On October 1, 2001, the Company purchased The Northland Company and its subsidiaries (Northland) from Citigroup. On October 3, 2001, Citigroup contributed the capital stock of Associates Insurance Company (Associates) to the Company. During April 2000, TPC completed a cash tender offer and merger and acquired all of Travelers Insurance Group Holdings Inc.’s outstanding shares of common stock that were not already owned by TPC for approximately $2.413 billion in cash financed by a loan from Citigroup. On May 31, 2000, the Company acquired the surety business of Reliance Group Holdings, Inc. (Reliance Surety). Includes amounts related to Northland, Associates, the remainder of TIGHI and Reliance Surety from their dates of acquisition.
In connection with the 2002 offerings described below, TPC effected a corporate reorganization under which:
On August 1, 2002, Commercial Insurance Resources, Inc. (CIRI), a subsidiary of the Company and the holding company for the Gulf Insurance Group (Gulf), completed its previously announced transaction with a group of outside investors and senior employees of Gulf. Capital investments made by the investors and employees included $85.9 million of mandatory convertible preferred stock, $49.7 million of convertible notes and $3.6 million of common equity, representing a 24% ownership interest of CIRI, on a fully diluted basis. The dividend rate on the preferred stock is 6.0%. The interest rate on the notes is 6.0% payable on an interest-only basis. The notes mature on December 31, 2032. Trident II, L.P., Marsh & McLennan Capital Professionals Fund, L.P., Marsh & McLennan Employees’ Securities Company, L.P. and Trident Gulf Holding, LLC (collectively Trident) invested $125.0 million, and a group of approximately 75 senior employees of Gulf invested $14.2 million. Fifty percent of the CIRI senior employees investment was financed by CIRI. This financing is collateralized by the CIRI securities purchased and is forgivable if Trident achieves certain investment returns. The applicable agreements provide for registration rights and transfer rights and restrictions and other matters customarily addressed in agreements with minority investors. Gulf’s results, net of minority interest, are included in the Commercial Lines segment.
Operating income is defined by the Company as net income (loss) excluding net realized investment gains (losses), restructuring charges, the cumulative effect of the changes in accounting principles and TPC minority interest in 2000. Operating income is considered a more appropriate indicator of underwriting results and results of operations. Net realized investment gains (losses) are significantly impacted by both discretionary and other economic factors and are not necessarily indicative of operating trends. The major components of operating income and a reconciliation of operating income to net income are as follows:
million. These actions were taken as a result of recent payment and settlement experience. In addition, the Company strengthened prior year reserves for certain run-off lines of business including assumed reinsurance, and experienced favorable development in certain ongoing businesses including Personal Lines Auto. Run-off lines of business are those determined to be non-strategic which includes non-renewals of inforce policies and a cessation of writing new business, where allowed by law. Despite the benefit of higher average invested assets resulting from strong cash flows from underwriting, 2002 net investment income of $1.403 billion was down $89.4 million compared to $1.492 billion in 2001, reflecting reduced returns in the Company’s public equity investments and the lower interest rate environment. Operating income in 2002 was favorably impacted by lower weather-related catastrophe losses of $54.7 million in 2002 compared to $67.1 million of weather-related catastrophe losses in 2001. Also favorably impacting 2002 was the elimination of goodwill amortization and lower interest expense. Underwriting gain (loss), excluding catastrophes, prior year reserve development and goodwill amortization increased $269.0 million to $317.1 million in 2002. The 2002 underwriting results reflect the continuing favorable rate environment significantly in excess of loss cost trends, higher retention and selective growth in new business.
Revenues of $9.494 billion in 2002 increased $1.722 billion from 2001. The increase is primarily attributable to premium rate increases, higher fee income, the inclusion of the full-year of Northland and Associates in 2002 and the benefit of the Citigroup indemnification agreement. Total revenues for Northland and Associates were $946.7 million in 2002, an increase of $715.4 million over 2001 which only includes the fourth quarter of 2001. The increase in revenue for 2002 was partially offset by lower net investment income combined with lower realized investment
In addition to fee based products, National Accounts works with national and regional brokers to provide tailored insurance coverages and programs, mainly to large corporations. National Accounts also includes participation in
Operating income of $346.9 million for 2002 was $105.9 million higher than $241.0 million for 2001. Operating income in 2002 increased primarily due to premium rate increases in excess of loss cost trends and the $41.6 million impact of the terrorist attack on September 11th on 2001 operating income. This was partially offset by natural catastrophe losses of $54.7 million compared to $44.5 million of natural catastrophe losses in 2001. Favorable reserve development was recognized, primarily in automobile, due to the moderation in loss cost trends. The elimination of goodwill amortization also contributed to the increase in 2002 operating income. Despite the benefit of higher average invested assets resulting from strong cash flows from underwriting, 2002 net investment income of $278.8 million was $15.4 million lower than 2001 reflecting reduced returns in the Company’s public equity investments and the lower interest rate environment. Underwriting gain (loss), excluding catastrophes, prior year reserve development and goodwill amortization increased $68.2 million to $51.6 million in 2002. The 2002 underwriting results reflect an improved premium rate environment in both auto and property and a moderation in the increase in loss cost trends.
