Index to Financial Statements The Company’s discussions related to all items, other than net income (loss), are presented on a pretax basis, unless otherwise noted.
Net income of $1.70 billion in 2003 was a significant improvement over the net loss of $27 million in 2002. Results in 2003 reflected a favorable, but moderating, rate environment in excess of loss cost trends and a decline in unfavorable prior year reserve development. Those factors were partially offset by a $174 million increase in after-tax catastrophe losses in 2003. Net unfavorable prior year reserve development in 2003 was $309 million, including $339 million of charges related to reserve strengthening in the Company’s subsidiary Gulf Insurance Company (Gulf). In 2002, the $1.49 billion of net unfavorable prior year reserve development was driven by $1.39 billion of charges related to asbestos reserve strengthening. In December 2002, the Company increased its asbestos reserves to $3.40 billion, net of reinsurance recoverables, and fully utilized the $800 million pretax benefit under the Citigroup indemnification agreement. (For additional information see “-Asbestos Claims and Litigation”). The net loss in 2002 included an after-tax charge for the cumulative effect of a change in accounting principle of $243 million due to the adoption of Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (FAS 142). Net income in 2003 included $21 million of net realized investment gains, compared with $99 million of net realized investment gains in 2002.
Recoveries from former affiliate of $520 million, net of tax, in 2002 represent funds recovered under the Citigroup indemnification agreement.
Other 2004 claims and expenses related to the merger include $29 million of restructuring charges, $92 million of amortization expense related to finite-lived intangible assets acquired in the merger, and a benefit of $58 million associated with the accretion of the fair value adjustment to claims and claim adjustment expenses and reinsurance recoverables. Interest expense in 2004 included $100 million of additional interest expense on SPC debt assumed in the merger.
Other items increasing 2004 claims and expenses compared to 2003 include $224 million of charges to increase the allowances for estimated amounts due from reinsurance recoverables, policyholders receivables, and a co-surety on a specific construction contractor claim previously described in the Consolidated Overview section.
Net written premiums in 2004 in the majority of the Company’s remaining domestic specialty businesses were strong, with retention levels at or above historical levels. The Company continued to focus on retaining the profitable and well-priced book of business that has been built in recent years. Renewal price change increases in these operations moderated throughout the year to the upper single-digit level. New business levels in 2004 were down compared with 2003, when renewal rights transactions contributed to strong growth in new business. The impact of the decline in new business levels in 2004 was partially offset by premium growth resulting from the transfer of certain business from the Company’s Gulf operation, which was placed in runoff in the second quarter of the year. In addition, premium volume in these domestic businesses benefited in 2004 from a small amount of additional transfers of certain business previously written in the Commercial segment’s commercial accounts operation.
The policyholders with settlement agreements category includes structured agreements, coverage in place arrangements and, with respect to TPC, Wellington accounts and the settlement of the Statutory and Hawaii Actions and the Common Law Claims (for a fuller description of these matters, see “Item 3 - Legal Proceedings”) (collectively the “Direct Action Settlement”). Reserves are based on the expected payout for each policyholder under the applicable agreement. Structured agreements are arrangements under which policyholders and/or plaintiffs agree to fixed financial amounts to be paid at scheduled times. Structured agreements include the Company’s obligations related to PPG Industries, Inc. (PPG). In May 2002 the Company agreed along with approximately three dozen other insurers and PPG on key terms to settle asbestos related coverage litigation under insurance policies issued to PPG. This settlement is to be incorporated into the Plan of Reorganization (the Plan) proposed as part of the Pittsburgh Corning (PC) bankruptcy proceeding. There remain a number of contingencies to consummation of the settlement including the final execution of documents, court approval of the PC Plan over pending objections, approval of the settlement and possible appeals. Pursuant to the proposed PC Plan, PC along with enumerated affiliated companies (including PPG and Corning) are to receive the protections afforded by Section 524(g) of the Bankruptcy Code from certain asbestos related bodily injury claims. A recent ruling by the Third Circuit Court of Appeals in the In Re Combustion Engineering, Inc. (CE) matter may impact the scope of relief that is potentially available to the debtor and other Plan proponents. As a result, the PC bankruptcy court has sought additional briefing on the impact of the CE decision on the proposed
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short- and long-term cash requirements of its business operations. The liquidity requirements of the Company’s business have been met primarily by funds generated from operations, asset maturities and income received on investments. Cash provided from these sources is used primarily for claims and claim adjustment expense payments and operating expenses. Catastrophe claims, the timing and amount of which are inherently unpredictable, may create increased liquidity requirements. The timing and amount of reinsurance recoveries may be affected by reinsurer solvency and increasingly by reinsurance coverage disputes. Additionally, recent increases in asbestos-related claim payments, as well as potential judgments and settlements arising out of litigation, may also result in increased liquidity requirements. In the opinion of the Company’s management, the Company’s future liquidity needs will be met from all of the above sources.
