at reducing the risk associated with the exposure being
hedged and must be designated as a hedge at the inception of the
derivative contract. Accordingly, changes in the market or fair value of
the derivative instrument must be highly correlated with changes in the
market or fair value of the underlying hedge item. The Company monitors
the effectiveness of its hedges by periodically comparing the change in
value of the derivative instrument with the change in value of the
underlying hedged item. Derivatives used as hedges include interest rate
swaps, cross currency swaps and forward currency contracts.
Interest rate and cross currency swaps, are utilized to effectively
convert certain fixed rate preferred stock and guaranteed preferred
beneficial interests in Salomon Smith Barney subordinated debt securities
(TRUPS), a portion of investment banking and brokerage borrowings and the
majority of fixed rate term debt to variable rate instruments. These swaps
are recorded "off-balance sheet," with accrued inflows and outflows
reflected as adjustments to interest expense and/or dividends. Adjustments
to preferred stock dividends are recorded on an after-tax basis.
The Company utilizes forward currency contracts to hedge a portion of the
currency exchange rate exposure relating to non-U.S. dollar term debt
issued by the Company. The impact of translating the forward currency
contracts and the related debt to prevailing exchange rates is recognized
currently in income. The Company also utilizes forward currency contracts
to hedge certain investments in subsidiaries with functional currencies
other than the U.S. dollar. The impact of marking open contracts to
prevailing exchange rates and the impact of realized gains or losses on
maturing contracts, both net of the related tax effects, are included as
cumulative translation adjustments in stockholders' equity as is the
impact of translating the investments being hedged. Upon the disposition
of an investment in a subsidiary with a functional currency other than the
U.S. dollar, accumulated gains or losses previously included as cumulative
translation adjustments in stockholders' equity are recognized currently
in income.
Derivative instruments that do not meet the criteria to be designated as a
hedge are considered trading derivatives and are recorded at market or
fair value.
48
Notes to Supplemental Consolidated Financial Statements (continued)
Securities borrowed and securities loaned are recorded at the amount of
cash advanced or received. With respect to securities loaned, the Company
receives cash collateral in an amount in excess of the market value of
securities loaned. The Company monitors the market value of securities
borrowed and loaned on a daily basis with additional collateral obtained
as necessary.
Repurchase and resale agreements are treated as collateralized financing
transactions and are carried at the amounts at which the securities will
be subsequently reacquired or resold, including accrued interest, as
specified in the respective agreements. In the determination of income,
certain financing transactions are marked to fair value, which has no
material effect on the Company's results of operations. The Company's
policy is to take possession of securities purchased under agreements to
resell. The market value of securities to be repurchased and resold is
monitored, and additional collateral is requested where appropriate to
protect against credit exposure.
Brokerage receivables and brokerage payables include margin on futures
contracts.
Other assets include the value of management advisory contracts, which is
being amortized on the straight-line method over periods ranging from
twelve to twenty years.
INSURANCE SERVICES
Premiums from long-duration contracts, principally life insurance, are
earned when due. Premiums from short-duration insurance contracts are
earned over the related contract period. Short-duration contracts include
primarily property and casualty, credit life and accident and health
policies, including estimated ultimate premiums on retrospectively rated
policies. Benefits and expenses are associated with premiums by means of
the provision for future policy benefits, unearned premiums and the
deferral and amortization of policy acquisition costs.
Value of insurance in force represents the actuarially determined present
value of anticipated profits to be realized from life and accident and
health business on insurance in force at the date of the Company's
acquisition of its insurance subsidiaries using the same assumptions that
were used for computing related liabilities where appropriate. The value
of insurance in force acquired prior to December 31, 1993 is amortized
over the premium paying periods in relation to anticipated premiums. The
value of insurance in force relating to the acquisition of The Travelers
Corporation (old Travelers) was the actuarially determined present value
of the projected future profits discounted at interest rates ranging from
14% to 18% for the business acquired. The value of the business in force
is amortized over the contract period using current interest crediting
rates to accrete interest and using amortization methods based on the
specified products. Traditional life insurance is amortized over the
period of anticipated premiums; universal life in relation to estimated
gross profits; and annuity contracts employing a level yield method. The
value of insurance in force is reviewed periodically for recoverability to
determine if any adjustment is required.
Deferred policy acquisition costs for the life business represent the
costs of acquiring new business, principally commissions, certain
underwriting and agency expenses and the cost of issuing policies.
Deferred policy acquisition costs for traditional life business are
amortized over the premium-paying periods of the related policies, in
proportion to the ratio of the annual premium revenue to the total
anticipated premium revenue. Deferred policy acquisition costs of other
business lines are generally amortized over the life of the insurance
contract or at a constant rate based upon the present value of estimated
gross profits expected to be realized. For certain property and casualty
lines, acquisition costs (commissions and premium taxes) have been
deferred to the extent recoverable from future earned premiums and are
amortized ratably over the terms of the related policies. Deferred policy
acquisition costs are reviewed to determine if they are recoverable from
future income, including investment income, and, if not recoverable, are
charged to expense. All other acquisition expenses are charged to
operations as incurred.
49
Notes to Supplemental Consolidated Financial Statements (continued)
Separate and variable accounts primarily represent funds for which
investment income and investment gains and losses accrue directly to, and
investment risk is borne by, the contractholders. Each account has
specific investment objectives. The assets of each account are legally
segregated and are not subject to claims that arise out of any other
business of the Company. The assets of these accounts are generally
carried at market value. Amounts assessed to the contractholders for
management services are included in revenues. Deposits, net investment
income and realized investment gains and losses for these accounts are
excluded from revenues, and related liability increases are excluded from
benefits and expenses.
Other receivables include receivables related to retrospectively rated
policies on property-casualty business, net of allowance for estimated
uncollectible amounts.
Insurance policy and claims reserves represent liabilities for future
insurance policy benefits. Insurance reserves for traditional life
insurance, annuities, and accident and health policies have been computed
based upon mortality, morbidity, persistency and interest assumptions
applicable to these coverages, which range from 2.5% to 10%, including
adverse deviation. These assumptions consider Company experience and
industry standards and may be revised if it is determined that future
experience will differ substantially from that previously assumed.
Property-casualty reserves include (1) unearned premiums representing the
unexpired portion of policy premiums, and (2) estimated provisions for
both reported and unreported claims incurred and related expenses. The
reserves are adjusted regularly based on experience. Included in the
insurance policy and claims reserves in the Supplemental Consolidated
Statement of Financial Position at December 31, 1996 and 1995 are $1.568
billion and $778 million, respectively, of property-casualty loss reserves
related to workers' compensation that have been discounted using an
interest rate of 5%.
In determining insurance policy and claims reserves, the Company carries
on a continuing review of its overall position, its reserving techniques
and its reinsurance. Reserves for property-casualty insurance losses
represent the estimated ultimate cost of all incurred claims and claim
adjustment expenses. Since the reserves are based on estimates, the
ultimate liability may be more or less than such reserves. The effects of
changes in such estimated reserves are included in the results of
operations in the period in which the estimates are changed. Such changes
may be material to the results of operations and could occur in a future
period.
Contractholder funds represent receipts from the issuance of universal
life, pension investment and certain individual annuity contracts. Such
receipts are considered deposits on investment contracts that do not have
substantial mortality or morbidity risk. Account balances are increased by
deposits received and interest credited and are reduced by withdrawals,
mortality charges and administrative expenses charged to the
contractholders. Calculations of contractholder account balances for
investment contracts reflect lapse, withdrawal and interest rate
assumptions (ranging from 3.8% to 8.6%) based on contract provisions, the
Company's experience and industry standards. Contractholder funds also
include other funds that policyholders leave on deposit with the Company.
The fair value of these contracts is determined by discounting expected
cash flows at an interest rate commensurate with the Company's credit risk
and the expected timing of cash flows.
Derivatives used for non-trading purposes. See Note 20 for a discussion of
derivatives used for non-trading purposes.
Permitted Statutory Accounting Practices. The Company's insurance
subsidiaries are domiciled principally in Connecticut and Massachusetts
and prepare statutory financial statements in accordance with the
accounting practices prescribed or permitted by the insurance departments
of those states. Prescribed statutory accounting practices include a
variety of publications of the National Association of Insurance
Commissioners as well as state laws, regulations, and general
administrative rules. The impact of any accounting practices not so
prescribed on statutory surplus is not material.
50
Notes to Supplemental Consolidated Financial Statements (continued)
CONSUMER FINANCE SERVICES
Finance related interest and other charges are recognized as income using the
constant yield method. Allowances for losses are established by direct charges
to income in amounts sufficient to maintain the allowance at a level management
determines to be adequate to cover losses in the portfolio. The allowance
fluctuates based upon continual review of the loan portfolio and current
economic conditions. For financial reporting purposes, finance receivables are
considered delinquent when they are 60 days or more contractually past due.
Income stops accruing on finance receivables when they are 90 days contractually
past due. If payments are made on a finance receivable that is not accruing
income, and the receivable is no longer 90 days contractually past due, the
accrual of income resumes. Finance receivables are charged against the allowance
for losses when considered uncollectible. Personal loans are considered
uncollectible when payments are six months contractually past due and six months
past due on a recency of payment basis. Loans that are twelve months
contractually past due regardless of recency of payment are charged off.
Recoveries on losses previously charged to the allowance are credited to the
allowance at the time of recovery. Consideration of whether to proceed with
foreclosure on loans secured by real estate begins when a loan is 60 days past
due on a contractual basis. Real estate credit losses are recognized when the
title to the property is obtained.
Fees received and direct costs incurred for the origination of loans are
deferred and amortized over the contractual lives of the loans as part of
interest income. The remaining unamortized balances are reflected in interest
income at the time that the loans are paid in full, renewed or charged off.
2. Business Acquisitions
Acquisition of Aetna P&C
As discussed in Note 1, on April 2, 1996 TAP purchased from Aetna all of the
outstanding capital stock of ACSC and SFIC. To finance the purchase price and
transaction costs of $4.16 billion and capital contributions of $710 million to
Aetna P&C, TAP borrowed $2.65 billion from a syndicate of banks under a
five-year revolving credit facility (the Credit Facility) and sold approximately
33 million shares of its Class A Common Stock representing approximately 9% of
its outstanding common stock (at that time) to four private investors, including
Aetna, for an aggregate of $525 million. The Travelers Insurance Group Inc.
(TIGI), a wholly owned subsidiary of the Company, acquired approximately 328
million shares of Class B Common Stock of TAP in exchange for contributing the
outstanding capital stock of Travelers Indemnity and a capital contribution of
approximately $1.14 billion. In addition, TRV purchased from TAP $540 million of
Series Z Preferred Stock of TAP. Approximately $18 million of the purchase price
was funded through the settlement of receivables from Aetna.
On April 23, 1996, TAP sold in a public offering approximately 39 million shares
of its Class A Common Stock, representing approximately 9.75% of its outstanding
common stock, for total proceeds of $928 million. During the second quarter TAP
sold in public offerings $700 million in long-term notes (see Note 11) and
through subsidiary trusts $900 million in Trust Preferred Securities (see Note
15). The aggregate proceeds from the above offerings of $2.528 billion, together
with the proceeds from the issuance by TAP of approximately $700 million of
commercial paper, were used to repay in full the borrowings under the Credit
Facility and to redeem in full TAP's Series Z Preferred Stock.
The assets and liabilities of Aetna P&C are reflected in the Supplemental
Consolidated Statement of Financial Position at December 31, 1996 on a fully
consolidated basis at management's best estimate of their fair values at the
acquisition date. The excess of the purchase price over the estimated fair value
of net assets is approximately $1.16 billion and is being amortized over 40
years.
During 1996, TAP recorded charges related to the acquisition and integration of
Aetna P&C. These charges resulted primarily from anticipated costs of the
acquisition and the application of TAP's strategies, policies and practices to
Aetna P&C reserves and include: $229.1 million after tax and minority interest
($430 million before
51
Notes to Supplemental Consolidated Financial Statements (continued)
tax and minority interest) in reserve increases, net of reinsurance, related
primarily to cumulative injury claims other than asbestos (CIOTA); a $44.8
million after tax and minority interest ($84 million before tax and minority
interest) provision for an additional asbestos liability related to an existing
settlement agreement with a policyholder of Aetna P&C; a $32.0 million after tax
and minority interest ($60 million before tax and minority interest) charge
related to premium collection issues; a $21.8 million after tax and minority
interest ($41 million before tax and minority interest) provision for
uncollectibility of reinsurance recoverables; and an $18.7 million after tax and
minority interest ($35 million before tax and minority interest) provision for
lease and severance costs of Travelers Indemnity related to the restructuring
plan for the acquisition. In addition the Company recognized a gain of $363
million (before and after tax) from the issuance of shares of Class A Common
Stock by TAP and such gain is not reflected in the pro forma financial
information below.
The unaudited pro forma condensed results of operations presented below assume
the above transactions had occurred at the beginning of each of the periods
presented:
(in millions, expect per share amounts) 1996 1995*
--------------------------------------------------------------------------
Revenues $34,014 $32,594
Income from continuing operations $ 3,044 $ 1,740
Net income $ 2,710 $ 1,890
Continuing operations $ 2.53 $ 1.40
Net income $ 2.24 $ 1.53
* Historical results of Aetna P&C in 1995 include charges of $1.085 billion
($705 million after tax) representing an addition to environmental-related
and asbestos-related claims reserves.
The above unaudited pro forma condensed financial information is not necessarily
indicative either of the results of operations that would have occurred had this
transaction been consummated at the beginning of the periods presented or of
future operations of the combined companies.
Supplemental Information to the Supplemental Consolidated Statement of Cash
Flows Relating to the Acquisition of Aetna P&C
(millions) 1996
---------
Assets and liabilities of business acquired:
Invested assets $ 13,899
Reinsurance recoverables and other assets 10,409
Insurance policy and claim reserves (18,240)
Other liabilities (1,908)
-------------------------------------------------------------------
Cash payment related to business acquisition $ 4,160
===================================================================
Acquisition of Shearson Business
In July 1993, Smith Barney acquired the domestic retail brokerage and asset
management businesses (the Shearson Businesses) of Shearson Lehman Brothers
Holdings Inc., a subsidiary of American Express Company (American Express). In
addition to the amounts paid in 1993, Smith Barney Inc. has agreed to pay
American Express additional amounts that are contingent upon performance
(Contingent Consideration), consisting of up to $50 million per year for three
years based on its revenues and 10% of its after-tax profits in excess of $250
million per
52
Notes to Supplemental Consolidated Financial Statements (continued)
year over a five-year period. Contingent Consideration paid during 1996, 1995
and 1994 amounted to $110 million, $76 million and $69 million, respectively.
The 1996 payment includes a final payout of Contingent Consideration based on
revenues. The Contingent Consideration is being accounted for prospectively, as
additional purchase price, which will result in amortization over periods of up
to 20 years.
Acquisition of Security Pacific
On July 31, 1997, Commercial Credit Company acquired Security Pacific Financial
Services from BankAmerica Corporation for a purchase price of approximately $1.6
billion. The purchase included approximately $1.2 billion of net consumer
finance receivables and approximately $70 million of other net assets. The
excess of the purchase price over the estimated fair value of net assets was
$395.2 million and is being amortized over 25 years.
3. Disposition of Subsidiaries and Discontinued Operations
During 1996, gains on sale of subsidiaries and affiliates totaled $445 million
pre-tax and consisted of the sale in April of approximately 18% of TAP ($363
million), a net gain from the disposition of certain investment advisory
affiliates, including RCM Capital Management, a California Limited Partnership
(RCM) ($34 million) and the sale in the third quarter of The Mortgage
Corporation Limited ($48 million).
