· price increases, improved loss experience, and expense savings resulting from the restructuring and other actions and initiatives announced in recent years;
· general economic conditions, including changes in interest rates and the performance of financial markets;
Accordingly, absent unfavorable developments in the pricing environment, we expect our statutory expense ratio to generally remain stable or improve in 2004.
In November 2003, The St. Paul and Travelers Property Casualty Corp. announced the signing of a definitive merger agreement. See Item 1 in this report for further discussion of the Proposed Merger.
The most significant estimates relate to our reserves for property-liability insurance losses and loss adjustment expenses (“LAE”). We establish reserves for the estimated total unpaid cost of losses and LAE, which cover events that have already occurred. These reserves reflect our estimates of the total cost of claims that were reported to us, but not yet paid (“case” reserves), and the cost of claims “incurred but not yet reported” to us (“IBNR” reserves). For reported losses, we establish case reserves within the parameters of coverage provided in the insurance policy, surety bond or reinsurance agreement. For IBNR losses, we estimate reserves taking into account various statistical and actuarial projection techniques as well as other influencing factors. We continually review our reserves, using a variety of statistical and actuarial techniques to analyze current claim costs, frequency and severity data, and prevailing economic, social and legal factors. We also take into consideration other variables such as past loss experience, changes in legislative conditions, changes in judicial interpretation of legal liability and policy coverages, changes in claims handling practices and inflation. We consider not only monetary increases in the cost of what we insure, but also changes in societal factors that influence jury verdicts and case law, our approach to claim resolution, and, in turn, claim costs.
Environmental and Asbestos Reserves. Reserves for environmental and asbestos exposures cannot be estimated solely with the traditional loss reserving techniques described above, which rely on historical accident year development factors and take into consideration the previously mentioned variables. Environmental and asbestos reserves are more difficult to estimate than our other loss reserves because of legal issues, societal factors and difficulty in determining the parties who may ultimately be held liable. Therefore, in addition to taking into consideration the traditional variables that are utilized to arrive at our other loss reserve amounts, we also look at the length of time necessary to clean up polluted sites, controversies surrounding the identity of the responsible party, the degree of remediation deemed to be necessary, the estimated time period for litigation expenses, judicial expansions of coverage, medical complications arising with asbestos claimants’ advanced age, case law, and the history of prior claim development. We also consider the impact of changes in the legal environment, including our experience in the Western MacArthur matter, in establishing our reserves for other asbestos and environmental cases. Generally, case reserves and loss adjustment expense reserves are established where sufficient information has been obtained to indicate coverage under a specific insurance policy. We also consider end of period reserves in relation to paid losses in a period. Furthermore, IBNR reserves are established to cover additional estimated exposures related to policyholders that haven’t as yet asserted any claims as well as development on reserves assumed from other entities. These reserves are continually reviewed and updated as additional information is acquired.
· Venture Capital Entities-In our venture capital investment portfolio, we have numerous investments in small- to medium-sized companies, in which we have variable interests through stock ownership and, in some cases, loans. All of these investments are held for the purpose of generating investment returns, and the companies in which we invest span a variety of business sectors, including technology, telecommunications and healthcare. As a result of our review of this portfolio, we identified three entities that were required to be consolidated under the provisions of FIN 46(R). The combined carrying value of these entities at December 31, 2003 was $(5) million.
SFAS No. 150-As noted above, we adopted the provisions of SFAS 150 in the third quarter of 2003 with respect to our Preferred Securities, our only financial instruments that fell within the scope of SFAS No. 150. Upon the application of the provisions of FIN 46(R) in the fourth quarter of 2003 to trusts that issued these securities, we no longer have any financial instruments to which SFAS No. 150 applies.
SFAS No. 133-On January 1, 2001, we adopted the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended by SFAS Nos. 137 and 138. Provisions of SFAS No. 133 require the recognition of derivatives as either assets or liabilities on the balance sheet and
Underwriting result is a common measurement of a property-liability insurer’s performance, representing earned premiums less losses incurred and underwriting expenses. In accordance with provisions of SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” we have designated “underwriting result” as the measure we use to evaluate the performance of our property-liability underwriting segments. The statutory combined ratio, representing the sum of the statutory loss ratio and the statutory expense ratio, is also a common measure of underwriting performance. The statutory loss ratio measures insurance losses and loss adjustment expenses incurred as a percentage of earned premiums. The statutory expense ratio measures underwriting expenses as a percentage of premiums written. The lower the ratio, the better the result. The following table summarizes net written premiums, underwriting results and combined ratios for each of our property-liability underwriting business segments for the last three years (underwriting results are presented on a GAAP basis; combined ratios are presented on a statutory accounting basis). All data for 2002 and 2001 were reclassified to conform to our new segment reporting format implemented in 2003. Following the table are an overview of our property-liability operations and detailed analyses of our results by segment.