On March 11, 2003, TPC issued $1.40 billion of senior notes comprising $400 million of 3.75% senior notes due March 15, 2008, $500 million of 5.00% senior notes due March 15, 2013 and $500 million of 6.375% senior notes due March 15, 2033. The notes pay interest semi-annually on March 15 and September 15 of each year, beginning September 15, 2003, are senior unsecured obligations and rank equally with all of TPC’s other senior unsecured indebtedness. TPC may redeem some or all of the notes prior to maturity by paying a “make-whole” premium based on U.S. Treasury rates. The net proceeds from the sale of these notes were contributed to its primary subsidiary, TIGHI, so that TIGHI could prepay and refinance $500 million of 3.60% indebtedness to Citigroup and to redeem $900 million aggregate principal amount of TIGHI’s 8.00% to 8.08% junior subordinated debt securities held by subsidiary trusts. These trusts, in turn, used these funds to redeem $900 million of preferred capital securities on April 9, 2003.
Defense costs are also a part of the insured costs covered by liability policies and can be significant, sometimes greater than the cost of the actual paid claims. For some products this risk is mitigated by policy language such that the insured portion of defense costs erodes the amount of policy limit available to pay the claim. Such “defense within the limits” policies are most common for “claims made” products. When defense costs are outside of the limits, amounts paid do not erode the policy limits.
insurer. Claims on property coverage are typically reported soon after the actual damage occurs, although delays of several months are not unusual. The claim is settled when the two parties agree on the amount due in accordance with the policy contract language and the appropriate payment is made (or alternatively, the property replacement/repair is performed by the insurer). The resulting settlement process is typically fairly short term, although exceptions do exist.
The Company reports its reinsurance recoverables net of an allowance for estimated uncollectible reinsurance recoverables. The allowance is based upon the Company’s ongoing review of amounts outstanding, length of collection periods, changes in reinsurer credit standing, disputes, applicable coverage defenses, and other relevant factors. Accordingly, the establishment of reinsurance recoverables and the related allowance for uncollectible reinsurance recoverables is also an inherently uncertain process involving estimates. Changes in these estimates could result in additional income statement charges. The increase in the allowance for uncollectible reinsurance in 2004 was $364 million, $256 million of which was merger-related and $108 million of which resulted from the Company’s ongoing review process described above.
Consolidated Statement of Changes in Shareholders’ Equity for the years ended December 31, 2004, 2003 and 2002
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The St. Paul Travelers Companies, Inc., and subsidiaries as of December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
Municipal Trusts-The Company owns interests in various municipal trusts that were formed for the purpose of allowing more flexibility to generate investment income in a manner consistent with the Company’s investment objectives and tax position. As of December 31, 2004, there were 36 such trusts, which held a combined total of $450 million in municipal securities, of which $84 million were owned by outside investors. The net carrying value of the trusts owned by the Company at December 31, 2004 was $366 million.
Included in other liabilities in the consolidated balance sheet is the Company’s estimate of its liability for guaranty fund and other insurance-related assessments. The liability for expected state guaranty fund and other premium-based assessments is recognized as the Company writes or becomes obligated to write or renew the premiums on which the assessments are expected to be based. The liability for loss-based assessments is recognized as the related losses are incurred. At December 31, 2004 and 2003, the Company had a liability of $249 million and $180 million, respectively, for guaranty fund and other assessments and related recoveries of
The specific attributes of the Company’s four reportable business segments are as follows:
The primary reasons for the acquisition were, among other things, a) to create a stronger company that will provide significant benefits to shareholders and to customers alike; b) to capitalize on a common strategic focus on delivering the highest value to customers, agents and brokers and, working together, to expand future opportunities and capture new efficiencies; and c) to strengthen the combined company’s position as a leading provider of property and casualty insurance products.
The following presents a summary of the Company’s amortization expense for intangible assets by major asset class:
At December 31, 2004 and 2003, the Company’s claims and claim adjustment expense reserves included $4.57 billion and $3.27 billion, respectively, for asbestos and environmental-related claims, net of reinsurance.
On April 1, 2004, The St. Paul Travelers Companies, Inc. fully and unconditionally guaranteed the payment of all principal, premiums, if any, and interest on certain debt obligations of its subsidiaries TPC and TIGHI. The guarantees pertain to the $150 million 6.75% Notes due 2006, the $400 million 3.75% Notes due 2008, the $500 million 5.00% Notes due 2013, the $200 million 7.75% Notes due 2026, the $893 million 4.5% Convertible Notes due 2032 and the $500 million 6.375% Notes due 2033.