Due to claimants’ allegations of long-term bodily injury in CIOTA claims, numerous complex issues regarding these claims are presented. The claimants’ theories of liability must be evaluated, the 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, an assessment of a claimant’s damages must be made and the law of the applicable jurisdiction must be analyzed. In addition, the Company must review the number of policies it has issued to the policyholder and whether these policies are triggered by the allegations, the terms and limits of liability of these policies, the obligations of other insurers to respond to the claim and the role, if any, of non-CIOTA claims or potential non-CIOTA claims in any resolution process.
Changes in the general interest rate environment affect the returns available on new investments. 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 return available on new investments, but creates the opportunity for realized investment gains on disposition of fixed maturity investments. In 2002, interest rates declined to their lowest levels since the 1950’s, and equity returns were negative for the second consecutive year. These trends may continue into 2003, reducing the return available on the investment of funds.
For information about the outlook with respect to asbestos-related claims and liabilities see “- Asbestos Claims and Litigation” and “- Uncertainty Regarding Adequacy of Asbestos and Environmental Reserves.”
Effective April 1, 2001, the Company adopted FASB Emerging Issues Task Force (EITF) 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (EITF 99-20). EITF 99-20 provides new guidance on the recognition and measurement of interest income and impairment on certain investments, e.g., certain asset-backed securities. The recognition of impairment resulting from the adoption of EITF 99-20 is to be recorded as a cumulative effect adjustment as of the beginning of the fiscal quarter in which it is adopted. Interest income on beneficial interests falling within the scope of EITF 99-20 is to be recognized prospectively. As a result of adopting EITF 99-20, the Company recorded a charge of $1.3 million after tax, reflected as a cumulative effect adjustment. The implementation of this EITF did not have a significant impact on results of operations, financial condition or liquidity.
In the event that the consolidated return develops an alternative minimum tax (AMT), each company with an AMT on a separate company basis will be allocated a portion of the consolidated AMT. Settlement of the AMT will be made in the same manner and timing as the regular tax.
In addition, the Company assumed liabilities for qualified pension plan benefits for active Company employees. As a result, assets and liabilities for qualified pension plan benefits relating to active, but not retired or inactive, plan participants were transferred from the Citigroup qualified pension plan to the Company’s newly established qualified pension plan. The initial projected benefit obligation of the Company’s qualified pension plan at August 20, 2002 was $445.0 million. Assets of $390.0 million were transferred from the Citigroup pension plan to the Company’s pension plan in 2002 and were invested primarily in a Standard & Poors stock index fund and in a Lehman Brothers Aggregate bond index fund at December 31, 2002. A final asset transfer is expected in the first quarter of 2003.
The following table summarizes the components of net benefit expense recognized in the consolidated statement of income for TPC’s plans for the period August 20, 2002 through December 31, 2002.
Prior to the Citigroup Distribution, the Company participated in noncontributory defined benefit pension plans and a postretirement health care and life insurance benefit plan sponsored by Citigroup. The Company’s share of net expense (credit) related to these plans was $(3.9) million for January 1, 2002 through August 20, 2002, $11.7 million for 2001, and $14.5 million for 2000.
The effectiveness of these hedging relationships is evaluated on a retrospective and prospective basis using quantitative measures of correlation. If a hedge relationship is found to be ineffective, it no longer qualifies as a hedge, and any excess gains or losses attributable to such ineffectiveness as well as subsequent changes in fair value are recognized in realized investment gains (losses). During the year ended December 31, 2002, the Company realized a gain of $3.8 million from hedge ineffectiveness. During the year ended December 31, 2001, there was no hedge ineffectiveness.
At December 31, 2002 and 2001, the Company had $60.2 million and $102.0 million, respectively, of securities pledged as collateral to Citigroup to support a letter of credit facility for certain of the Company’s surety customers.