Shareholders’ equity of $12.0 billion, up $1.8 billion from the prior year
On March 21, 2002, TPC issued 231.0 million shares of its class A common stock in an initial public offering (IPO), representing approximately 23% of TPC’s common equity. After the IPO, Citigroup beneficially owned all of the 500.0 million shares of TPC’s outstanding class B common stock, each share of which is entitled to seven votes, and 269.0 million shares of TPC’s class A common stock, each share of which is entitled to one vote, representing at the time 94% of the combined voting power of all classes of TPC’s voting securities and 77% of the equity interest in TPC. Concurrent with the IPO, TPC issued $892.5 million aggregate principal amount of 4.5% convertible junior subordinated notes which mature on April 15, 2032. The IPO and the offering of the convertible notes are collectively referred to as the offerings.
Claims and claim adjustment expenses increased $3.374 billion or 43% in 2002 primarily due to the asbestos charge taken in the fourth quarter of 2002, the full year inclusion in 2002 of Northland and Associates, and increased loss cost trends, partially offset by the $704.0 million impact in 2001 of the terrorist attack on September 11. Weather-related catastrophe losses of $84.1 million in 2002 compared to $103.3 million in 2001. Unfavorable prior year reserve development in 2002 was $3.088 billion compared to favorable prior year reserve development of $59.5 million in 2001. Asbestos-related prior year reserve development in 2002 was $2.945 billion (prior to the benefit related to recoveries under the Citigroup indemnification agreement), a $2.756 billion increase over 2001. For additional information see “ - Asbestos Claims and Litigation.”
Revenues increased $526.9 million or 6% in 2003 and $1.851 billion or 25% in 2002.
Gulf markets products to national, mid-sized and small customers and distributes them through both wholesale brokers and retail agents and brokers throughout the United States with particular emphasis on management and professional liability coverages and excess and surplus lines of insurance. Gulf net written premiums increased $83.4 million or 14% in 2003 as a result of significant rate increases across all classes of management liability products. Gulf net written premiums decreased $28.8 million in 2002 due to Gulf’s decision to exit non-core businesses, including assumed reinsurance, transportation, residual value and property, partially offset by increases in Gulf’s core specialty lines.
Policyholders with settlement agreements include structured agreements, coverage in place arrangements and Wellington accounts. 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 with approximately three dozen other insurers and PPG on key terms to settle asbestos-related coverage litigation under insurance policies issued to PPG. While there remain a number of contingencies, including the final execution of documents, court approval over possible opposition and possible appeal, the Company believes that the completion of the settlement pursuant to the terms announced in May 2002 is likely. The Company’s single payment contribution to the proposed settlement is approximately $388.8 million after reinsurance. Coverage in place arrangements represent agreements with major policyholders on specified amounts of coverage to be provided. Payment obligations may be subject to annual maximums and are only made when valid claims are presented. Wellington accounts refer to the 35 defendants that are parties to a 1985 agreement settling certain disputes concerning insurance coverage for their asbestos claims. Many of the aspects of the Wellington agreement are similar to those of coverage in place arrangements in which the parties have agreed on specific amounts of coverage and the terms under which the coverage can be accessed. During the course of 2003, the Company made final payments to three policyholders with settlement agreements. No new policyholders were added to this category during 2003.
The Company makes investments in collateralized mortgage obligations, or CMOs. 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 Company’s investment strategy is to purchase CMO tranches which offer the most favorable return given the risks involved. One significant risk evaluated is prepayment sensitivity. This drives the investment process to generally favor prepayment protected CMO tranches including planned amortization classes and last cash flow tranches. The Company does not purchase residual interests in CMOs.
On January 22, 2004, the Company’s Board of Directors declared a quarterly dividend of $0.08 per share on class A and class B common stock, payable on February 27, 2004, to shareholders of record on February 4, 2004. The declaration and payment of future dividends to holders of the Company’s common stock will be at the discretion of the Company’s Board of Directors and will depend upon many factors, including the Company’s financial condition, earnings, capital requirements of TPC’s operating subsidiaries, legal requirements, regulatory constraints and other factors as the Board of Directors deems relevant. In addition, if the merger with St. Paul is consummated, dividend decisions will be those of the Board of Directors of the combined St. Paul Travelers Companies, Inc. (St. Paul Travelers). Dividends would be paid by St. Paul Travelers only if declared by its Board of Directors out of funds legally available and subject to any other restrictions that may be applicable to St. Paul Travelers. Subject to the foregoing, it is anticipated that St. Paul Travelers will pay a regular quarterly dividend of $0.22 per share, after adjustment for the conversion of Company shares pursuant to the .4334 exchange ratio.
On September 25, 2002, the Board of Directors approved a $500.0 million share repurchase program. Purchases of class A and class B stock may be made from time to time in the open market, and it is expected that funding for the program will principally come from dividends from TPC’s operating subsidiaries. Shares repurchased are reported as treasury stock in the consolidated balance sheet. During 2003, TPC repurchased approximately 2.6 million shares of class A common stock at a total cost of $40.0 million, representing the first acquisition of shares under this program. Also during 2003, 1.8 million shares of common stock were acquired from employees as treasury stock primarily to cover payroll withholding taxes in connection with the vesting of restricted stock awards and exercises of stock options. In anticipation of the potential merger with St. Paul, the Company does not anticipate the repurchase of additional shares in 2004.