The current income tax payable was $188 million and $226 million at December 31, 2004 and 2003, respectively and is included in other liabilities in the consolidated balance sheet.
On March 21, 2002, TPC sold approximately 231 million shares of its class A common stock in a public offering for net proceeds of $4.09 billion.
Prior to the merger, TPC’s Board of Directors approved a $500 million share repurchase program. During 2003, TPC repurchased approximately 1.1 million shares (as adjusted for the merger) of its common stock at a total cost of $40 million. That repurchase program was terminated upon completion of the merger.
On April 1, 2004, in connection with the merger, the Company assumed 23 million outstanding SPC stock options, of which approximately 4 million remained unvested related to legacy SPC equity-based compensation plans. These stock options retained the same terms and conditions that were applicable prior to the merger. Under the SPC stock option programs, stock option awards were granted having a ten year term with an exercise price equal to the fair value of the Company’s common stock on the date of grant. Generally, options vest 25% each year over a four-year period. Certain stock option awards granted under the SPC 1994 Stock Plan between February 2002 and February 3, 2003 permitted an employee exercising an option to be granted a new option (a reload option) in an amount equal to the number of shares of the Company common stock used to satisfy the exercise price due upon exercise of an option. The reload options are granted at an exercise price equal to the fair market value of the Company common stock on the date of grant, vest one year after the grant date and are exercisable for the remaining term of the related original option.
Weighted average target asset allocations at December 31, 2004 by asset category were as follows:
For those hedge relationships that are terminated, hedge designations removed, or forecasted transactions that are no longer expected to occur, the hedge accounting treatment described in the paragraphs above will no longer apply. For fair value hedges, any changes to the hedged item remain as part of the basis of the asset and
The fair value of commercial paper included in debt outstanding at December 31, 2004 approximated its book value of $499 million because of its short-term nature. For other debt, the fair value estimate was based upon the bid price at December 31, 2004 and 2003.
SPC, which is not covered by the bankruptcy court rulings or the settlements described above, has numerous defenses in all of the direct action cases asserting Common Law Claims that are pending against it. Many of these defenses have been raised in initial motions to dismiss filed by SPC and other insurers. There have been favorable rulings during 2003 and 2004 in Texas and during 2004 in Ohio on some of these motions filed by SPC and other insurers that dealt with statute of limitations and the validity of the alleged causes of actions. The plaintiffs in these actions have appealed these favorable rulings. SPC’s defenses include the fact that these novel theories have no basis in law; that they are directly at odds with the well established law pertaining to the insured/insurer relationship; that there is no generalized duty to warn as alleged by the plaintiffs; and that the applicable statute of limitations as to many of these claims has long since expired.
Financial Condition and Results of Operations-Asbestos Claims and Litigation”, “-Environmental Claims and Litigation” and “-Uncertainty Regarding Adequacy of Asbestos and Environmental Reserves.”
As part of ongoing, industry-wide investigations, the Company and its affiliates have received subpoenas and written requests for information from government agencies. The areas of inquiry addressed to the Company include its relationship with brokers and agents, the Company’s involvement with “non-traditional insurance and reinsurance products,” lawyer liability insurance and branding requirements for salvage automobiles. The Company or its affiliates have received subpoenas or written requests for information from: (i) State of California Office of the Attorney General; (ii) State of California Department of Insurance; (iii) Licensing and Market Conduct Compliance Division, Financial Services Commission of Ontario, Canada; (iv) State of Connecticut Insurance Department; (v) State of Connecticut Office of the Attorney General; (vi) State of Delaware Department of Insurance; (vii) State of Florida Department of Financial Services; (viii) State of Florida Office of Insurance Regulation; (ix) State of Florida Department of Legal Affairs Office of the Attorney General; (x) State of Illinois Department of Financial and Professional Regulation; (xi) State of Iowa Insurance Division; (xii) State of Maryland Insurance Administration; (xiii) Commonwealth of Massachusetts Office of the Attorney General; (xiv) State of Minnesota Office of the Attorney General; (xv) State of New York Office of the Attorney General; (xvi) State of New York Department of Insurance; (xvii) State of North Carolina Department of Insurance; (xviii) State of Ohio Office of the Attorney General; (xix) Commonwealth of Pennsylvania Office of the Attorney General; (xx) State of Texas Department of Insurance; (xxi) State of West Virginia Office of the Attorney General; and (xxii) the United States Securities and Exchange Commission. The Company is cooperating fully with these subpoenas and requests for information. In addition, the Company is currently undertaking its own review of the matters addressed by these subpoenas and requests for information. The Company is not able to predict the outcome of the various agencies’ investigations or the reviews being undertaken, or how these matters may affect the Company, if at all.