During 1994, gains on sale of subsidiaries and affiliates totaled $226 million
pre-tax and consisted of the sale in December of American Capital Management &
Research Inc. (American Capital) ($162 million), the sale in November of Smith
Barney's investment in HG Asia Holdings Ltd. ($34 million), and the sale in
October of Bankers and Shippers Insurance Company ($30 million).
Transport Spin-off
On September 29, 1995, the Company made a pro rata distribution to the Company's
stockholders of shares of Class A Common Stock, $.01 par value per share, of
Transport Holdings Inc. (Holdings), which at the time was a wholly owned
subsidiary of the Company, and the indirect owner of Transport Life Insurance
Company. The results of Holdings were included in income from continuing
operations through September 29, 1995, the spin-off date.
Discontinued Operations
In December 1994, the Company sold its group dental insurance business to
Metropolitan Life Insurance Company (MetLife) for $52 million and recognized an
after-tax gain of $9 million ($28 million pre-tax), and on January 3, 1995 the
Company sold its group life business as well as its related non-medical group
insurance businesses to MetLife for $350 million and recognized in the first
quarter of 1995 an after-tax gain of $20 million ($31 million pre-tax). In
connection with the sale, The Travelers Insurance Company (TIC) ceded 100% of
its risks in the group life and related businesses to MetLife on an indemnity
reinsurance basis, effective January 1, 1995. In connection with the reinsurance
transaction, TIC transferred assets with a fair market value of approximately
$1.5 billion to MetLife, equal to the statutory reserves and other liabilities
transferred.
On January 3, 1995, TIC and MetLife, and certain of their affiliates, formed The
MetraHealth Companies, Inc. (MetraHealth) joint venture by contributing their
medical businesses to MetraHealth, in exchange for shares of common stock of
MetraHealth. No gain was recognized upon the formation of the joint venture.
Upon formation of the joint venture TIC and its affiliates owned 50% of the
outstanding capital stock of MetraHealth, and the other 50% was owned by MetLife
and its affiliates. In March 1995, MetraHealth acquired HealthSpring, Inc. for
common stock of MetraHealth, resulting in a reduction in the participation of
the Company and MetLife in the MetraHealth venture to 48.25% each.
In October 1995, the Company completed the sale of its ownership in MetraHealth
to United HealthCare Corporation. Gross proceeds to the Company in 1995 were
$831 million in cash, and the Company recognized a gain in 1995 of $110 million
after tax ($165 million pre-tax). During 1996 the Company received a contingency
53
Notes to Supplemental Consolidated Financial Statements (continued)
payment (based on MetraHealth's 1995 results) and recognized a gain in 1996 of
$31 million after tax ($48 million pre-tax). Both of these gains are reflected
in discontinued operations.
All of the businesses sold to MetLife or contributed to MetraHealth have been
accounted for as a discontinued operation. Revenues from discontinued operations
for the years ended December 31, 1995 and 1994 amounted to $1.040 billion and
$3.522 billion, respectively. Revenues in 1996 were immaterial.
In March 1997, the Company entered into a non-binding letter of intent to sell
all of the outstanding stock of Basis Petroleum, Inc. (Basis), a wholly owned
subsidiary which owns and operates oil refineries in the U.S. Gulf Coast area,
to Valero Energy Corporation (Valero). This transaction resulted in a pre-tax
loss of approximately $505 million ($290 million after tax). The sale was
completed on May 1, 1997. Proceeds from the sale included cash of $365 million,
Valero common stock with a market value of $120 million and participation
payments based on a fixed notional throughput and the difference, if any,
between an average market crackspread, as defined, and a base crackspread, as
defined, over each of the next ten years. The total of the participation
payments is capped at $200 million, with a maximum of $35 million per year. In
addition, as a result of Valero's merger agreement with PG&E Corporation,
Valero's common stock was exchanged for stock of PG&E Corporation and a new
stock of the spin-off company (New Valero), representing Valero's refining
assets. In the third quarter of 1997, the Company liquidated its interest in the
PG&E and New Valero common stock. In July 1997, the Company paid Valero $3
million in connection with the final determination of working capital. The
estimated loss includes severance costs and anticipated operating losses to be
incurred prior to the completion of the sale, and reflects other estimates of
value at time of closing. Revenues of Basis for the years ended December 31,
1996, 1995 and 1994 were immaterial.
4. Business Segment Information
The Company is a diversified, integrated financial services company engaged in
investment services, life and property and casualty insurance services and
consumer finance. The following table presents certain information regarding
these industry segments:
(millions) 1996 1995 1994
------- -------- --------
Revenues
Investment Services $18,871 $ 17,512 $ 13,466
Life Insurance Services 3,765 3,858 3,488
Property & Casualty Insurance Services 8,224 4,545 4,538
Consumer Finance Services 1,411 1,354 1,239
Corporate and Other 143 18 (12)
------- -------- --------
$32,414 $ 27,287 $ 22,719
======= ======== ========
Income from continuing operations
before income taxes and minority interest
Investment Services $ 3,073 $ 1,827 $ (117)
Life Insurance Services 1,009 893 651
Property & Casualty Insurance Services 512 595 307
Consumer Finance Services 343 378 356
Corporate and Other 71 (373) (172)
------- -------- --------
$ 5,008 $ 3,320 $ 1,025
======= ======== ========
54
Notes to Supplemental Consolidated Financial Statements (continued)
Income from continuing operations
Investment Services $ 1,871 $ 1,112 $ 12
Life Insurance Services 653 581 421
Property & Casualty Insurance Services
(after minority interest of $47 in 1996) 362 453 249
Consumer Finance Services 223 246 227
Corporate and Other 173 (251) (162)
-------- --------- ---------
$ 3,282 $ 2,141 $ 747
======== ========= =========
Identifiable assets
Investment Services $246,126 $ 229,404 $ 218,070
Life Insurance Services 40,329 37,912 33,151
Property & Casualty Insurance Services 49,779 23,647 22,007
Consumer Finance Services 9,061 8,196 7,729
Corporate and Other 653 3,185 6,136
-------- --------- ---------
$345,948 $ 302,344 $ 287,093
======== ========= =========
The Investment Services segment consists of investment banking, asset
management, securities brokerage, proprietary trading, and other financial
services provided through Salomon Smith Barney and its subsidiaries for all
years presented, and in 1994 only, the investment management services provided
by RCM (sold in June 1996) and the mutual fund management and distribution
services provided through American Capital (sold in December 1994, see Note 3).
The Life Insurance Services segment includes individual and group life
insurance, accident and health insurance, annuities and investment products,
which are offered primarily through The Travelers Insurance Company, The
Travelers Life and Annuity Company and Primerica Financial Services (PFS).
The Property & Casualty Insurance Services segment provides property-casualty
insurance, including workers' compensation, liability, automobile, property and
commercial multi-peril to businesses and other institutions and automobile and
homeowners insurance to individuals. Property-casualty insurance policies are
issued primarily by subsidiaries of the Company's newly formed majority-owned
subsidiary Travelers Property Casualty Corp. and its property-casualty insurance
subsidiaries, including Travelers Indemnity, Gulf Insurance Company, ACSC and
SFIC.
The Consumer Finance Services segment includes consumer lending (including
secured and unsecured personal loans, real estate-secured loans and consumer
goods financing) and credit cards. Also included in this segment are
credit-related insurance services provided through American Health and Life
Insurance Company (AHL) and its affiliate.
Corporate and Other consists of corporate staff and treasury operations, certain
corporate income and expenses that have not been allocated to the operating
subsidiaries, including gains and losses from the sale of stock of subsidiaries
and affiliates. RCM, the remaining component of what were the Mutual Funds and
Asset Management operations in 1994, is reported as part of Corporate and Other
in 1995 and through its date of sale in 1996.
Cumulative effect of accounting changes, and capital expenditures for property,
plant and equipment and related depreciation expense are not material to any of
the business segments. Intersegment sales are not significant.
For gains and special charges included in each segment, see "Results of
Operations" discussion in Management's Discussion and Analysis of Financial
Condition and Results of Operations.
55
Notes to Supplemental Consolidated Financial Statements (continued)
The operations of the Company's Life Insurance, Property and Casualty Insurance
and Consumer Finance segments are conducted predominantly in North America. The
Investments Services segment conducts business primarily in North America,
Europe and Asia. The following table sets forth financial data by geographic
location for the Company's Investment Services segment.
Income (Loss) Before
Income Taxes From
(millions) Revenues Continuing Operations Total Assets
- -------------------------------------------------------------------------------------
Year Ended December 31, 1996
North America $15,326 $2,952 $152,435
Europe 3,365 77 76,875
Asia and Other 180 44 16,816
- -------------------------------------------------------------------------------------
Investment Services $18,871 $3,073 $246,126
=====================================================================================
Year Ended December 31, 1995
North America $12,869 $1,263 $141,973
Europe 4,370 607 75,292
Asia and Other 273 (43) 12,139
- -------------------------------------------------------------------------------------
Investment Services $17,512 $1,827 $229,404
=====================================================================================
Year Ended December 31, 1994
North America $11,188 $618 $144,992
Europe 1,717 (845) 65,082
Asia and Other 561 110 7,996
- -------------------------------------------------------------------------------------
Investment Services $13,466 $(117) $218,070
=====================================================================================
5. Principal Transaction Revenues
The following table presents principal transaction revenues by business activity
from continuing operations for the years ended December 31, 1996, 1995 and 1994.
- --------------------------------------------------------------------------------
(millions)
For the Year Ended December 31, 1996 1995 1994
- --------------------------------------------------------------------------------
Fixed Income $2,049 $900 $132
Equities 576 995 357
Physical commodities 393 238 191
Other 9 7 (260)
- --------------------------------------------------------------------------------
Principal transaction revenues $3,027 $2,140 $420
================================================================================
56
Notes to Supplemental Consolidated Financial Statements (continued)
Fixed income revenues include realized and unrealized gains and losses arising
from the trading, as principal and agent, of government and government agency
securities, investment and non-investment grade corporate debt, municipal
securities, preferred stock, mortgage securities (primarily U.S. government
agencies, including interest only and principal only strips), and emerging
market fixed income securities and derivatives. Revenues also include realized
and unrealized gains and losses generated from a variety of fixed income
securities utilized in arbitrage strategies for the Company's own account, and
realized and unrealized gains and losses arising from the spot and forward
trading of currencies and exchange-traded and over-the-counter (OTC) currency
options. Realized and unrealized gains and losses resulting from changes in the
market or fair value of options on fixed income securities, interest rate swaps,
currency swaps, swap options, caps and floors, financial futures, OTC options
and forward contracts on fixed income securities are reflected as fixed income
revenue.
Equities. Revenues from equities consist of realized and unrealized gains and
losses arising from proprietary and customer trading of U.S. and non-U.S. equity
securities, including common and convertible preferred stock, convertible
corporate debt, equity-linked notes and exchange-traded and OTC equity options
and warrants. Revenues also include realized and unrealized gains and losses on
equity securities and related derivatives utilized in arbitrage strategies for
the Company's own account.
Physical commodities trading is conducted primarily through Salomon Smith
Barney's wholly owned subsidiary Phibro Inc. (Phibro). Phibro trades crude oil,
refined oil products, natural gas, electricity, metals, petrochemicals, ethanol,
coffee, grains, cocoa and sugar. In 1996, Phibro discontinued trading coal, coke
and fertilizers. Commodity revenues consist of realized and unrealized gains and
losses from trading these commodities and related derivative instruments.
Other. 1994 results reflect a pre tax charge of $303 million ($189 million
after-tax) to correct general ledger balances, of which $194 million ($126
million after-tax) is related to London-based companies and $109 million ($63
million after-tax) arose from the completion of a detailed review of Salomon's
general ledger balances related to interest rate swaps.
6. Investments
Fair values of investments in fixed maturities are based on quoted market prices
or dealer quotes or, if these are not available, discounted expected cash flows
using market rates commensurate with the credit quality and maturity of the
investment. The fair value of investments for which a quoted market price or
dealer quote are not available amounted to $6.1 billion and $5.9 billion at
December 31, 1996 and 1995, respectively.
57
Notes to Supplemental Consolidated Financial Statements (continued)
The amortized cost and estimated market values of investments in fixed
maturities were as follows:
Amortized Gross Unrealized Market
----------------------------
December 31, 1996 Cost Gains Losses Value
----------------------- --------------------------
(millions)
Available for sale:
Mortgage-backed securities-principally obligations of U.S.
Government agencies $ 8,416 $146 $ (38) $ 8,524
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies 3,757 102 (11) 3,848
Obligations of states and political subdivisions 5,254 124 (31) 5,347
Debt securities issued by foreign governments 1,161 41 (4) 1,198
Corporate securities 24,636 462 (70) 25,028
-------------------------------------------------
$43,224 $875 $(154) $43,945
=================================================
Held to maturity, principally mortgage-backed securities $ 53 $ 9 $ - $ 62
=================================================
Amortized Gross Unrealized Market
----------------------------
December 31, 1996 Cost Gains Losses Value
----------------------- --------------------------
(millions)
Available for sale:
Mortgage-backed securities-principally obligations of U.S.
Government agencies $ 5,936 $ 169 $(20) $ 6,085
U.S. Treasury securities and obligations of
U.S. Government corporations and agencies 2,653 195 - 2,848
Obligations of states and political subdivisions 3,993 110 (11) 4,092
Debt securities issued by foreign governments 433 20 - 453
Corporate securities 16,569 619 (22) 17,166
-------------------------------------------------
$29,584 $1,113 $(53) $30,644
=================================================
Held to maturity, principally mortgage-backed securities $ 68 $ 11 $ - $ 79
=================================================
58
Notes to Supplemental Consolidated Financial Statements (continued)
The amortized cost and estimated market value at December 31, 1996 by
contractual maturity are shown below. Actual maturities will differ from
contractual maturities because borrowers may have the right to call or prepay
obligations with or without call or prepayment penalties.
Estimated
(millions) Amortized Market
Cost Value
------- -------
Due in one year or less $ 2,003 $ 2,012
Due after one year through five years 10,962 11,095
Due after five years through ten years 10,249 10,409
Due after ten years 11,594 11,905
------- -------
34,808 35,421
Mortgage-backed securities 8,469 8,586
------- -------
$43,277 $44,007
======= =======
Realized gains and losses on fixed maturities for the years ended December 31,
were as follows:
(millions) 1996 1995 1994
---- ---- ----
Realized gains
Pre-tax $231 $157 $ 52
---- ---- ----
After-tax $150 $102 $ 34
---- ---- ----
Realized losses
Pre-tax $361 $244 $201
---- ---- ----
After-tax $235 $159 $131
---- ---- ----
Net realized gains on equity securities and other investments, after-tax,
amounted to $120 million, $155 million and $18 million for the years ended
December 31, 1996, 1995 and 1994, respectively. Net unrealized gains (losses) on
equity securities at December 31, 1996 and 1995 were $44 million and $97
million, respectively.
The Company had industry concentrations of corporate bonds and short-term
investments at December 31 as follows:
(millions) 1996 1995
------ ------
Finance $4,399 $2,342
Banking $4,252 $2,138
Electric utilities $2,268 $1,582
Oil and gas $1,533 $1,362
59
Notes to Supplemental Consolidated Financial Statements (continued)
At December 31, significant concentrations of mortgage loans and real estate
were for properties located in highly populated areas in the states listed
below:
Mortgage Loans Real Estate
------------------- -----------------
(millions) 1996 1995 1996 1995
---- ---- ---- ----
California $811 $1,121 $393 $51
New York $390 $ 429 -- $49
Florida $283 $ 323 $ 49 $17
Texas $283 $ 300 $ 36 $56
Massachusetts $276 $ 111 $ 17 $ 4
Illinois $182 $ 203 $ 81 $58
Virginia $247 $ 194 $ -- $--
Other mortgage loan and real estate investments are dispersed throughout the
United States, with no combined holdings in any other state exceeding $200
million.