Reserves for losses and loss adjustment expenses on a statutory basis were $24.029 billion, $23.280 billion and $20.215 billion at December 31, 2003, 2002 and 2001, respectively. The $749.0 million increase from December 31, 2002 to December 31, 2003 was primarily due to business growth, and reserve strengthening at Gulf which increased reserves by $521.1 million and American Equity which increased reserves by $115.0 million, partially offset by asbestos and environmental net loss payments of $607.0 million. The $3.065 billion increase from December 31, 2001 to December 31, 2002 was primarily due to the increase in asbestos reserves of $2.584 billion during the year, partially offset by net loss payments of $521.7 million for asbestos and environmental claims.
Effective January 1, 2003, the Company adopted FASB Statement of Financial Accounting Standards No. 150 (FAS 150), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, which establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. FAS 150 requires an issuer to classify the following instruments as liabilities (or assets in some circumstances):
Automobile policies provide coverage for liability to others for both bodily injury and property damage, and for physical damage to an insured’s own vehicle from collision and various other perils. In addition, many states require policies to provide first-party personal injury protection, frequently referred to as no-fault coverage.
The Company has geographic exposure to catastrophe losses in certain areas of the country. Catastrophes can be caused by various natural and manmade events including hurricanes, windstorms, earthquakes, hail, severe winter weather, explosions and fires. 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 larger areas, especially those that are heavily populated. The Company generally seeks to reduce its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance.
In establishing environmental reserves, the Company evaluates the exposure presented by each policyholder and the anticipated cost of resolution, if any. In the course of this analysis, the Company considers the probable liability, available coverage, relevant judicial interpretations and historical value of similar exposures. In addition, the Company considers the many variables presented, such as the nature of the alleged activities of the policyholder at each site; the allegations of environmental harm 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 each 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 policyholder, including the role of any umbrella or excess insurance the Company has issued to the policyholder; the involvement of other insurers; the potential for other available coverage, including the number of years of coverage; the role, if any, of non-environmental claims or potential non-environmental claims, in any resolution process; and the applicable law in each jurisdiction. Conventional actuarial techniques are not used to estimate these reserves. Net environmental losses paid were $155.2 million, $160.6 million and $207.6 million for the years ended December 31, 2003, 2002 and 2001, respectively.
the ratio of the exercise price of the replacement award to the closing price of the Company’s class A common stock on August 20, 2002, immediately after the Citigroup Distribution, was the same as the ratio of the exercise price of the Citigroup option to the price of Citigroup common stock immediately before the Citigroup Distribution.
In addition, the Directors Plan allows deferred receipt of shares of class A common stock (deferred stock) to a future distribution date or upon termination of their service. The after-tax compensation cost associated with this plan was not significant in 2003 and 2002.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (2003 Medicare Act) was enacted. As permitted by FASB Staff Position No. FAS 106-1, the Company has chosen to defer recognition of the effects of the 2003 Medicare Act on its postretirement benefit plan. The Company does not expect that the 2003 Medicare Act will have a significant impact on the accumulated postretirement benefit obligation or net postretirement benefit expense.
Derivatives that are not designated or do not qualify as hedges are also carried at fair value with changes in value reflected in net realized investment gains (losses). The Company has certain U.S. treasury futures contracts and foreign currency forward contracts, which are not designated as hedges at December 31, 2003 and 2002.
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 are ultimately reflected as an element of the yield. For cash flow hedges, any changes in fair value of the end-user derivative remain in accumulated other changes in equity from nonowner sources, and are included in earnings of future periods when earnings are also affected by the variability of the hedged cash flow. If the hedged relationship was discontinued because a forecasted transaction will not occur when scheduled, any changes in fair value of the end-user derivative are immediately reflected in net realized investment gains (losses). During the years ended December 31, 2003 and 2002, the Company recognized no gain or loss and a gain of $4.9 million, respectively, from discontinued forecasted transactions.
The carrying value and fair value of the Company’s debt and the TIGHI debentures was as follows:
In May 2002, the Company agreed with approximately three dozen other insurers and PPG Industries, Inc. (PPG) on key terms to settle asbestos-related coverage litigation under insurance policies issued to PPG. While there remain a number of contingencies, including the final execution of documents, court approval and possible appeals, the Company believes that the completion of the settlement pursuant to the terms announced in May 2002 is likely. The Company’s single payment contribution to the proposed settlement is approximately $388.8 million after reinsurance.
In conjunction with the purchase of TIGHI’s outstanding shares in April 2000, TPC borrowed $2.2 billion pursuant to a note agreement with Citigroup. This note was prepaid during 2002 following the offerings. Interest expense included in the consolidated statement of income was $5.5 million and $79.2 million in 2002 and 2001, respectively. See note 8.
The Company purchases annuities from former affiliates to settle certain claims. Through 2004, the Company has agreed to use TIC as the most preferred provider of annuities, as long as Citigroup maintains competitive ratings and its products are competitively priced. Reinsurance recoverables at December 31, 2003 and 2002 included $760.6 million and $810.4 million, respectively, related to these annuities.