“catastrophe losses.” We revised our definition of losses reported as “catastrophes” to include only those events that we believe generate losses beyond a level normally expected in our business. This revised definition has no impact on our recorded results for any period included in this report. Catastrophe losses reported in prior periods have been revised to conform to our new definition. In 2003, we did not experience any significant catastrophe losses, as newly defined; however, we recorded a net $55 million reduction in the provision for catastrophes incurred in prior years, nearly all of which was related to the September 11, 2001 terrorist attack.
Within our commercial surety segments, we have exposures related to a small number of accounts, which are now in various stages of bankruptcy proceedings. In addition, certain other accounts have experienced deterioration in creditworthiness since we issued bonds to them. Given the current economic climate and its impact on these companies, we may experience an increase in claims and, possibly, incur high severity losses. Such losses would be recognized in the period in which the claims are filed and determined to be a valid loss under the provisions of the surety bond issued.
The 2003 underwriting loss included a $350 million provision recorded in the fourth quarter to increase net prior accident year loss reserves. The majority of remaining underwriting losses in 2003 consisted of current-year loss provisions related to reporting endorsements. Further information regarding the $350 million prior-year loss provision is included in the following table.
As noted above, as part of our focus on claim resolution, we increased our emphasis on routinely reviewing our case reserves and put in place a process where managers actively review each adjuster’s entire inventory of pending files to assure, among other things, that case reserves are adequate to support settlement values. In addition, as we moved further into runoff, our mix of paid and outstanding claims changed and we expected that our statistical data would reflect fewer new claims. We expected our claim counts to go down and the average size of our outstanding and paid claims to go up since newly reported claims are often settled at minimal loss or loss expense cost.
Case redundancy-While there were claims settlements which exceeded the claim-specific reserve that had been established, on the whole, claims were being settled at a level significantly less than the individual case reserve previously carried. During 2001, the amount of excess reserves above settled amounts as a percentage of previously established reserves (referred to as a redundancy ratio) were in the range of 25% to 30%. By the end of 2002, the redundancy ratio had increased to between 35% and 40%. We expected this ratio to stay within this range to support our best estimate of a reasonable provision for our loss reserves.
2002 vs. 2001-The significant decline in written premium volume in 2002 reflected the impact of our decision to place these businesses in runoff. International runoff lines of business accounted for $110 million of written premium volume in 2002, down 54% from $240 million in 2001. We continued to underwrite business in selected markets while we attempted to sell certain of our operations. Our Lloyd’s runoff premium totaled $114 million in 2002, compared with $253 million in 2001. Unionamerica syndicate premium volume totaled $18 million in 2002, down significantly from 2001 premiums of $99 million.
Because many of the coverages we offer involve claims that may not ultimately be settled for many years after they are incurred, subjective judgments as to our ultimate exposure to losses are an integral and necessary component of our loss reserving process. We record our reserves by considering a range of estimates bounded by a high and low point. Within that range, we record our best estimate. We continually review our reserves, using a variety of statistical and actuarial techniques to analyze current claim costs, frequency and severity data, and prevailing economic, social and legal factors. We adjust reserves established in prior years as loss experience develops and new information becomes available. Adjustments to previously estimated reserves are reflected in our financial results in the periods in which they are made.
We consider “long-tail” exposures to include those lines of business in which the majority of coverage involves average loss payment lags of three years or more beyond the expiration of the policy and, accordingly, can cause an increased level of uncertainty in estimating loss reserves. The primary lines of our business fitting those criteria are general liability, workers’ compensation, and casualty excess reinsurance. For the medical malpractice business we underwrote prior to our exit from that line of business, reserves do not exceed a three-year average life, but do involve a high degree of uncertainty. We analyze these reserves in accordance with our accounting policy as further described in the “Critical Accounting Policies” section of this discussion.
Gross paid losses in 2003 include the $747 million payment, inclusive of $7 million in interest, made in the first quarter pursuant to the Western MacArthur litigation settlement agreement. Western MacArthur accounted for $9 million of gross incurred losses in 2003. Included in gross incurred losses in 2002 (including the $150 million reserve increase) were $995 million of losses related to the Western MacArthur agreement. Also included in the gross and net incurred losses for the year ended December 31, 2002, but
As discussed above, investment and funding decisions and pension plan assumptions can materially impact our consolidated financial results of operations. Consequently, our Benefit Plans’ Investment Committee regularly evaluates investment returns, asset allocation strategies, possible plan contributions, and plan assumptions. Regardless of the extent of our analysis of such factors, plan assumptions reflect judgments and are subject to changes in economic factors. There can be no assurance that our assumptions will prove to be correct or that they will not be subject to significant adjustments over time. For purposes
Statutory Loss Ratio (a statutory financial measure): The company uses the statutory definition of loss ratio. This ratio is calculated by dividing losses and loss adjustment expenses incurred by net earned premiums. Net earned premiums and losses and loss adjustment expenses, are both GAAP and statutory measures.
While our reported reserves make a reasonable provision for our unpaid loss and LAE obligations, it should be noted that the process of estimating required reserves, by its very nature, involves substantial uncertainty. The level of uncertainty can be influenced by factors such as the existence of coverage with long duration payment patterns and changes in claim handling practices, as well as the factors noted above. Ultimate actual payments for claims and LAE could turn out to be significantly different from our estimates.