Aggregate annual maturities on mortgage loans are as follows:
(millions)
Past maturity $ 82
1997 462
1998 438
1999 538
2000 556
2001 277
Thereafter 1,459
------
$3,812
======
7. Securities Borrowed, Loaned and Subject to Repurchase Agreements
Securities borrowed or purchased under agreements to resell, at their respective
carrying values, consisted of the following at December 31:
(millions) 1996 1995
------- -------
Resale agreements $72,881 $60,509
Deposits paid for securities borrowed 25,104 24,517
------- -------
$97,985 $85,026
======= =======
Securities loaned or sold under agreements to repurchase, at their respective
carrying values, consisted of the following at December 31:
(millions) 1996 1995
------- -------
Repurchase agreements $ 97,282 $108,996
Deposits received for securities loaned 6,290 4,474
------- -------
$103,572 $113,470
======== ========
60
Notes to Supplemental Consolidated Financial Statements (continued)
The resale and repurchase agreements represent collateralized financing
transactions used to generate net interest income and facilitate trading
activity. These instruments are collateralized principally by government and
government agency securities and generally have terms ranging from overnight to
up to a year. It is the Company's policy to take possession of the underlying
collateral, monitor its market value relative to the amounts due under the
agreements, and, when necessary, require prompt transfer of additional
collateral or reduction in the loan balance in order to maintain contractual
margin protection. In the event of counterparty default, the financing agreement
provides the Company with the right to liquidate the collateral held. Resale
agreements and repurchase agreements are reported net by counterparty, when
applicable, pursuant to FASB Interpretation 41, "Offsetting of Amounts Related
to Certain Repurchase and Reverse Repurchase Agreements" (FIN 41). Excluding the
impact of FIN 41, resale agreements totaled $88.0 billion at December 31, 1996.
At December 31, 1996, the market value of securities collateralizing resale
agreements was $89.0 billion.
Deposits paid for securities borrowed (securities borrowed) and deposits
received for securities loaned (securities loaned) are recorded at the amount of
cash advanced or received and are collateralized principally by government and
government agency securities, corporate debt and equity securities. Securities
borrowed transactions require the Company to deposit cash with the lender. With
respect to securities loaned, the Company receives cash collateral in an amount
generally in excess of the market value of securities loaned. The Company
monitors the market value of securities borrowed and securities loaned daily,
and additional collateral is obtained as necessary. At December 31, 1996, the
market value of securities collateralizing securities borrowed was $24.6
billion.
8. Brokerage Receivables and Brokerage Payables
The Company has receivables and payables for financial instruments purchased
from and sold to brokers and dealers and customers. The Company is exposed to
risk of loss from the inability of brokers and dealers or customers to pay for
purchases or to deliver the financial instrument sold, in which case the Company
would have to sell or purchase the financial instruments at prevailing market
prices. Credit risk is reduced to the extent that an exchange or clearing
organization acts as a counterparty to the transaction.
The Company seeks to protect itself from the risks associated with customer
activities by requiring customers to maintain margin collateral in compliance
with regulatory and internal guidelines. Margin levels are monitored daily, and
customers deposit additional collateral as required. Where customers cannot meet
collateral requirements, the Company will liquidate sufficient underlying
financial instruments to bring the customer into compliance with the required
margin level.
Exposure to credit risk is impacted by market volatility, which may impair the
ability of clients to satisfy their obligations to the Company. Credit limits
are established and closely monitored for customers and brokers and dealers
engaged in forward and futures and other transactions deemed to be
credit-sensitive.
Brokerage receivables and brokerage payables, which arise in the normal course
of business, consisted of the following at December 31:
(millions) 1996 1995
------- -------
Receivables from customers $ 9,488 $ 8,603
Receivables from brokers, dealers and clearing organizations 2,104 1,709
------- -------
Total brokerage receivables $11,592 $10,312
======= =======
Payables to customers $ 8,160 $ 7,490
Payables to brokers, dealers and clearing organizations 1,859 4,667
------- -------
Total brokerage payables $10,019 $12,157
======= =======
61
Notes to Supplemental Consolidated Financial Statements (continued)
9. Trading Securities and Commodities
Trading securities and commodities at market value consisted of the following at
December 31:
1996 1995
---------------------- -------------------------
(millions) Sold Sold
Not Yet Not Yet
Owned Purchased Owned Purchased
--------- ----------- ---------- -------------
Government and government agency securities - U.S. $ 51,980 $41,864 $ 50,004 $24,845
Government and government agency securities - non-U.S. 35,189 31,699 39,842 21,994
Corporate debt securities 14,668 2,334 13,030 1,854
Equity securities 7,396 6,142 4,952 3,823
Contractual commitments 7,218 9,984 7,428 9,446
Mortgage loans and collateralized mortgage securities 4,345 - 2,347 -
Physical commodities 995 9 1,223 278
Other 4,777 - 2,976 -
--------- ----------- ---------- -------------
$ 126,568 $92,032 $121,802 $62,240
========= =========== ========== =============
See Note 20 for a discussion of trading securities, commodities,
derivatives and related risks.
10. Consumer Finance Receivables
Consumer finance receivables, net of unearned finance charges of $635
million and $690 million at December 31, 1996 and 1995, respectively,
consisted of the following:
(millions) 1996 1995
------- -------
Real estate-secured loans $ 3,457 $ 2,957
Personal loans 3,200 3,051
Credit cards 907 762
Sales finance and other 507 468
------- -------
Consumer finance receivables 8,071 7,238
Accrued interest receivable 54 47
Allowance for credit losses (240) (193)
------- -------
Net consumer finance receivables $ 7,885 $ 7,092
======= =======
An analysis of the allowance for credit losses on consumer finance
receivables at December 31, was as follows:
(millions) 1996 1995 1994
------- ------- -------
Balance, January 1 $ 193 $ 182 $ 168
Provision for consumer finance credit losses 260 171 152
Amounts written off (245) (188) (163)
Recovery of amounts previously written off 26 27 25
Allowance on receivables purchased 6 1 --
------- ------- -------
Balance, December 31 $ 240 $ 193 $ 182
------- ------- -------
Net outstandings $ 8,071 $ 7,238 $ 6,885
------- ------- -------
Allowance for credit losses as a % of net outstandings 2.97% 2.66% 2.64%
======= ======= =======
Contractual maturities of receivables before deducting unearned finance
charges and excluding accrued interest were as follows:
62
Notes to Supplemental Consolidated Financial Statements (continued)
Receivables
Outstanding Due
(millions) December 31, Due Due Due Due After
1996 1997 1998 1999 2000 2000
----------------- ----------- ----------- ----------- --------- -----------
Real-estate secured loans $3,505 $ 193 $ 199 $ 211 $252 $2,650
Personal loans 3,710 1,137 996 747 431 399
Credit cards 905 67 63 58 53 664
Sales finance and other 586 343 117 57 46 23
------------- ----------- ----------- ----------- --------- -----------
$8,706 $1,740 $1,375 $1,073 $782 $3,736
------------- ----------- ----------- ----------- --------- -----------
Percentage 100% 20% 16% 12% 9% 43%
============= =========== =========== =========== ========= ===========
Contractual terms average 16 years on real estate-secured loans (excluding call
provisions) and 4 years on personal loans. Experience has shown that a
substantial amount of the receivables will be renewed or repaid prior to
contractual maturity dates. Accordingly, the foregoing tabulation should not be
regarded as a forecast of future cash collections.
The Company has a geographically diverse consumer finance loan portfolio. At
December 31, the distribution by state was as follows:
1996 1995
-------- --------
Ohio 11% 12%
North Carolina 9% 10%
Pennsylvania 6% 7%
California 6% 5%
South Carolina 6% 6%
Texas 5% 5%
Tennessee 5% 5%
All other states* 52% 50%
-------- --------
100% 100%
======== ========
* In 1996 none of the remaining states individually accounts for more than
5% of total consumer finance receivables.
The estimated fair value of the consumer finance receivables portfolio depends
on the methodology selected to value such portfolio (i.e., exit value versus
entry value). Exit value represents a valuation of the portfolio based upon
sales of comparable portfolios which takes into account the value of customer
relationships and the current level of funding costs. Under the exit value
methodology, the estimated fair value of the receivables portfolio at December
31, 1996 is approximately $671 million above the recorded carrying value. Entry
value is determined by comparing the portfolio yields to the yield at which new
loans are being originated. Under the entry value methodology, the estimated
fair value of the receivables portfolio at December 31, 1996 is approximately
equal to the aggregate carrying value due to the increase in variable rate
receivables whose rates are periodically reset and the fact that the average
yield on fixed rate receivables is approximately equal to that on new fixed rate
loans made at year-end 1996. Fair values included in Note 21 are based on the
exit value methodology.
63
Notes to Supplemental Consolidated Financial Statements (continued)
11. Debt
Investment banking and brokerage borrowings
Investment banking and brokerage borrowings consisted of the following at
December 31:
1996 1995
-------------------------- ---------------------------
Weighted Weighted
Average Average
Balance Interest Rate Balance Interest Rate
----------- ------------- --------- ---------------
Bank borrowings $ 4,388 5.8% $ 4,081 4.9%
Commercial paper 4,133 5.7% 3,198 5.9%
Other 1,499 3,970
------- -------
$10,020 $11,249
======= =======
Investment banking and brokerage borrowings are short-term in nature and include
commercial paper, bank borrowings and other borrowings, such as deposit
liabilities, used to finance Salomon Smith Barney's operations, including the
securities settlement process. Outstanding bank borrowings include both U.S.
dollar and non-U.S. dollar denominated loans. The non-U.S. dollar loans are
denominated in multiple currencies including Japanese yen, German mark and U.K.
sterling. All commercial paper outstanding at December 31, 1996 and 1995 was U.S
dollar denominated.
Smith Barney has a $500 million, 364-day revolving credit agreement with a bank
syndicate that extends through May 1997. Smith Barney may borrow under its
revolving credit facility at various interest rate options (LIBOR, CD or base
rate) and compensates the banks for the facility through commitment fees. As of
December 31, 1996, there were no borrowings outstanding under this facility.
Salomon Brothers Inc (SBI), an indirect wholly owned subsidiary of Salomon Smith
Barney, has a $2.1 billion committed secured standby bank credit facility for
financing securities positions. The facility contains certain restrictive
covenants that require, among other things, that SBI maintain minimum levels of
excess net capital and net worth, as defined. SBI's excess net capital exceeded
the minimum required under the facility by $587 million and SBI's net worth
exceeded the minimum amount required by $496 million at December 31, 1996. In
1996, Salomon Brothers International Limited (SBIL), an indirect wholly owned
subsidiary of Salomon Smith Barney, entered into a $1.0 billion committed
securities repurchase facility. The facility is subject to restrictive covenants
including a requirement that SBIL maintain minimum levels of tangible net worth
and excess financial resources, as defined. At December 31, 1996, SBIL was in
compliance with all covenants related to this facility. In 1996, Phibro entered
into a $500 million unsecured committed revolving line of credit. This facility
requires Phibro to maintain minimum levels of capital and net working capital,
as defined. Phibro exceeded these minimums at December 31, 1996. At December 31,
1996, there were no outstanding borrowings under any of these facilities.
Smith Barney is limited by covenants in its revolving credit facility as to the
amount of dividends that may be paid to TRV.
Salomon Smith Barney also has substantial borrowing arrangements consisting of
facilities that it has been advised are available, but where no contractual
lending obligation exists.
64
Notes to Supplemental Consolidated Financial Statements (continued)
Short-term borrowings
At December 31, short-term borrowings consisted of commercial paper outstanding
with weighted average interest rates as follows:
1996 1995
------------------------------ ------------------------------
(millions) Outstanding Interest Rate Outstanding Interest Rate
----------- ------------- ----------- -------------
Commercial Credit Company $1,482 5.55% $1,394 5.86%
Travelers Property Casualty Corp. 25 5.64% -- --
The Travelers Insurance Company 50 5.53% 74 5.84%
------ ------
$1,557 $1,468
====== ======
TRV, Commercial Credit Company (CCC), TAP and The Travelers Insurance Company
(TIC) issue commercial paper directly to investors. Each maintains unused credit
availability under its respective bank lines of credit at least equal to the
amount of its outstanding commercial paper. Each may borrow under its revolving
credit facilities at various interest rate options (LIBOR, CD, base rate or
money market) and compensates the banks for the facilities through commitment
fees.
TRV, CCC and TIC have an agreement with a syndicate of banks to provide $1.0
billion of revolving credit, to be allocated to any of TRV, CCC or TIC. The
participation of TIC in this agreement is limited to $250 million. The revolving
credit facility consists of five-year revolving credit facility which expires in
June 2001. At December 31, 1996, $250 million was allocated to TRV, $650 million
was allocated to CCC, and $100 million was allocated to TIC. Under this
facility, the Company is required to maintain a certain level of consolidated
stockholders' equity (as defined in the agreement). At December 31, 1996, this
requirement was exceeded by approximately $4.3 billion. At December 31, 1996,
there were no borrowings outstanding under this facility.
At December 31, 1996, CCC also had a committed and available revolving credit
facility on a stand-alone basis of $1.5 billion, which expires in 2001.
CCC is limited by covenants in its revolving credit agreements as to the amount
of dividends and advances that may be made to its parent or its affiliated
companies. At December 31, 1996, CCC would have been able to remit $308 million
to the parent under its most restrictive covenants.
As discussed in Note 2, during the first quarter of 1996 TAP entered into a
five-year revolving credit facility in the amount of $2.65 billion with a
syndicate of banks. The Credit Facility was used to finance in part the purchase
of Aetna P&C. All borrowings under the Credit Facility have been repaid in full.
The Credit Facility was subsequently amended to extend the maturity to December
2001 and reduce the amount available to $500 million, none of which is currently
utilized. Under the Credit Facility TAP is required to maintain a certain level
of consolidated stockholders' equity (as defined in the agreement). At December
31, 1996, this requirement was exceeded by approximately $2.8 billion.
The carrying value of short-term borrowings approximates fair value.
65
Notes to Supplemental Consolidated Financial Statements (continued)
Long-term debt
At December 31, long-term debt was as follows:
Weighted
Average
(millions) Coupon Rate Maturities 1996 1995
----------- ---------- -------- -------
Travelers Group Inc.
Senior Notes 7.34% 1997-2025 $ 1,848 $ 1,948
Other(a) 55 94
Commercial Credit Company
Senior Notes 7.09% 1997-2025 5,750 5,200
Salomon Smith Barney Holdings Inc.
Senior Notes (b) 6.26% 1997-2023 15,738 14,920
Travelers Property Casualty Corp.
Senior Notes 6.83% 1999-2026 1,250 --
Other(c) (1) --
The Travelers Insurance Group Inc.
Other(d) 56 73
-------- -------
Total
Senior Notes $ 24,586 $22,068
Other 110 167
-------- -------
$ 24,696 $22,235
======== =======
(a) Unamortized premium of $20 million in 1996 and $27 million in 1995; and an
ESOP note guarantee of $35 million in 1996 and $67 million in 1995.
(b) Includes $4.036 billion and $3.774 billion of non-U.S. dollar denominated
debt at December 31, 1996 and 1995, respectively.
(c) Unamortized discount.
(d) Principally 12% GNMA/FNMA-collateralized obligations.
Salomon Smith Barney issues both U.S. dollar and non-U.S. dollar denominated
fixed and variable rate debt. However, Salomon Smith Barney utilizes interest
rate swap agreements to effectively convert most of its fixed rate debt to
variable rate debt. The maturity structure of the swaps generally corresponds
with the maturity structure of the debt being hedged. At December 31, 1996,
Salomon Smith Barney had entered into interest rate swaps to convert $8.8
billion of its $11.7 billion of fixed rate debt to variable rate obligations.
