Investment income earned on operating funds increased by $1.3 million, or 13.5 percent, in 1994 compared to a decrease of $2.4 million, or 20 percent, in 1993. The 1994 increase is due primarily from interest income earned on the proceeds from the July issuance of preferred stock. The 1993 decrease reflected significantly lower short-term interest rates throughout most of the major world markets in comparison to 1992.
On July 1, 1994, the Company entered into a finite risk contract providing protection primarily for exposures relating to Orion, Syndicate 701 and Swann & Everett. The contract provided for a payment by the Company of $80 million ($50 million of which was borrowed from the reinsurance company) to the reinsurance company and for payment by the Company of the first $73 million of paid claims. The contract entitles the Company to recover paid claims in excess of the Company's $73 million retention. At December 31, 1994, the recoveries were limited to $108.3 million, which includes the Company's payment of $80 million. In addition, commencing December 31, 1996, depending on the timing and amount of paid loss recoveries under the contract, the Company may be entitled to receive a payment from the reinsurance company in excess of the amounts recovered for paid losses if the contract is terminated. The contract is accounted for under the deposit method of accounting and the accounting requirements for discontinued operations. The Company recorded a $6 million charge in the second
Worldwide risk management and insurance services operating expenses, excluding $40.2 million of restructuring charges, increased by $18.4 million, or 2.2 percent, in 1994 compared to a decrease of $2.6 million, or 0.3 percent in 1993. Foreign exchange rate changes, including hedging contracts gains and losses, increased expenses by $7.9 million in 1994 and reduced expenses by $37.8 million in 1993. Contributing to the 1994 increase were higher insurance costs and increased operating expenses of $13 million in the Latin America operations, primarily due to the 1993 Mexico acquisition, somewhat offset by a decline in expenses of $8.9 million for operations sold in 1993. Reductions in 1993 expenses resulting from the favorable effect of foreign exchange rates were offset by higher insurance costs, travel and entertainment expenses and systems development costs in comparison to 1992 levels.
The 1994 charges for restructuring required $6.9 million of cash payments during 1994. The Company anticipates that approximately $35.4 million of the remaining balance of $62.1 million will be funded in 1995.
The decline in cash dividend payments reflects the reduction in the Company's common stock dividend by 90 percent. The estimated annualized savings from this action is approximately $39 million. In addition, dividends on the Company's Series B Preferred Shares are payable in kind (additional preferred shares) until December 15, 1996 and thereafter, at the election by the Board of Directors, until December 15, 1999.
As described in Notes 3, 6, and 14 of Notes to Financial Statements, the Company believes its most significant litigation matters and other contingencies have been settled. In addition, as described in Note 5 of Notes to Financial Statements, during 1994, the Company was advised that the Joint Committee on Taxation had approved the agreement reached in 1993 by the Company and the Appeals Office of the IRS on settlement of tax issues with respect to the years 1980 through 1986. Also during 1994, the Company reached an agreement with the IRS on settlement of the examination of years 1987 through 1989. In February 1995 the Company paid the amounts due for the years 1980 through 1989 and charged the net tax and interest totaling $35.6 million against previously established reserves.
ALEXANDER & ALEXANDER SERVICES INC. & SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS--(CONTINUED) FOR THE YEARS ENDED DECEMBER 31, (IN MILLIONS)
NOTES TO FINANCIAL STATEMENTS (DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS)
The following table sets forth the funded status and amounts recognized in the Company's Consolidated Balance Sheets:
The weighted average interest rate on short-term borrowings was 7.0 percent and 5.2 percent at December 31, 1994 and 1993, respectively.
F. CREDIT AGREEMENT At December 31, 1994 the Company had a $150 million credit agreement with various banks which would have expired in July 1995. The agreement provided for unsecured borrowings and contained various financial covenants, including limits on minimum net worth, maximum consolidated debt, minimum interest coverage and minimum consolidated cash flow from operations. The Company had full and immediate access to the $150 million credit line and had no borrowings outstanding under this agreement at December 31, 1994. At December 31, 1994, the Company was in technical default on two financial covenants under this agreement and was granted a waiver with respect to compliance with such covenants.
The number of options exercisable at December 31 were as follows:
At December 31, 1994 and 1993, the Company had the following written interest rate option agreements outstanding, by year of final maturity:
Starting in late 1992, the purchaser of Shand has asserted a number of claims under both the Mutual Fire indemnification provision and the errors-and-omissions indemnification provision of the sales agreement. Most of those claims have been resolved by a series of settlement agreements, involving the settlement or release of (a) claims relating to reinsurance recoverables due to Shand's subsidiaries from Mutual Fire, (b) claims relating to deterioration of reserves for business written by Mutual Fire and ceded to Shand's subsidiaries, and (c) a number of errors-and-omissions claims by third-party reinsurers against Shand. Under the settlement agreement entered into in January 1995, covering the errors-and-omissions claims by third-party reinsurers, the Company obtained a release and limitation of indemnification obligations relating to certain third-party errors-and-omissions claims, and restructured the contractual relationship with the purchaser so that the parties' future interests as to third-party claims are more closely aligned. The Company will pay $14 million in cash, issue a five-year interest bearing note in the principal amount of $14 million and expects to pay a contingent obligation of $4.5 million. In the fourth quarter of 1994, the Company recorded a pre-tax charge of $32.5 million ($21.1 million after-tax, or $0.48 per share) associated with this settlement. Notwithstanding these settlements, the limitation of certain contract obligations and the restructuring of the parties' relationship, some of the Company's indemnification provisions under the 1987 agreement are still in effect. As a result, there remains the possibility of substantial exposure under the indemnification provisions of the 1987 agreement, although the Company, based on current facts and circumstances, believes the possibility of a material loss resulting from these exposures is remote.