Investments’ issuance of additional shares under various stock option and incentive plans and, in 2002, the issuance of common shares upon the conversion of a portion of its preferred stock.
The size of our investment portfolio allows our portfolio managers a degree of flexibility in determining which individual investments should be sold to achieve our primary investment goals of assuring our ability to meet our commitments to policyholders and other creditors and maximizing our investment returns. In order to meet the objective of maintaining a flexible portfolio that can achieve these goals, our fixed income and equity portfolios are classified as “available-for-sale.” We continually evaluate these portfolios, and our purchases and sales of investments are based on our cash requirements, the characteristics of our insurance liabilities, and current market conditions. We also monitor the difference between our cost and the estimated fair value of investments, which involves uncertainty as to whether declines in value are temporary in nature. At the time we determine an “other than temporary” impairment in the value of a particular investment to have occurred, we consider the current facts and circumstances, including the financial position and future prospects of the entity that issued the investment security, and make a decision to either record a write-down in the carrying value of the security or sell the security; in either case, recognizing a realized loss.
In the first quarter of 2003, we revised our property-liability insurance business segment reporting structure to reflect the manner in which those businesses are managed. Our property-liability underwriting operations consist of two segments constituting our ongoing operations (Specialty Commercial and Commercial Lines), and one segment comprising our runoff operations (Other). The composition of those respective segments is described in greater detail below. The following is a summary of changes made to our segments in the first quarter of 2003.
In addition to our property-liability business segment, we also have aproperty-liability investment operation segment, as well as an asset management segment, consisting of our majority ownership in Nuveen Investments.
In 2003, we recorded a $59 million pretax loss provision (net of reinsurance) related to one of our accounts that was in bankruptcy and unable to perform its bonded obligations. In April 2003, a bankruptcy court approved the sale of substantially all of the assets of the account. Following that approval, we received claim notices with respect to approximately $120 million of bonds securing certain workers’ compensation and retiree health benefit obligations of the account. We originally recorded a net pretax loss provision of $89 million when the claim notices were received. In the fourth quarter of 2003, we re-estimated the amount of reinsurance recoverable related to that pretax loss, and recorded a $27 million reduction in our net loss. Conversely, in the fourth quarter of 2003, we recorded a $27 million provision to strengthen our Surety operation’s prior-year loss reserves, primarily related to a re-estimation of reinsurance recoverable related to losses incurred in 2002 associated with Enron Corporation’s bankruptcy.
Discontinued Operations. The “activity on reserves of discontinued operations” represents certain activity related to the 1999 sale of our standard personal insurance business. The reserve balances
If we believe that any of our deferred tax assets will not result in future tax benefits, we must establish a valuation allowance for the portion of these assets that we think will not be realized. The net change in the valuation allowance for deferred tax assets was a decrease of $10 million in 2003, and an increase of $27 million in 2002, both relating to our foreign operations. Based predominantly upon a review of our anticipated future earnings, but also including all other available evidence, both positive and negative, we have concluded it is “more likely than not” that our net deferred tax assets will be realized.
5.25% Senior Notes-In July 2002, concurrent with the issuance of 17.8 million of our common shares in a public offering, we issued 8.9 million equity units, each having a stated amount of $50, for gross
8.125% Senior Notes-Also in April 2000, we issued $250 million of senior notes due April 15, 2010. Proceeds were used to repay commercial paper debt and for general corporate purposes.
Our U.S. pension plans’ weighted-average target asset allocations at December 31, 2003, and 2002, by asset category are as follows:
Equity securities include 804,035 shares of our common stock with a market value of $32 million and $27 million at December 31, 2003 and 2002, respectively.
Any unvested balances under the Plan will immediately vest upon consummation of the Proposed Merger, which constitutes a Change of Control as defined by the Plan.
Investment Commitments-We have long-term commitments to fund venture capital investments totaling $792 million as of December 31, 2003. Of that amount, approximately $501 million of commitments are to fund investments in St. Paul Venture Capital VI, LLC (“Fund VI”), one of our
In September 2001, we sold American Continental Life Insurance Company, a small life insurance company we had acquired as part of our MMI purchase, to CNA Financial Corporation. We received cash proceeds of $21 million, and recorded a net after-tax loss on the sale of $1 million.
Related to our April 2000 purchase of MMI, we recorded a charge of $28 million, including $4 million of employee-related costs and $24 million of occupancy-related costs. The employee-related costs represented severance and related benefits such as outplacement counseling to be paid to, or incurred on behalf of, terminated employees. We estimated that approximately 130 employee positions would be eliminated, at all levels throughout MMI, and 119 employees were terminated. The occupancy-related cost represented excess space created by the terminations, calculated by determining the percentage of anticipated excess space, by location, and the current lease costs over the remaining lease period. The amounts payable under the existing leases were not discounted, and sublease income was included in the calculation only for those locations where sublease agreements were in place.