The contractual weighted average fixed rate on swapped fixed rate debt and the
weighted average variable rate on swapped debt (Salomon Smith Barney's actual
borrowing cost) was 6.8% and 6.1% at December 31, 1996 and 6.8% and 6.2% at
December 31, 1995, respectively.
Smith Barney has $1.0 billion revolving credit agreement with a bank syndicate
that extends through May 1999. Smith Barney may borrow under this credit
facility at various interest rate options (LIBOR, CD or base rate) and
compensates the banks for the facility through commitment fees. As of December
31, 1996 there were no borrowings outstanding under this facility.
66
Notes to Supplemental Consolidated Financial Statements (continued)
Aggregate annual maturities for the next five years on long-term debt
obligations (based on final maturity dates) excluding principal payments on the
ESOP loan obligation and the 12% GNMA/FNMA-collateralized obligations, are as
follows:
(millions) 1997 1998 1999 2000 2001 Thereafter(a)
------ ------ ------ ------ ------ -------------
Travelers Group Inc. $ 185 $ 250 $ 100 $ 200 $ -- $1,113
Commercial Credit Company 350 300 350 750 700 3,300
Salomon Smith Barney Holdings Inc. 3,103 2,937 2,494 1,800 1,326 4,078
Travelers Property Casualty Corp. -- -- 400 -- 500 350
------ ------ ------ ------ ------ ------
$3,638 $3,487 $3,344 $2,750 $2,526 $8,841
====== ====== ====== ====== ====== ======
(a) Includes $450 million redeemable at option of holders during 1999 at face
amount.
The fair value of the Company's long-term debt is estimated based on the quoted
market price for the same or similar issues or on current rates offered to the
Company for debt of the same remaining maturities. At December 31, 1996 the
carrying value and the fair value of the Company's long-term debt were:
(millions) Carrying Fair
Value Value
------- -------
Travelers Group Inc. $ 1,903 $ 1,926
Commercial Credit Company 5,750 5,888
Salomon Smith Barney Holdings Inc. 15,738 15,943
Travelers Property Casualty Corp. 1,249 1,246
The Travelers Insurance Group Inc. 56 62
------- -------
$24,696 $25,065
======= =======
12. Insurance Policy and Claims Reserves
Insurance policy and claims reserves consisted of the following at December 31:
(millions) 1996 1995
------- -------
Benefit and loss reserves:
Property-casualty $29,967 $14,715
Accident and health 928 754
Life and annuity 8,555 8,663
Unearned premiums 3,909 2,166
Policy and contract claims 585 622
------- -------
$43,944 $26,920
======= =======
67
Notes to Supplemental Consolidated Financial Statements (continued)
The table below is a reconciliation of beginning and ending property-casualty
reserve balances for claims and claim adjustment expenses for the years ended
December 31:
(millions) 1996 1995 1994
------- -------- --------
Claims and claim adjustment expense reserves
at beginning of year $14,715 $ 13,872 $ 13,805
Less reinsurance recoverables on unpaid losses 4,613 3,621 3,615
------- -------- --------
Net balance at beginning of year 10,102 10,251 10,190
------- -------- --------
Provision for claims and claim adjustment expenses
for claims arising in the current year 4,827 2,898 3,201
Estimated claims and claim adjustment expenses for claims
arising in prior years 192 (227) (248)
Increase for purchase of Aetna P&C 11,752 -- --
------- -------- --------
Total increases 16,771 2,671 2,953
------- -------- --------
Claims and claim adjustment expense payments for claims arising in:
Current year 1,858 887 989
Prior years 3,199 1,933 1,903
------- -------- --------
Total payments 5,057 2,820 2,892
------- -------- --------
Net balance at end of year 21,816 10,102 10,251
Plus reinsurance recoverables on unpaid losses 8,151 4,613 3,621
------- -------- --------
Claims and claim adjustment expense reserves at end of year $29,967 $ 14,715 $ 13,872
------- -------- --------
In 1996 estimated claims and claim adjustment expenses for claims arising in
prior years included $238 million of net favorable development in certain
Commercial Lines and Personal Lines coverages. Also in 1996, estimated claims
and claim adjustment expenses for claims arising in prior years included $430
million within Commercial Lines related to acquisition-related charges primarily
related to CIOTA, insurance products involving financial guarantees, and assumed
reinsurance. In addition, as a result of the Company's review of Aetna P&C's
insurance reserves, Commercial Lines reserves were increased by $60 million and
Personal Lines reserves were decreased by $60 million.
In 1995, estimated claims and claim adjustment expenses for claims arising in
prior years included favorable loss development in certain workers'
compensation, general liability and commercial auto lines of approximately $150
million; however, since the business to which it relates is subject to premium
adjustments on retrospectively rated policies, the net impact on results of
operations is not significant. In addition, in 1995 estimated claims and claim
adjustment expenses for claims arising in prior years included favorable loss
development in Personal Lines of approximately $60 million.
In 1994, estimated claims and claim adjustment expenses for claims arising in
prior years included favorable loss development in Personal Lines automobile and
homeowners coverage of $100 million, offset by unfavorable development of $100
million for Commercial Lines asbestos and environmental claims from 1985 and
prior. In addition, in 1994 Commercial Lines experienced favorable prior year
loss development in workers' compensation, other liability and commercial
automobile product lines in its National Accounts business for post-1985
accident years. This favorable development amounted to $261 million; however,
since the business to which it relates is subject to premium adjustments on
retrospectively rated policies, the net impact on results of operations is not
significant.
The property-casualty claims and claim adjustment expense reserves include
$2.315 billion and $806 million for asbestos and environmental related claims
net of reinsurance at December 31, 1996 and 1995, respectively.
68
Notes to Supplemental Consolidated Financial Statements (continued)
It is difficult to estimate the reserves for environmental and asbestos-related
claims due to the vagaries of court coverage decisions, plaintiffs' expanded
theories of liability, the risks inherent in major litigation and other
uncertainties. Conventional actuarial techniques are not used to estimate such
reserves.
For environmental claims, the Company estimates its financial exposure and
establishes reserves based upon an analysis of its historical claim experience
and the facts of the individual underlying claims. More specifically, the unique
facts presented in each claim are evaluated individually and collectively. Due
consideration is given to the many variables presented in each claim, as
discussed above.
The following factors are evaluated in projecting the ultimate reserve for
asbestos-related claims: available insurance coverage; limits and deductibles;
an analysis of each policyholder's potential liability; jurisdictional
involvement; past and projected future claim activity; past settlement values of
similar claims; allocated claim adjustment expense; potential role of other
insurance, and applicable coverage defenses, if any. Once the gross ultimate
exposure for indemnity and allocated claim adjustment expense is determined for
a policyholder by policy year, a ceded projection is calculated based on any
applicable facultative and treaty reinsurance. In addition, a similar review is
conducted for asbestos property damage claims. However, due to the relatively
minor claim volume, these reserves have remained at a constant level.
As a result of these processes and procedures, the reserves carried for
environmental and asbestos claims at December 31, 1996 are the Company's best
estimate of ultimate claims and claim adjustment expenses, based upon known
facts and current law. However, the conditions surrounding the final resolution
of these claims continues to change. Currently, it is not possible to predict
changes in the legal and legislative environment and their impact on the future
development of asbestos and environmental claims. Such development will be
impacted by future court decisions and interpretations and changes in Superfund
and other legislation. Because of these future unknowns, additional liabilities
may arise for amounts in excess of the current reserves. These additional
amounts, or a range of these additional amounts, cannot now be reasonably
estimated, and could result in a liability exceeding reserves by an amount that
would be material to the Company's operating results in a future period.
However, the Company believes that it is not likely that these claims will have
a material adverse effect on the Company's financial condition or liquidity.
The Company has a geographic exposure to catastrophe losses in certain North
Atlantic states, California and South Florida. Catastrophes can be caused by
various events including hurricanes, windstorms, earthquakes, hail, severe
winter weather, explosions and fires, and the incidence and severity of
catastrophes are inherently unpredictable. The extent of losses from a
catastrophe is a function of both the total amount of insured exposure in the
area affected by the event and the severity of the event. Most catastrophes are
restricted to small geographic areas; however, hurricanes and earthquakes may
produce significant damage in large, heavily populated areas. The Company
generally seeks to reduce its exposure to catastrophe through individual risk
selection and the purchase of catastrophe reinsurance.
13. Reinsurance
The Company's insurance operations participate in reinsurance in order to limit
losses, minimize exposure to large risks, provide additional capacity for future
growth and effect business-sharing arrangements. Life reinsurance is
accomplished through various plans of reinsurance, primarily coinsurance,
modified coinsurance and yearly renewable term. Property-casualty reinsurance is
placed on both a quota-share and excess of loss basis. The property-casualty
insurance subsidiaries also participate as a servicing carrier for, and a member
of, several pools and associations. Reinsurance ceded arrangements do not
discharge the insurance subsidiaries or the Company as the primary insurer,
except for cases involving a novation.
69
Notes to Supplemental Consolidated Financial Statements (continued)
Reinsurance amounts included in the Supplemental Consolidated Statement of
Income were:
Ceded to
(millions) Gross Other Net
Amount Companies Amount
------- ------- ------
Year ended December 31, 1996
Premiums
Life insurance $ 1,529 $ (296) $1,233
Accident and health insurance 402 (98) 304
Property-casualty insurance 7,902 (1,806) 6,096
------- ------- ------
$ 9,833 $(2,200) $7,633
------- ------- ------
Claims incurred $ 8,389 $(1,892) $6,497
======= ======= ======
Year ended December 31, 1995
Premiums
Life insurance $ 1,497 $ (272) $1,225
Accident and health insurance 499 (87) 412
Property-casualty insurance 4,752 (1,412) 3,340
------- ------- ------
$ 6,748 $(1,771) $4,977
------- ------- ------
Claims incurred $ 5,806 $(1,726) $4,080
======= ======= ======
Year ended December 31, 1994
Premiums
Life insurance $ 1,484 $ (288) $1,196
Accident and health insurance 514 (89) 425
Property-casualty insurance 5,052 (1,529) 3,523
------- ------- ------
$ 7,050 $(1,906) $5,144
------- ------- ------
Claims incurred $ 5,725 $(1,328) $4,397
======= ======= ======
Reinsurance recoverables, net of valuation allowance, at December 31 include
amounts recoverable on unpaid and paid losses and were as follows:
(millions) 1996 1995
------- ------
Reinsurance Recoverables
Life business $ 1,521 $1,804
Property-casualty business:
Pools and associations 4,160 2,775
Other reinsurance 4,553 1,882
------- ------
$10,234 $6,461
======= ======
Included in Life business reinsurance recoverables at December 31, 1996 and 1995
is approximately $720 million and $929 million, respectively, of receivables
from MetLife in connection with the sale of the group life business.
70
Notes to Supplemental Consolidated Financial Statements (continued)
14. Income Taxes
The provision for income taxes attributable to income from continuing operations
(before minority interest) for the years ended December 31 was as follows:
(millions) 1996 1995 1994
------- ------- -----
Current:
Federal $ 1,287 $ 924 $ 296
Foreign 12 356 408
State 333 188 103
------- ------- -----
1,632 1,468 807
------- ------- -----
Deferred:
Federal 51 (95) 147
Foreign 67 (130) (627)
State (71) (64) (49)
------- ------- -----
47 (289) (529)
------- ------- -----
$ 1,679 $ 1,179 $ 278
======= ======= =====
The reconciliation of the federal statutory income tax rate to the Company's
effective income tax rate applicable to income from continuing operations
(before minority interest) for the years ended December 31 was as follows:
1996 1995 1994
---- ---- ----
Federal statutory rate 35.0% 35.0% 35.0%
Limited taxability of investment income (2.7) (3.2) (10.6)
State and foreign income taxes
(net of federal income tax benefit) 3.6 2.6 4.3
Issuance of stock by subsidiary (2.7) -- --
Sale of subsidiaries -- -- 6.2
Adjustment of tax accruals -- -- (10.0)
Other, net 0.3 1.1 2.2
---- ---- ----
Effective income tax rate 33.5% 35.5% 27.1%
==== ==== ====
71
Notes to Supplemental Consolidated Financial Statements (continued)
Deferred income taxes at December 31 related to the following:
(millions) 1996 1995
--------- ---------
Deferred tax assets:
Differences in computing policy reserves $ 2,036 $ 1,161
Deferred compensation 834 715
Employee benefits 241 308
Other deferred tax assets 1,037 991
--------------------
Gross deferred tax assets 4,148 3,175
--------------------
Valuation allowance 100 100
--------------------
Deferred tax assets after valuation allowance 4,048 3,075
--------------------
Deferred tax liabilities:
Deferred policy acquisition costs and
value of insurance in force (719) (610)
Investment management contracts (246) (249)
Investments (84) (168)
Fixed assets (107) (37)
Mark to market on inventory (187) (365)
Cumulative translation adjustments (114) (117)
Undistributed earnings of non-U.S. subsidiaries (84) (113)
Other deferred tax liabilities (275) (301)
--------------------
Gross deferred tax liabilities (1,816) (1,960)
--------------------
Net deferred tax asset $ 2,232 $ 1,115
====================
Tax benefits allocated directly to stockholders' equity for the years ended
December 31, 1996, 1995 and 1994 were $171 million, $84 million, and $17
million, respectively.
The Company provides income taxes on the undistributed earnings of non-U.S.
subsidiaries except to the extent that such earnings are indefinitely invested
outside the United States. At December 31, 1996, $1.3 billion of accumulated
undistributed earnings of non-U.S. subsidiaries was indefinitely invested. At
the existing U.S. federal income tax rate, additional taxes of $376 million
would have to be provided if such earnings were remitted.
Income taxes are not provided for on the Company's life insurance subsidiaries'
retained earnings designated as "policyholders' surplus" because such taxes will
become payable only to the extent such retained earnings are distributed as a
dividend or exceed limits prescribed by federal law. Distributions are not
contemplated from this portion of the life insurance companies' retained
earnings, which aggregated $971 million (subject to a tax effect of $340
million) at December 31, 1996.
As a result of the acquisition of old Travelers, a valuation allowance of $100
million was established in 1993 to reduce the net deferred tax asset on
investment losses to the amount that, based upon available evidence, is more
likely than not to be realized. The $100 million valuation allowance is
sufficient to cover any capital losses on investments that may exceed the
capital gains able to be generated in the life insurance group's consolidated
federal income tax return based upon management's best estimate of the character
of the reversing temporary differences. Reversal of the valuation allowance is
contingent upon the recognition of future capital gains or a change in
circumstances which causes the recognition of the benefits to become more likely
than not. The initial recognition of any benefit produced by the reversal of the
valuation allowance will be recognized by reducing goodwill.
72
Notes to Supplemental Consolidated Financial Statements (continued)
The net deferred tax asset, after the valuation allowance of $100 million,
relates to temporary differences that are expected to reverse as net ordinary
deductions. The Company will have to generate approximately $6.3 billion of
taxable income, before the reversal of these temporary differences, primarily
over the next 10-15 years, to realize the remainder of the deferred tax asset.
Management expects to realize the remainder of the deferred tax asset based upon
its expectation of future taxable income, after the reversal of these deductible
temporary differences, of at least $2.8 billion annually. The Company has
reported pre-tax financial statement income from continuing operations exceeding
$3.1 billion, on average, over the last three years and has incurred taxable
income of approximately $2.8 billion, on average, over the same period of time.
At December 31, 1996, the Company has no ordinary or capital loss carryforwards.
15. Preferred Stock and Stockholders' Equity
Preferred stock
The following table sets forth the Company's preferred stock outstanding at
December 31:
1996 1995
------------------------- ------------------------
Liquidation Carrying Carrying
Preference Number Value Number Value
Per Share of Shares (millions) of Shares (millions)
----------- ------------------------- -------------------------
Series A $ 250 1,200,000 $ 300 1,200,000 $ 300
Series B $ 50 -- -- 2,500,000 125
Series D $ 50 7,500,000 375 7,500,000 375
Series J $ 500 400,000 200 400,000 200
Series K $ 500 500,000 250 -- --
Salomon Series C $ 500 -- -- 225,000 112
------------------------ ------------------------
9,600,000 $1,125 11,825,000 $1,112
======================== ========================
Series C $53.25 3,085,612 $ 164 4,406,431 $ 235
======================== ========================
Series I $1,000 420,000 $ 420 560,000 $ 560
======================== ========================
Series A
In July 1992, the Company sold in a public offering 12.0 million depositary
shares, each representing 1/10th of a share of 8.125% Cumulative Preferred
Stock, Series A (Series A Preferred), at an offering price of $25 per depositary
share. The Series A Preferred has cumulative dividends payable quarterly and a
liquidation preference equivalent to $25 per depositary share plus accrued and
accumulated unpaid dividends. On or after July 28, 1997, the Company may, at its
option, redeem the Series A Preferred, in whole or in part, at any time at a
redemption price of $25 per depositary share plus dividends accrued and unpaid
to the redemption date.
Series B
During 1996, $125 million of liquidation value of the 5.50% Convertible
Preferred Stock Series B (Series B Preferred) representing 2,499,945 shares of
Series B Preferred was converted into 10,203,648 shares of common stock. Each
share of the Series B Preferred was converted into 4.081635 shares of TRV common
stock at a conversion price of $18.375 per share. The remaining 55 shares were
redeemed for cash at $51.925 per share plus accrued and unpaid dividends.
Series C
In connection with the acquisition of The Travelers Corporation (old Travelers)
in 1993, the Company converted the old Travelers $4.53 Series A ESOP Convertible
Preference Stock which was issued to prefund old Travelers' matching obligations
under its Employee Stock Ownership Plan (ESOP) into $4.53 Series C Convertible
Preferred Stock (Series C Preferred) of the Company with a stated value and a
liquidation preference of $53.25 per share. The Series C Preferred is
convertible into one share of Travelers Group Inc. common stock for each $21.99
of stated value of Series C Preferred, subject to antidilution adjustments in
certain circumstances. Each share of
73
Notes to Supplemental Consolidated Financial Statements (continued)
Series C Preferred is entitled to 3.915 votes on election of directors and all
other matters submitted to a vote of stockholders. Dividends on the Series C
Preferred are cumulative and accrue in the amount of $4.53 per annum per share.
The Series C Preferred is redeemable at the option of the Company on or after
January 1, 1998 (or earlier at the option of the holder under certain limited
circumstances) at a redemption price of $53.25 per share plus accrued and unpaid
dividends thereon to the date fixed for redemption.
Series D
Also in connection with the Company's acquisition of old Travelers, 7.5 million
shares of 9 1/4% Series B Preference Stock of old Travelers were converted into
7.5 million shares of 9 1/4% Series D Preferred Stock (Series D Preferred) of
the Company with a stated value and liquidation preference of $50 per share. The
Series D Preferred is held in the form of depositary shares, with two depositary
shares representing each preferred share. Annual dividends of $4.625 per share
($2.3125 per depositary share) are payable quarterly. Dividends are cumulative
from the date of issue. The Series D Preferred is not redeemable prior to July
1, 1997. On and after July 1, 1997, the Series D Preferred is redeemable at the
Company's option at a price of $50 per share (equivalent to $25 per depositary
share), plus accrued and unpaid dividends, if any, to the redemption date.
Series I
In October 1987, the Company issued 700,000 shares of Series I Cumulative
Convertible Preferred Stock (Series I Preferred) to affiliates of Berkshire
Hathaway Inc. at $1,000 per share. Annual cumulative dividends on the Series I
Preferred of $90 per share are payable quarterly. Each share of Series I
Preferred has a redemption value of $1,000 and is convertible into 44.60526
shares of Travelers common stock (subject to adjustment in the event of stock
splits and stock dividends). Series I Preferred shareholders are entitled to
vote on all matters on which the Company's common stockholders vote, and are
entitled to one vote per common share into which it is convertible. Commencing
October 31, 1995, 140,000 Series I Preferred shares must be redeemed annually
(if not previously converted) at $1,000 per share plus any accrued and unpaid
dividends. The first tranche of 140,000 Series I Preferred shares was redeemed
in October 1995, while the second and third tranches of 140,000 shares were
converted into 6.2 million shares of common stock each in October 1996 and
October 1997, respectively.
Series J
In February 1993, the Company issued 8.0 million depositary shares, each
representing one-twentieth of a share of 8.08% Cumulative Preferred Stock,
Series J (Series J Preferred). Holders of the Series J Preferred are entitled to
three votes per share (.15 votes per depositary share) when voting together as a
class with the TRV common stock on all matters submitted to a vote of the
Company's stockholders. The Series J Preferred has cumulative dividends payable
quarterly and a liquidation preference of $500 per share ($25 per depositary
share) plus any accrued and unpaid dividends. On or after March 31, 1998, the
Company may, at its option, redeem the Series J Preferred, in whole or in part,
at any time at a redemption price of $500 per share ($25 per depositary share)
plus dividends accrued and unpaid to the redemption date.
Series K
In February 1996, the Company issued 10.0 million depositary shares, each
representing one-twentieth of a share of 8.40% Cumulative Preferred Stock,
Series K (Series K Preferred). Holders of the Series K Preferred are entitled to
three votes per share (.15 votes per depositary share) when voting together as a
class with the TRV common stock on all matters submitted to a vote of the
Company's stockholders. The Series K Preferred has cumulative dividends payable
quarterly and a liquidation preference of $500 per share ($25 per depositary
share) plus any accrued and unpaid dividends. On or after March 31, 2001, the
Company may, at its option, redeem the Series K Preferred, in whole or in part,
at any time at a redemption price of $500 per share ($25 per depositary share)
plus dividends accrued and unpaid to the redemption date.
74
Notes to Supplemental Consolidated Financial Statements (continued)
Salomon Series C
In August 1996, the Company redeemed 225,000 shares (4.5 million depositary
shares) of Series C 9.50% Cumulative Preferred Stock (Salomon Series C
Preferred). All of the outstanding Salomon Series C Preferred was redeemed at
$500 per share ($25 per depositary share).
The Company has entered into interest rate swap agreements that effectively
convert fixed rate dividends on certain preferred stock into variable rate
obligations. These swaps reduced preferred dividends by $21 million, $19
million, and $28 million in 1996, 1995 and 1994, respectively.
Mandatorily redeemable preferred securities of subsidiary trusts
During 1996 the Company formed statutory business trusts under the laws of the
state of Delaware. Each trust exists for the exclusive purposes of (i) issuing
Trust Securities (both common and preferred) representing undivided beneficial
interests in the assets of the Trust; (ii) investing the gross proceeds of the
Trust securities in junior subordinated deferrable interest debentures
(subordinated debentures) of its parent; and (iii) engaging in only those
activities necessary or incidental thereto. These subordinated debentures and
the related income effects are eliminated in the supplemental consolidated
financial statements. Distributions on the mandatorily redeemable preferred
securities of subsidiary trusts below have been classified as interest expense
in the Supplemental Consolidated Statement of Income. The following table
summarizes the financial structure of the Company's subsidiary trusts at
December 31, 1996.
Travelers Travelers Travelers Travelers P&C
Capital I Capital II Capital III Capital I
--------- ---------- ----------- ---------
Trust Preferred Securities:
Issuance date October 1996 December 1996 December 1996 April 1996
Shares issued 16,000,000 400,000 200,000 32,000,000
Liquidation preference per $ 25 $1,000 $1,000 $ 25
share
Liquidation value (in $400 $ 400 $ 200 $800
millions)
Coupon rate 8% 7 3/4% 7 5/8% 8.08%
Distributions payable Quarterly Semi-annually Semi-annually Quarterly
Distributions guaranteed by TRV TRV TRV TAP
Common shares issued to parent 494,880 12,372 6,186 989,720
Junior Subordinated Debentures:
Amount owned (in millions) $412 $412 $206 $825
Coupon rate 8% 7 3/4% 7 5/8% 8.08%
Interest payable Quarterly Semi-annually Semi-annually Quarterly
Maturity date September 30, 2036 December 1, 2036 December 1, 2036 April 30, 2036
Redeemable by issuer on or after October 7, 2001 December 1, 2006 Not redeemable April 30, 2001
Travelers P&C SI Financing
Capital II Trust I
---------- -------
Trust Preferred Securities:
Issuance date May 1996 July 1996
Shares issued 4,000,000 13,800,000
Liquidation preference per $ 25 $ 25
share
Liquidation value (in $100 $345
millions)
Coupon rate 8% 9 1/4%
Distributions payable Quarterly Quarterly
Distributions guaranteed by TAP Salomon Smith
Barney
Common shares issued to parent 123,720 426,800
Junior Subordinated Debentures:
Amount owned (in millions) $103 $356
Coupon rate 8% 9 1/4%
Interest payable Quarterly Quarterly
Maturity date May 15, 2036 June 30, 2026
Redeemable by issuer on or after May 15, 2001 June 30, 2001
SI Financing Trust I, a wholly owned subsidiary of Salomon Smith Barney, issued
TRUPS units to the public. Each TRUPS unit includes a preferred security of SI
Financing Trust I, as shown in the table above, and a purchase contract which
requires the holder to purchase, in 2021 (or earlier if the Salomon Smith Barney
elects to accelerate the contract), one depositary share representing a
one-twentieth interest in a share of Travelers 9.50% Cumulative Preferred Stock,
Series L. Salomon Smith Barney is obligated under the terms of each purchase
contract to pay contract fees of 0.25% per annum. Salomon Smith Barney has
entered into an interest rate swap agreement to effectively convert the fixed
rate obligations on the TRUPS units into variable rate obligations.
Stockholders' equity
Common stock
The Company has outstanding warrants to purchase shares of its common stock at
an exercise price of $13.00 per common share, exercisable until July 31, 1998.
These warrants, which enable the holder to purchase three shares of common stock
each, are publicly traded and at December 31, 1996 and 1995 outstanding warrants
would enable holders to purchase 11,244,777 and 11,247,798 shares, respectively,
of common stock of the Company.
75
Notes to Supplemental Consolidated Financial Statements (continued)
At December 31, 1996, 18,717,890 shares of authorized common stock were reserved
for convertible securities and warrants.
Subsidiary capital
The combined insurance subsidiaries' statutory capital and surplus at December
31, 1996 and 1995 was $9.046 billion and $5.873 billion, respectively, and is
subject to certain restrictions imposed by state insurance departments as to the
transfer of funds and payment of dividends. The combined insurance subsidiaries'
net income, determined in accordance with statutory accounting practices, for
the years ended December 31, 1996, 1995 and 1994 was $843 million (which
includes $285 million for Aetna P&C in the first quarter of 1996), $745 million
and $228 million, respectively.
TIC is subject to various regulatory restrictions that limit the maximum amount
of dividends available to its parent without prior approval of the Connecticut
Insurance Department. A maximum of $507 million of statutory surplus is
available in 1997 for such dividends without the prior approval of the
Connecticut Insurance Department.
TAP's insurance subsidiaries are subject to various regulatory restrictions that
limit the maximum amount of dividends available to be paid to their parent
without prior approval of insurance regulatory authorities. Dividend payments to
TAP from its insurance subsidiaries are limited to $647 million in 1997 without
prior approval of the Connecticut Insurance Department.
Certain of the Company's U.S. and non-U.S. broker-dealer subsidiaries are
subject to various securities and commodities regulations and capital adequacy
requirements promulgated by the regulatory and exchange authorities of the
countries in which they operate. The principal regulated subsidiaries, their net
capital requirement or equivalent and excess over the minimum requirement are as
follows:
($Millions) ($Millions)
Excess over
Net Capital minimum
Subsidiary Jurisdiction or equivalent requirement
- ----------------------------------------- ---------------------------------------------------- ---------------- -----------------
Salomon Brothers Inc U.S. Securities and Exchange Commission $1,029 $ 987
Uniform Net Capital Rule (Rule 15c3-1)
Smith Barney Inc. U.S. Securities and Exchange Commission $1,216 $1,060
Uniform Net Capital Rule (Rule 15c3-1)
Salomon Brothers International Limited United Kingdom's Securities and Futures Authority $3,077 $ 390
See Note 11 for additional restrictions on stockholders' equity.
16. Incentive Plans
The Company has adopted a number of compensation plans to attract, retain and
motivate officers and other key employees, to compensate them for their
contributions to the growth and profits of the Company and to encourage employee
stock ownership.
The Company's employee compensation plans currently consist of the continuation
of Travelers' and Salomon's respective plans that were in effect prior to the
Merger. Accordingly, the following information summarizes the Travelers and
Salomon predecessor plans.
76
Notes to Supplemental Consolidated Financial Statements (continued)
Travelers Predecessor Plans
Travelers' stock option plans provide for the granting of stock options to
officers and key employees of the Company and its participating subsidiaries.
Options are granted at the fair market value of the Company's common stock at
the time of grant for a period of ten years. Generally, options vest over a
five-year period and are exercisable only if the optionee is employed by the
Company. The plans also permit an employee exercising an option to be granted
new options (reload options) in an amount equal to the number of common shares
used to satisfy the exercise price and the withholding taxes due upon exercise.
The reload options are granted for the remaining term of the related original
option and vest over a six-month period.
At December 31, 1996, 163,242,003 shares were available for future grant under
Travelers option plans.
Information with respect to stock options granted under Travelers' option plans
is as follows:
1996 1995 1994
----------------------------- ---------------------------- ----------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
-------------- ----------- -------------- ---------- ------------- ------------
Outstanding, beginning of 71,603,130 $12.53 72,521,343 $10.26 67,001,114 $ 9.39
year
Granted-original 8,395,460 $21.53 13,823,736 $14.32 12,978,338 $12.03
Granted-reload 30,770,388 $24.17 22,535,379 $16.41 5,420,213 $11.93
Forfeited (4,067,078) $12.15 (4,552,005) $11.40 (4,162,284) $10.61
Exercised (42,211,806) $15.90 (32,725,323) $11.07 (8,716,038) $ 7.13
----------- ----------- ----------
Outstanding, end of year 64,490,094 $17.07 71,603,130 $12.53 72,521,343 $10.26
=========== =========== ==========
Exercisable at year end 13,950,576 14,767,290 25,347,849
The following table summarizes information about stock options outstanding under
Travelers' option plans at December 31, 1996:
Options Outstanding Options Exercisable
--------------------------------------------- ------------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Number Remaining Exercise Number Exercise
Prices Outstanding Contractual Life Price Exercisable Price
- ------------ --------------- ------------------ --------- ------------- ---------------
$0-$6.67 2,488,922 3.8 years $4.84 2,291,920 $4.71
$6.67-$13.33 26,632,655 6.9 years $10.75 7,813,676 $10.86
$13.33-$20.00 8,138,676 7.7 years $16.55 1,728,010 $16.35
$20.00-$26.67 22,030,152 6.6 years $23.53 2,113,887 $21.64
$26.67-$33.33 5,199,689 5.7 years $28.79 3,083 $28.87
-------------- ------------
$0-$33.33 64,490,094 6.7 years $17.07 13,950,576 $12.17
============== ============
Travelers, through its Capital Accumulation Plan and other restricted stock
programs, issues shares of the Company's common stock in the form of restricted
stock to participating officers and other key employees. The restricted stock
generally vests after a two or three-year period. Except under limited
circumstances, during this period the stock cannot be sold or transferred by the
participant, who is required to render service to the Company during the
restricted period. Participants may elect to receive part of their awards in
restricted stock and part in stock options. Unearned compensation expense
associated with the restricted stock grants represents the market value of the
Company's common stock at the date of grant and is recognized as a charge to
income ratably over the vesting period.
77
Notes to Supplemental Consolidated Financial Statements (continued)
At December 31, 1996, 73,358,448 shares were available for future grant under
Travelers' restricted stock plans.
Information with respect to Travelers' restricted stock awards is as follows:
1996 1995 1994
---------- ---------- ----------
Shares awarded 17,141,073 20,950,065 15,901,655
Weighted average fair market value per share $20.13 $12.00 $12.91
After-tax compensation cost charged to earnings
(in millions) $134 $114 $88
Salomon Predecessor Plans
Salomon Inc Stock Incentive Plan (SSIP)
SSIP provides for the issuance of up to 5.9 million shares in the form of
options, restricted stock and stock bonuses, as well as an additional grant of
up to 2.5 million shares in the form of the stand-alone stock appreciation
rights, phantom stock and cash bonuses to key employees. In December 1996, 2.7
million options were awarded under the SSIP with an exercise price set at the
market value of the Company's common stock on the date of grant ($26.48). The
awards expire five years after the grant date and vest 100% three years after
the grant date.
The Non-Qualified Stock Option Plan of 1984, as amended (the 1984 Plan)
The 1984 Plan, which was terminated on June 30, 1994, provided for the granting
of options to certain key employees. Stock appreciation rights (SARs)
accompanied some of the options granted under the 1984 Plan. The exercise of
SARs extinguishes the related option. Options issued under the 1984 Plan expire
ten years from the date of grant.
Information with respect to stock options granted under Salomon's option plans
is as follows:
1996 1995 1994
----------------------- ------------------------ ------------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------ ---------- ------------- ---------- ------------ -----------
Outstanding, beginning of 1,209,332 $12.07 2,438,071 $12.77 2,937,249 $12.85
year
Granted 2,712,000 $26.48 0 - 0 -
Forfeited (10,848) $12.38 (185,941) $26.00 (18,984) $13.00
Exercised (347,814) $14.59 (1,042,798) $11.20 (480,194) $13.28
--------- --------- ---------
Outstanding, end of year 3,562,670 $22.79 1,209,332 $12.07 2,438,071 $12.77
========= ========= =========
Exercisable at year end 850,670 1,209,332 2,438,071
78
Notes to Supplemental Consolidated Financial Statements (continued)
The following table summarizes information about stock options outstanding under
Salomon option plans at December 31, 1996:
Options Outstanding Options Exercisable
--------------------------------- -----------------------------
Exercise Number Remaining Number Exercise
Price Outstanding Contractual Life Exercisable Price
- ------------- ------------- ------------------ ---------------- ---------
$11.76 274,455 4.9 years 274,455 $11.76
$10.70 576,215 0.9 years 576,215 $10.70
$26.48 2,712,000 0.9 years -- --
--------- -------
$10.70-$26.48 3,562,670 4.0 years 850,670
========= =======
The Equity Partnership Plan (EPP)
Under EPP, qualifying employees receive a portion of their compensation in the
form of common stock. Original terms of EPP deferred payment of the stock for
five years and required the Company to contribute an additional 17.65% of the
deferred compensation amount to the participant's account. The EPP award is
forfeited if the participant's employment is terminated for cause within the
five year vesting period. Beginning in 1996, EPP was amended to reduce the
deferral period from five years to three years, increase the additional
contribution of the Company from 17.65% to 25%, and introduce additional
forfeiture provisions. Under the amended plan, the award is forfeited if the
participant leaves the Company to join a competitor within three years after the
award date. If a participant leaves other than by virtue of death, disability,
retirement or as a result of downsizing during the three years following the
award, the entire additional contribution of 25% is forfeited. The 1996
amendments apply only to awards granted in 1996 and subsequent years.
Information with respect to Salomon's EPP awards is as follows:
1996 1995 1994
--------- --------- ---------
Shares awarded 6,097,798 4,508,066 9,517,783
Fair market value per share $26.55 $21.24 $21.61
After-tax compensation cost charged to earnings
(in millions) $90 $63 $159
Pro Forma Impact of FAS No. 123
The Company applies Opinion 25 and related interpretations in accounting for its
stock-based compensation plans. Since stock options under both Travelers' and
Salomon's plans are issued at fair market value on the date of award, no
compensation cost has been recognized for these awards.
FAS No. 123 provides an alternative to Opinion 25 whereby fair values may be
ascribed to options using a valuation model and amortized to compensation cost
over the vesting period of the options. Had the Company applied FAS No. 123 in
accounting for the Travelers and Salomon stock options, net income and net
income per share would have been the pro forma amounts indicated below:
79
Notes to Supplemental Consolidated Financial Statements (continued)
1996 1995
---------------------------- ---------------------------
In millions Per Share In millions Per Share
----------- --------- ----------- ---------
Net income, as reported $2,948 $2.45 $2,291 $1.89
FAS No. 123 pro forma adjustments
after-tax and minority interest (51) (.04) (18) (.02)
------- ----- ------ -----
Net income, pro forma $2,897 $2.41 $2,273 $1.87
======= ===== ====== =====
The pro forma adjustments relate to options granted during 1996 and 1995 for
which a fair value on the date of grant was determined using the Black-Scholes
option pricing model. No effect has been given to options granted prior to 1995.
FAS No. 123 requires that reload options be treated as separate grants from the
related original option grants. Under Travelers' reload program, upon exercise
of an option, employees generally tender previously owned shares to pay the
exercise price and related tax withholding, and receive a reload option covering
the same number of shares rendered for such purposes. New reload options vest at
the end of a six month period and are only granted if Travelers stock price has
increased at least twenty percent over the exercise price of the option being
reloaded. Reload options are intended to encourage employees to exercise options
at an earlier date and to retain the shares so acquired, in furtherance of
Travelers' long-standing policy of encouraging increased employee stock
ownership. The result of this program is that employees generally will exercise
options as soon as they are able and, therefore, these options have shorter
expected lives. Shorter option lives result in lower valuations using the
Black-Scholes option model. However, such values are expensed more quickly due
to the shorter vesting period of reload options. In addition, since reload
options are treated as separate grants, the existence of the reload feature in
Travelers' plan results in a greater number of options being valued.
Shares received through option exercises under the reload program are subject to
restrictions on sale. Discounts (as measured by the estimated cost of
protection) have been applied to the fair value of options granted under
Travelers' plans to reflect these sale restrictions.
The weighted average fair value of Travelers options granted during 1996 and
1995 was $3.00 and $2.20 per share, respectively. The weighted average expected
life of reload options was approximately 1 year for 1996 and 1995. The weighted
average expected life of original grants was approximately 3 years for 1996 and
1995. The fair value of Salomon options granted during 1996 was $7.76 per share
and the expected life of these options was 5 years. There were no Salomon
options granted during 1995. Valuation and related assumption information are
presented below:
Weighted averages for options granted during
--------------------------------------------
1996 1995
---------------- ---------------
Valuation assumptions:
Expected volatility 28.5% 27.4%
Risk-free interest rate 5.58% 6.06%
Expected annual dividends per share $0.37 $0.32
Expected annual forfeitures 5% 5%
80
Notes to Supplemental Consolidated Financial Statements (continued)
17. Pension Plans
The Company's pension plans currently consist of the continuation of Travelers
Group's and Salomon's respective plans that were in effect prior to the Merger.
Accordingly, the following information summarizes the predecessor pension plans.
Travelers Predecessor Plans
Travelers has a noncontributory defined benefit pension plan covering the
majority of its U.S. employees. Benefits for this plan are based on an account
balance formula. Under this formula, each employee's accrued benefit can be
expressed as an account that is credited with amounts based upon the employee's
pay, length of service and a specified interest rate, all subject to a minimum
benefit level. This plan is funded in accordance with the Employee Retirement
Income Security Act of 1974 and the Internal Revenue Code. Certain non-U.S.
employees of the Company are covered by noncontributory defined benefit plans.
These plans are funded based upon local laws and the costs associated with these
plans are not material.
The following is a summary of the components of pension expense for Travelers'
principal defined benefit plan for the years ended December 31:
(millions) 1996 1995 1994
----- ----- -----
Service cost $74 $81 $105
Interest cost 190 195 173
Actual return on plan assets (228) (388) (66)
Net amortization and deferral (1) 165 (161)
----- ----- -----
Net periodic pension cost $35 $53 $51
===== ===== =====
The following table sets forth the funded status of Travelers' principal defined
benefit plan at December 31:
(millions) 1996 1995
------- -------
Actuarial present value of benefit obligation:
Vested benefits $2,594 $2,713
Non-vested benefits 70 52
------- -------
Accumulated benefit obligation 2,664 2,765
Effect of future salary increases 48 37
------- -------
Projected benefit obligation 2,712 2,802
Plan assets at fair value 2,718 2,638
------- -------
Projected benefit obligation in excess of or
(less than) plan assets (6) 164
Unrecognized transition asset 1 2
Unrecognized prior service benefit 12 14
Unrecognized net (loss) (71) (228)
Adjustment to recognize minimum liability -- 175
------- -------
Accrued pension liability (prepaid pension cost) $(64) $127
======= =======
Actuarial assumptions:
Weighted average discount rate 7.50% 7.25%
Weighted average rate of compensation increase 4.50% 4.50%
Expected long-term rate of return on plan assets 9.00% 9.25%
81
Notes to Supplemental Consolidated Financial Statements (continued)
Plan assets are held in various separate accounts and the general account of The
Travelers Insurance Company, a subsidiary of Travelers Group, and certain
investment trusts. These accounts and trusts invest in stocks, U.S. Government
bonds, corporate bonds, mortgage loans and real estate.
Salomon Predecessor Plans
Substantially all full-time U.S. employees of Salomon participate in defined
contribution plans. The costs relating to such plans were $34 million, $26
million and $24 million in 1996, 1995 and 1994, respectively.
Non-U.S. Salomon employees generally participate in defined benefit plans that
are insured or otherwise funded. The costs relating to such plans were $25
million, $25 million and $16 million in 1996, 1995 and 1994, respectively. The
present value of benefits associated with these plans is not significant.
18. Postretirement Benefits
The Company provides postretirement health care, life insurance and survival
income benefits to certain eligible retirees. These benefits relate primarily to
former unionized employees of predecessor companies, certain employees of
Salomon Smith Barney and former employees of old Travelers. Other retirees are
generally responsible for most or all of the cost of these benefits (while
retaining the benefits of group coverage and pricing).
The Company generally funds its share of the cost of postretirement benefits on
a pay-as-you-go basis. However, the Company has made contributions to a survivor
income plan, the assets of which are currently invested in a major insurance
company's general investment portfolio.
The following is a summary of the components of net periodic postretirement
benefit cost for the Company's principal plans for the years ended December 31:
(millions)
1996 1995 1994
---- ---- ---
Service cost $2 $3 $5
Interest cost 30 39 38
Net amortization and deferral (10) (2) --
---- ---- ---
Net periodic postretirement benefit cost $22 $40 $43
==== ==== ===
The following table sets forth the funded status of the Company's principal
postretirement benefit plans at December 31:
(millions)
1996 1995
---- ----
Accumulated postretirement benefit obligation:
Retirees $354 $443
Other fully eligible plan participants 38 46
Other active plan participants 29 32
---- ----
421 521
Plan assets at fair value 4 4
---- ----
Accumulated postretirement benefit obligation in
excess of plan assets 417 517
Unrecognized net gain 131 39
Unrecognized prior service benefit (cost) 8 9
---- ----
Accrued postretirement benefit liability 556 $565
==== ====
82
Notes to Supplemental Consolidated Financial Statements (continued)
For measurement purposes, the annual rate of increase in the per capita cost of
covered health care benefits ranged from 12.7% in 1996, decreasing gradually to
5.0% by the year 2005 and remaining at that level thereafter. The health care
cost trend rate assumption affects the amounts reported. To illustrate,
increasing the assumed health care cost trend rates by one percentage point in
each year would increase the accumulated postretirement benefit obligation as of
December 31, 1996 by approximately $23 million. The impact on net periodic
postretirement benefit cost of such an increase would not be material.
The discount rates used in determining the accumulated postretirement benefit
obligation ranged from 7.00% to 7.50% at December 31, 1996 and from 7.00% to
7.25% at December 31, 1995. For certain plans associated with Smith Barney and
old Travelers, the weighted average assumed rate of compensation increase was
approximately 3.5% for both 1996 and 1995. For certain plans associated with
Salomon the weighted average assumed rate of compensation increase was
approximately 6.0%. For other plans, no assumptions have been made for rate of
compensation increases, since active employees are responsible for the full cost
of these benefits upon retirement.
19. Lease Commitments
Rentals
Rental expense (principally for offices and computer equipment) was $397
million, $405 million and $476 million for the years ended December 31, 1996,
1995 and 1994, respectively.
Future minimum annual rentals under noncancellable operating leases, net of
sublease income, are as follows:
(millions)
1997 $ 362
1998 303
1999 248
2000 177
2001 143
Thereafter 911
------
$2,144
======
The Company and certain of Salomon Smith Barney's subsidiaries together have an
option to purchase the buildings presently leased for Salomon Smith Barney's
executive offices and New York City operations at the expiration of the lease
term.
20. Trading Securities, Commodities, Derivatives and Related Risks
The Company uses derivative financial instruments in the normal course of
business for end user and, in the case of Salomon Smith Barney, trading
purposes. The Company enters into a variety of derivatives such as swaps, swap
options, cap and floor agreements, futures contracts, forward currency
contracts, forward purchase and sale agreements, option contracts and warrants.
These transactions generally require future settlement, and are either executed
on an exchange or traded as OTC instruments. Derivatives have widely varying
terms, and durations that range from a few days to a number of years depending
on the instrument.
Interest rate swaps are OTC instruments where two counterparties agree to
exchange periodic interest payment streams calculated on a predetermined
notional principal amount. The most common interest rate swaps generally involve
one party paying a fixed interest rate and the other party paying a variable
rate. Other types of interest rate swaps include basis swaps, cross-currency
swaps, equity swaps and commodity swaps. Basis swaps consist of both parties
paying variable interest streams based on different reference rates.
Cross-currency swaps involve the exchange of coupon payments in one currency for
coupon payments in another currency. An equity swap is an agreement to exchange
cash flows on a notional amount based on changes in the values of a
83
Notes to Supplemental Consolidated Financial Statements (continued)
referenced index, such as the Standard & Poor's 500 Index. Commodity swaps
involve the exchange of a fixed price of a commodity for a floating price, which
is usually the prevailing spot price, throughout the swap term. The most common
commodity swaps are petroleum-based; other types are based on metals or soft
commodities.
Caps are derivatives which require the writer to pay the purchaser an excess
amount, if the reference rate exceeds a contractual rate at specified times
during the contract. Likewise, a floor is a contractual commitment that requires
the writer to pay an excess amount, if any, of a contractual rate over a
reference rate at specified times over the life of the contract. Swap options
are OTC contracts that entitle the holder to either enter into an interest rate
swap at a future date or to cancel an existing swap at a future date.
Futures contracts are exchange-traded derivatives to either receive (purchase)
or deliver (sell) a standard amount or value of a commodity or financial
instrument at a specified future date and price (or, with respect to futures
contracts on indices, the net cash amount). Maintaining a futures contract will
typically require the Company to deposit with the futures exchange (or other
financial intermediary), as security for its obligations, an amount of cash or
other specified asset (initial margin) that typically ranges from 1% to 10% of
the face amount of the contract (but may be higher in some circumstances).
Additional cash or assets (variation margin) may be required to be deposited
daily as the mark-to-market value of the futures contract fluctuates. Futures
contracts may be settled by physical delivery of the underlying asset or cash
settlement (for index futures) on the settlement date, or by entering into an
offsetting futures contract with the futures exchange prior to the settlement
date. Forward contracts are OTC derivatives to purchase or sell a specified
amount of financial instruments, foreign currency, or commodities at a future
date at a predetermined price. The notional amount for forward settling
securities transactions represents the amount of cash that will be paid or
received by the counterparties when the transaction settles. Upon settlement,
the security is reflected on the statement of financial condition as either long
or short inventory.
Option contracts are contractual agreements which give the purchaser the right,
but not the obligation, to purchase or sell a financial instrument, commodity,
or currency at a predetermined price. In return for this right, the purchaser
pays a premium to the seller (or writer) of the option. Option contracts also
exist for various indices and are similar to options on a security or other
instruments except that, rather than settling by physical delivery of the
underlying instrument, they are settled in cash. Options on futures contracts
give the purchaser the right, in return for the premium paid, to assume a
position in a futures contract. Warrants have characteristics similar to those
of options whereby the buyer has the right, but not the obligation, to purchase
a certain instrument at a specific future date and price. The seller (or writer)
of the option/warrant is subject to the risk of an unfavorable change in the
underlying financial instrument, commodity, or currency. The purchaser is
subject to market risk to the extent of the premium paid and credit risk. The
Company is obligated to post margin for options on futures. Option contracts may
be either exchange-traded or OTC. Exchange-traded options issued by certain
regulated intermediaries, such as the Options Clearing Corporation, are the
obligations of the issuing intermediary. In contrast to such options, which
generally have standardized terms and performance mechanics, all of the terms of
an OTC option, including the method of settlement, term, exercise price,
premium, guarantees and security, are determined by negotiation of the parties,
and there is no intermediary between the parties to assume the risks of
performance. The Company issues warrants that entitle holders to cash
settlements on exercise based upon movements in market prices of specific
financial instruments and commodities, foreign exchange rates and equity
indices.
The Company sells various financial instruments which have not been purchased
(short sales). In order to sell them short, the Company borrows these
securities, or receives the securities as collateral in conjunction with
short-term financing agreements and, at a later date, must deliver (i.e.
replace) like or substantially the same financial instruments or commodities to
the parties from which they were originally borrowed. The Company is exposed to
market risk for short sales. If the market value of an instrument sold short
increases, the Company's obligation, reflected as a liability, would increase
and revenues from principal transactions would be reduced.
84
Notes to Supplemental Consolidated Financial Statements (continued)
The way in which the Company accounts for and presents derivatives in its
financial statements depends on both the type and purpose of the derivative held
or issued. As discussed in the Summary of Significant Accounting Policies, the
Company records all derivatives used for trading purposes, including those used
to hedge trading positions, at market or fair value. Consequently, changes in
the amounts recorded in the Company's Supplemental Consolidated Statements of
Financial Condition resulting from movements in market or fair value are
included in "Principal transactions" in the period in which they occur. The
accounting and reporting treatment of derivatives used for non-trading purposes
varies, depending on the nature of exposure being hedged (see Summary of
Significant Accounting Policies).
Derivatives and short sales risk may expose the Company to both market risk and
credit risk in excess of the amount recorded on the supplemental consolidated
statements of financial condition. These off-balance sheet risks are discussed
in more detail below.
Market Risk Market risk is the potential loss the Company may incur as a result
of changes in the market or fair value of a particular financial instrument,
commodity or derivative. All financial and commodities-related instruments,
including derivatives and short sales, are subject to market risk. The Company's
exposure to market risk is determined by a number of factors, including the
size, duration, composition and diversification of positions held, the absolute
and relative levels of interest rates and foreign currency exchange rates, as
well as market volatility and illiquidity. For instruments such as options and
warrants, the time period during which the options or warrants may be exercised
and the relationship between the current market price of the underlying
instrument and the option's or warrant's contractual strike or exercise price
also affect the level of market risk. The most significant factor influencing
the overall level of market risk to which the Company is exposed is its use of
hedging techniques to mitigate such risk. The Company manages market risk by
setting risk limits and monitoring the effectiveness of its hedging policies and
strategies.
Credit Risk The Company regularly transacts business with, and owns securities
issued by, a broad range of corporations, governments, international
organizations, central banks and other financial institutions. Phibro, a wholly
owned subsidiary of Salomon Smith Barney, regularly transacts business with
independent and government-owned oil producers, a wide variety of end users,
trading companies and financial institutions. Credit risk is measured by the
loss the Company would record if its counterparties failed to perform pursuant
to terms of their contractual obligations and the value of collateral held, if
any, was not adequate to cover such losses. The Company has established controls
to monitor the creditworthiness of counterparties, as well as the quality of
pledged collateral, and uses master netting agreements whenever possible to
mitigate the Company's exposure to counterparty credit risk. Master netting
agreements enable the Company to net certain assets and liabilities by
counterparty. The Company also nets across product lines and against cash
collateral, provided such provisions are established in the master netting and
cash collateral agreements. The Company may require counterparties to submit
additional collateral when deemed necessary.
The Company enters into collateralized financing agreements in which it extends
short-term credit, primarily to major financial institutions. The Company
generally controls access to the collateral pledged by the counterparties, which
consists largely of securities issued by the G-7 governments or their agencies
that may be liquidated in the event of counterparty default.
In addition, the Company seeks to protect itself from the risks associated with
customer activities by requiring customers to maintain margin collateral in
compliance with regulatory requirements and its own internal guidelines, which
are generally more stringent than regulatory margin requirements. Margin levels
are monitored daily and additional collateral must be deposited as required. If
customers cannot meet collateral requirements, the Company will liquidate
sufficient underlying financial instruments to bring the account in compliance
with the required margin level.
85
Notes to Supplemental Consolidated Financial Statements (continued)
Liquidity Risk. Liquidity risk is the possibility that the Company may not be
able to rapidly adjust the size of its derivative positions in times of high
volatility and financial stress at a reasonable cost. The liquidity of
derivative products is correlated to the liquidity of the underlying cash
instrument. As with non-derivative financial instruments, the Company's
valuation policies for derivatives include consideration of liquidity factors.
Trading Activity
Salomon Smith Barney trades both derivative and cash financial instruments. The
trading activities are conducted for both Salomon Smith Barney's customers as
well as for the Company's own account. In accordance with FAS No. 105,
"Disclosure of Information about Financial Instruments with Off-Balance Sheet
Risk and Financial Instruments with Concentrations of Credit Risk" (FAS No. 105)
and FAS No. 119, "Disclosure about Derivative Financial Instruments and Fair
Value of Financial Instruments" (FAS No. 119), the following table discloses the
notional amounts of derivative financial instruments held by Salomon Smith
Barney for trading purposes. The determination of notional amounts does not
consider any of the market risk factors previously discussed. Notional amounts
are indicative only of the volume of activity and are not a measure of market
risk. Market risk is influenced by the nature of the items that comprise a
particular category of financial instrument, as well as the relationship among
the various off and on-balance sheet items. For these reasons, the
interpretation of notional amounts as a measure of market risk could be
materially misleading.
December 31, 1996 December 31, 1995
---------------------------------- -----------------------------------
Current Market or Current Market or
Notional Fair Value Notional Fair Value
----------------------- -----------------------------------
(billions) Amounts Assets Liabilities Amounts Assets Liabilities
- ------------------------------------------------------------------------------------------------------------------------------------
Exchange-issued products:
Futures contracts (a) $530.9 $ -- $ -- $575.4 $ -- $ --
Other exchange-issued products:
Equity contracts 13.1 .1 .2 16.9 .5 .3
Fixed income contracts 61.2 -- -- 46.7 .2 --
Physical commodities contracts 5.0 -- -- 4.5 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total exchange-issued products 610.2 .1 .2 643.5 .7 .3
- ------------------------------------------------------------------------------------------------------------------------------------
OTC swaps, swap options, caps and floors:
Swaps 842.3 545.0
Swap options written 10.8 5.6
Swap options purchased 24.1 20.5
Caps and floors 117.1 102.0
- ------------------------------------------------------------------------------------------------------------------------------------
Total OTC swaps, swap options, caps and floors 994.3 4.2 6.6 673.1 4.3 6.6
- ------------------------------------------------------------------------------------------------------------------------------------
OTC foreign exchange contracts and options:
Forward currency contracts 94.3 .7 .6 69.2 .5 .5
Options written 37.1 -- .3 24.5 -- .6
Options purchased 38.7 .5 -- 23.4 .3 --
- ------------------------------------------------------------------------------------------------------------------------------------
Total OTC foreign exchange contracts and options 170.1 1.2 .9 117.1 .8 1.1
- ------------------------------------------------------------------------------------------------------------------------------------
Other options and contractual commitments:
Options and warrants on equities and equity indices 45.8 1.1 1.8 24.2 1.1 .6
Options and forward contracts on fixed-income 202.8 .3 .2 211.6 .1 .5
securities
Physical commodities contracts 22.6 .3 .3 22.5 .4 .3
- ------------------------------------------------------------------------------------------------------------------------------------
Total contractual commitments $2,045.8 $7.2 $10.0 $1,692.0 $7.4 $9.4
====================================================================================================================================
(a) Margin on futures contracts is included in brokerage receivables/payables
on the Supplemental Consolidated Statement of Financial Condition.
86
Notes to Supplemental Consolidated Financial Statements (continued)
The annual average balances of the Company's options and contractual
commitments, based on month-end balances are as follows:
1996 1995
------------------------- -------------------------
Average Average Average Average
(billions) Assets Liabilities Assets Liabilities
- -----------------------------------------------------------------------------------------------------
Swaps, swap options, caps and floors $3.6 $5.5 $4.1 $6.6
Index and equity contracts and options 1.3 1.1 1.2 .8
Foreign exchange contracts and options 1.0 1.0 .9 1.0
Physical commodities contracts .4 .3 .5 .5
Other .5 .7 .6 .7
- -----------------------------------------------------------------------------------------------------
Total contractual commitments $6.8 $8.6 $7.3 $9.6
=====================================================================================================
End User Activity
In the normal course of business the Company also employs certain derivative
financial instruments as an end user to manage various risks. Fair values were
determined by reference to quoted market prices or, for interest rate swaps,
estimated based upon the payments either party would have to make to terminate
the swap. The notional and fair values of end user derivatives at December 31,
were as follows:
1996 Notional Value Fair Value
- ---- -------------- -----------------------
(billions) Open Contracts Asset Liability
-------------- ----- ---------
Interest rate swaps:
Pay a fixed rate, receive a floating rate $0.9
Pay a floating rate, receive a fixed rate 14.6
Currency swap 1.3
-------------------------------------------------------
$16.8 $0.4 $0.2
=======================================================
Purchase Sell
-------- ----
Foreign currency forwards $1.6 $.5 $ -- $ --
Financial futures .6 .1 -- --
-------------------------------------------------------
$2.2 $.6 $ -- $ --
=======================================================
1995 Notional Value Fair Value
- ---- -------------- -----------------------
(billions) Open Contracts Asset Liability
-------------- ----- ---------
Interest rate swaps:
Pay a fixed rate, receive a floating rate $ 0.5
Pay a floating rate, receive a fixed rate 12.2
Currency swap 0.7
-------------------------------------------------------
$13.4 $0.7 $0.1
=======================================================
Purchase Sell
-------- ----
Foreign currency forwards $1.4 $0.8 $ -- $ --
Financial futures 0.2 -- -- --
-------------------------------------------------------
$1.6 $0.8 $ -- $ --
=======================================================
Certain of the Company's subsidiaries utilize swap contracts to effectively
manage interest rate and currency risk. Salomon Smith Barney utilizes interest
rate and cross currency swaps to effectively convert a majority of its long-term
debt, a portion of its short-term borrowings and its guaranteed preferred
beneficial interests in Salomon Smith Barney subordinated debt securities
(TRUPS) from fixed to variable rate instruments (see Notes 11 and 15,
respectively). Salomon Smith Barney also employs an interest rate swap contract
to convert variable
87
Notes to Supplemental Consolidated Financial Statements (continued)
interest rate risk to a fixed rate of interest. In addition, there are interest
rate swaps converting the fixed rate preferred stock of Salomon exchanged for
Travelers preferred stock in connection with the Merger, to variable rate
instruments. These swaps are recorded "off-balance sheet," with accrued inflows
and outflows reflected as adjustments to interest expense and/or dividends.
Adjustments to preferred stock are recorded on an after-tax basis. Certain of
the Company's insurance subsidiaries utilize swaps to manage differing interest
rate and/or currency risk profiles of its liabilities and related fixed income
investment portfolio. These swaps are recorded on the supplemental consolidated
statement of financial position at fair value with unrealized gains and losses
on the swap reported as adjustments to stockholders' equity.
Certain subsidiaries also utilize forward contracts to hedge exposure to
volatility of foreign currency exchange rates. Salomon Smith Barney uses forward
currency contracts to hedge a portion of the currency exchange rate exposure
relating to non-U.S. dollar denominated debt. The impact of translating the
forward currency contract and related debt to prevailing exchange rates is
recognized currently in income. Certain of the Company's insurance subsidiaries
use forward contracts to hedge foreign investments. Changes in the fair value of
these forwards are recorded currently in income as an offset to the translation
adjustment related to the underlying investment. Both Salomon Smith Barney and
certain insurance subsidiaries utilize forward currency contracts to hedge
certain investments in foreign branches and foreign currency denominated
investments. These forward contracts are recorded on the supplemental
consolidated statement of financial position at fair value with unrealized gains
and losses on the forward contract reported as adjustments to stockholders'
equity.
The Company's insurance subsidiaries also enter into financial futures contracts
to hedge expected cash flows related to certain customer deposits and investment
maturities, redemptions and sales against adverse changes in market interest
rates. These futures contracts, which are settled in cash on a daily basis, are
recorded as other liabilities on the supplemental statement of financial
position at fair value. Realized gains or losses are recorded as an adjustment
to the cost basis of the related asset when acquired.
21. Fair Value of Financial Instruments
The following table summarizes the fair value and carrying amount of the
Company's financial instruments at December 31, 1996 and 1995. Contractholder
funds amounts exclude certain insurance contracts not within the scope of FAS
No. 107, "Disclosure About Fair Value of Financial Instruments." The carrying
value of short-term financial instruments approximates fair value because of the
relatively short period of time between the origination of the instruments and
their expected realization. The carrying value of receivables and payables
arising in the ordinary course of business approximates fair market value. The
fair value assumptions were based upon subjective estimates of market conditions
and perceived risks of the financial instruments at a certain point in time as
disclosed further in various notes to the supplemental consolidated financial
statements. Disclosed fair values for financial instruments do not reflect any
premium or discount that could result from offering for sale at one time the
Company's entire holdings of a particular financial instrument. Potential taxes
and other expenses that would be incurred in an actual sale or settlement are
not reflected in amounts disclosed.
88
Notes to Supplemental Consolidated Financial Statements (continued)
1996 1995
---------------------------- ----------------------------
(millions) Carrying Amount Fair Value Carrying Amount Fair Value
--------------- ----------- --------------- ----------
Assets:
Investments $56,509 $56,518 $40,965 $40,976
Securities borrowed or purchased
under agreements to resell 97,985 97,985 85,026 85,026
Trading securities and
commodities owned 126,568 126,568 121,802 121,802
Net consumer finance receivables 7,885 8,556 7,092 7,745
Separate accounts with guaranteed
returns 1,114 1,118 1,527 1,591
Liabilities:
Long-term debt 24,696 25,065 22,235 22,923
Securities loaned or sold under
agreements to repurchase 103,572 103,572 113,470 113,470
Trading securities and commodities
sold not yet purchased 92,032 92,032 62,240 62,240
Contractholder funds:
With defined maturities 1,671 1,665 2,449 2,460
Without defined maturities 9,085 8,841 9,282 9,016
Separate accounts
with guaranteed returns 1,017 899 1,475 1,408
22. Pledged Assets and Commitments
Pledged Assets
At December 31, 1996, the approximate market values of securities sold under
agreements to repurchase, excluding the impact of FIN 41, or pledged by the
Company were:
- -----------------------------------------------------------------------------------------
(millions)
- -----------------------------------------------------------------------------------------
For securities sold under agreements to repurchase $114,021
As collateral for securities borrowed of approximately equivalent value 39,734
As collateral on bank loans 3,195
To clearing organizations or segregated under securities laws and regulations 1,998
For securities loaned 1,593
As collateral for letters of credit 127
Other 65
- -----------------------------------------------------------------------------------------
Repurchase agreements and securities pledged $160,733
=========================================================================================
At December 31, 1996, the Company had $2.4 billion of outstanding letters of
credit from banks to satisfy various collateral and margin requirements.
Guarantees of Securities of Other Issuers
TAP underwrote insurance guaranteeing the securities of other issuers, primarily
corporate and industrial revenue bond issuers. The aggregate gross amount of
guarantees of principal and interest for such securities was $8.285 billion and
$1.730 billion at December 31, 1996 and 1995, respectively. Reserves for the
financial guarantee business, which includes reserves for defaults, incurred but
not reported losses and unearned premiums, totaled $71 million at December 31,
1996 and were not significant at December 31, 1995.
89
Notes to Supplemental Consolidated Financial Statements (continued)
It is not practicable to estimate a fair value for these financial guarantees
because there is no quoted market price for such contracts, it is not
practicable to reliably estimate the timing and amount of all future cash flows
due to the unique nature of each of these contracts, and TAP no longer writes
such guarantees.
Included in the gross amounts are financial guarantees representing TAP's
participation in the Municipal Bond Insurance Association's guarantee of
municipal bond obligations of $7.556 billion and $1.603 billion at December 31,
1996 and 1995, respectively. The bonds are generally rated A or above, and TAP's
participation has been reinsured.
At December 31, 1996, the scheduled maturities for these guarantees, net of
TAP's participation in the municipal bond guarantee pools, are $142 million,
$250 million, $8 million, $13 million and $316 million for 1997, 1998, 1999,
2000 and 2001 and thereafter, respectively.
Credit Cards
The Company provides bank and private label credit card services through CCC and
its subsidiaries. These services are provided to individuals and to affinity
groups nationwide. At December 31, 1996 and 1995 total credit lines available to
credit cardholders were $6.622 billion and $5.870 billion, respectively.
Other Commitments
Salomon Smith Barney and a principal broker-dealer subsidiary have each provided
a portion of a residual value guarantee in connection with the lease of the
buildings occupied by Salomon Smith Barney's executive offices and New York
operations. The amount of the guarantee is dependent upon the final build-out
costs with a maximum of $586 million.
The Company makes commitments to fund partnership investments and transfers
receivables to third parties with recourse from time to time. The off-balance
sheet risks of these financial instruments were not significant at December 31,
1996 or 1995.
23. Contingencies
At December 31, 1996, a subsidiary of the Company was in arbitration with
underwriters at Lloyd's of London (Lloyd's) in New York State to enforce
reinsurance contracts with respect to recoveries for certain asbestos claims.
The dispute involved the ability of old Travelers to aggregate asbestos claims
under a market agreement between Lloyd's and old Travelers or under the
applicable reinsurance treaties. In the fourth quarter of 1997, the Company
finalized an agreement to settle this arbitration with underwriters at Lloyd's.
The outcome of this agreement will have no impact on earnings.
With respect to environmental and asbestos property and casualty insurance
claims, see Note 12.
In the ordinary course of business, the Company and/or its subsidiaries are
defendants or co-defendants in various litigation matters, other than
environmental and asbestos property and casualty insurance claims. Although
there can be no assurances, the Company believes, based on information currently
available, that the ultimate resolution of these legal proceedings would not be
likely to have a material adverse effect on its results of operations, financial
condition or liquidity.
90
Notes to Supplemental Consolidated Financial Statements (continued)
24. Selected Quarterly Financial Data (unaudited)
1996
----------------------------------------------------------------
(In millions, except per share amounts) First Second Third Fourth Total
----------------------------------------------------------------
Total revenues $7,509 $8,248 $8,096 $8,561 $32,414
Total expenses 6,194 7,534 6,985 7,138 27,851
Gain (loss) on sales of stock of
subsidiaries and affiliates -- 397 48 -- 445
Income before income taxes and
minority interest 1,315 1,111 1,159 1,423 5,008
Provision for income taxes 485 281 414 499 1,679
Minority interest, net of income taxes -- (44) 44 47 47
----------------------------------------------------------------
Income from continuing operations 830 874 701 877 3,282
Discontinued operations, net of income taxes (34) (7) 3 (296) (334)
----------------------------------------------------------------
Net income $ 796 $ 867 $ 704 $ 581 $ 2,948
================================================================
Earnings per share of common stock:
Continuing operations $ 0.69 $ 0.74 $ 0.58 $ 0.73 $ 2.74
Discontinued operations (0.03) (0.01) -- (0.25) (0.29)
----------------------------------------------------------------
Net income $ 0.66 $ 0.73 $ 0.58 $ 0.48 $ 2.45
================================================================
Common stock price per share:
High $23.5000 $22.8750 $24.9375 $31.6667 $31.6667
Low $19.0000 $18.8333 $19.3750 $24.5625 $18.8333
Close $22.0000 $22.8125 $24.5625 $30.2500 $30.2500
Dividends per share of common stock $ 0.0750 $ 0.0750 $ 0.0750 $ 0.0750 $ 0.3000
1995
---------------------------------------------------------------
(In millions, except per share amounts) First Second Third Fourth Total
---------------------------------------------------------------
Total revenues $6,495 $6,556 $7,132 $7,104 $27,287
Total expenses 5,840 6,074 5,977 6,056 23,947
Gain (loss) on sales of stock of
subsidiaries and affiliates -- -- -- (20) (20)
Income before income taxes and
minority interest 655 482 1,155 1,028 3,320
Provision for income taxes 238 165 425 351 1,179
Minority interest, net of income taxes -- -- -- -- --
---------------------------------------------------------------
Income from continuing operations 417 317 730 677 2,141
Discontinued operations, net of income taxes 4 29 19 98 150
---------------------------------------------------------------
Net income $ 421 $ 346 $ 749 $ 775 $ 2,291
===============================================================
Earnings per share of common stock:
Continuing operations $ 0.34 $ 0.25 $ 0.61 $ 0.56 $ 1.76
Discontinued operations -- 0.02 0.02 0.09 0.13
---------------------------------------------------------------
Net income $ 0.34 $ 0.27 $ 0.63 $ 0.65 $ 1.89
===============================================================
Common stock price per share:
High $13.2917 $15.0000 $17.7917 $21.2917 $21.2917
Low $10.7917 $12.6250 $14.6667 $16.2917 $10.7917
Close $12.8750 $14.5833 $17.7083 $20.8750 $20.8750
Dividends per share of common stock $ 0.0667 $ 0.0667 $ 0.0667 $ 0.0667 $ 0.2667
Due to changes in the number of average shares outstanding, quarterly earnings
per share of common stock do not add to the totals for the years. The above
information has been restated to reflect the stock splits as discussed in Note
1.
91
SCHEDULE I
Travelers Group Inc.
(Parent Company Only)
Condensed Financial Information of Registrant
(In millions of dollars)
Condensed Statement of Income
Year Ended December 31,
-------------------------------------
1996 1995 1994
------- ------- -----
Revenues $ 1 $ (5) $ 3
------- ------- -----
Expenses:
Interest 162 129 120
Other 126 104 87
------- ------- -----
Total 288 233 207
------- ------- -----
Pre-tax loss (287) (238) (204)
Income tax benefit 103 85 82
------- ------- -----
Loss before equity in net income
of subsidiaries (184) (153) (122)
Equity in net income of subsidiaries
from continuing operations 3,466 2,294 869
Equity in net income of subsidiaries
from discontinued operations (334) 150 180
------- ------- -----
Net income $2,948 $2,291 $927
======= ======= =====
The condensed financial statements should be read in conjunction with the
supplemental consolidated financial statements and notes thereto and the
accompanying notes to the condensed financial information of Registrant.
92
SCHEDULE I
Travelers Group Inc.
(Parent Company Only)
Condensed Financial Information of Registrant
(In millions of dollars)
Condensed Statement of Financial Position
December 31,
-------------------------
1996 1995
-------- --------
Assets
Investment in subsidiaries at equity $ 21,018 $ 18,446
Advances to and receivables from subsidiaries 88 220
Cost of acquired businesses in excess of net assets 436 493
Other-principally investments 650 237
-------- --------
$ 22,192 $ 19,396
======== ========
Liabilities
Junior Subordinated Debentures, held by subsidiary Trusts $ 1,026 $ --
Long-term debt 1,903 2,042
Advances from and payables to subsidiaries -- 262
Other liabilities 546 285
-------- --------
3,475 2,589
-------- --------
Redeemable preferred stock, held by subsidiary 226 226
-------- --------
Redeemable preferred stock - Series I 420 560
-------- --------
ESOP Preferred stock - Series C 164 235
Guaranteed ESOP obligation (35) (67)
-------- --------
129 168
-------- --------
Stockholders' equity
Preferred stock ($1.00 par value; authorized shares:
30 million), at aggregate liquidation value 1,125 1,112
Common stock ($.01 par value; authorized shares:
1.5 billion; issued shares: 1996 - 1,384,707,342 and
1995 - 1,368,269,744) 14 14
Additional paid-in capital 7,806 7,227
Retained earnings 12,934 10,504
Treasury stock, at cost (1996 - 243,500,547 shares;
1995 - 239,158,362 shares) (4,123) (3,470)
Unrealized gain (loss) on investment securities 469 756
Other, principally unearned compensation (283) (290)
-------- --------
17,942 15,853
-------- --------
$ 22,192 $ 19,396
======== ========
The condensed financial statements should be read in conjunction with the
supplemental consolidated financial statements and notes thereto and the
accompanying notes to the condensed financial information of Registrant.
93
SCHEDULE I
Travelers Group Inc.
(Parent Company Only)
Condensed Financial Information of Registrant
(In millions of dollars)
Condensed Statement of Cash Flows
Year Ended December 31,
---------------------------------
1996 1995 1994
------- ------- -------
Cash flows from operating activities
Net income $ 2,948 $ 2,291 $ 927
Adjustments to reconcile net income to
cash provided by operating activities:
Equity in net income of subsidiaries (3,132) (2,444) (1,049)
Dividends received from subsidiaries, net 1,808 508 1,409
Advances (to) from subsidiaries, net (83) 132 (31)
Other, net 316 217 377
------- ------- -------
Net cash provided by (used in) operating activities 1,857 704 1,633
------- ------- -------
Cash flows from investing activities
Capital contribution to subsidiary (1,140) -- --
Other investments, primarily short-term, net (408) (198) --
------- ------- -------
Net cash provided by (used in) investing activities (1,548) (198) --
------- ------- -------
Cash flows from financing activities
Dividends paid (518) (478) (395)
Issuance of preferred stock 250 -- --
Redemption of preferred stock (112) -- --
Redemption of Series I redeemable preferred stock -- (140) --
Redemption of redeemable preferred stock (held by
subsidiary) -- (35) (100)
Stock tendered for payment of withholding taxes (201) (94) (42)
Treasury stock acquired (642) (420) (795)
Issuance of long-term debt -- 700 --
Issuance of junior subordinated debentures 1,026 -- --
Payments and redemptions of long-term debt (100) -- (93)
Net change in short-term borrowings -- (101) (228)
Other, net (12) 62 20
------- ------- -------
Net cash provided by (used in) financing activities (309) (506) (1,633)
------- ------- -------
Change in cash $ -- $ -- $ --
------- ------- -------
Supplemental disclosure of cash flow information:
Cash paid during the period for interest $ 157 $ 112 $ 102
------- ------- -------
Cash received during the period for taxes $ 263 $ 155 $ 268
======= ======= =======
The condensed financial statements should be read in conjunction with the
supplemental consolidated financial statements and notes thereto and the
accompanying notes to the condensed financial information of Registrant.
94
SCHEDULE I
Notes to Condensed Financial Statements of Registrant
1. Basis of Presentation
The accompanying financial statements include the accounts of Travelers Group
Inc. (the Parent) and on an equity basis its subsidiaries and affiliates and
should be read in conjunction with the Supplemental Consolidated Financial
Statements and notes thereto.
2. Supplementary Disclosure of Non-Cash Investing and Financing Activities
During 1994, the Parent issued $261 million of redeemable preferred stock to
various subsidiaries in exchange for an equivalent value of Travelers Group Inc.
common stock previously held by these subsidiaries. This activity was recorded
as a non-cash capital contribution to subsidiaries by the Parent. During 1995,
$35 million of this redeemable preferred stock was repurchased and retired.
95
Independent Auditors' Report
The Board of Directors and Stockholders
Travelers Group Inc.
We have audited the accompanying supplemental consolidated statement of
financial position of Travelers Group Inc. and subsidiaries as of December 31,
1996 and 1995, and the related supplemental consolidated statements of income,
changes in stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 1996. These supplemental consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these supplemental consolidated
financial statements based on our audits. We did not audit the consolidated
statement of financial condition of Salomon Inc and subsidiaries as of December
31, 1996 and 1995, or the related consolidated statements of income, changes in
stockholders' equity and cash flows for each of the years in the three-year
period ended December 31, 1996, which consolidated statements reflect total
assets of $194,881 million and $188,428 million as of December 31, 1996 and
1995, respectively, and total revenues of $9,046 million, $8,953 million and
$6,194 million for the years ended December 31, 1996, 1995 and 1994,
respectively. Those consolidated financial statements were audited by other
auditors whose report has been furnished to us, and our opinion, insofar as it
relates to the amounts included for Salomon Inc and subsidiaries for such
periods, is based solely on the report of such other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of the other auditors provide a
reasonable basis for our opinion.
The supplemental consolidated financial statements give retroactive effect to
the merger of Travelers Group Inc. and Salomon Inc on November 28, 1997, which
has been accounted for as a pooling of interests as described in Note 1 to the
supplemental consolidated financial statements. Generally accepted accounting
principles proscribe giving effect to a consummated business combination
accounted for by the pooling of interests method in financial statements that do
not include the date of consummation. The supplemental consolidated financial
statements do not extend through the date of consummation. However, they will
become the historical consolidated financial statements of Travelers Group Inc.
and subsidiaries after financial statements covering the date of consummation of
the business combination are issued.
96
In our opinion, based on our audits and the report of other auditors, the
supplemental consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Travelers Group Inc. and
subsidiaries as of December 31, 1996 and 1995, and the results of their
operations and their cash flows for each of the years in the three-year period
ended December 31, 1996 in conformity with generally accepted accounting
principles applicable after financial statements are issued for a period which
includes the date of consummation of the business combination.
Our audits also included the supplemental financial statement schedule relating
to Travelers Group Inc. (Parent Company Only). This supplemental financial
statement schedule is the responsibility of the Company's management. Our
responsibility is to express an opinion on the supplemental financial statement
schedule based on our audits. In our opinion, based on our audits and the report
of other auditors, such supplemental financial statement schedule, when
considered in relation to the supplemental consolidated financial statements
taken as a whole, presents fairly, in all material respects, the information set
forth therein.
/s/ KPMG PEAT MARWICK LLP
New York, New York
November 28, 1997
97