TIG's business properties include 55 lease locations, which represent approximately 671,000 square feet. TIG occupies approximately 275,000 square feet of space in Irving, Texas for which the lease expires in 2009 and may be extended by TIG for two renewal periods of five years each. All of TIG's other existing leases expire by the end of 2007.
Overview. Net income decreased by $44 million or 85% in 1998 as compared to 1997. 1998 results were impacted by a number of adjustments and expenses that totaled $120 million pre-tax or $78 million after tax. These adjustments and expenses were composed of the following: a) $48 million of pre-tax adjustments and expenses related to a program within the Custom Markets operating segment, which was placed in run-off in the third quarter of 1998. This included the recognition of a premium deficiency of $33 million (See Notes B and C to the Consolidated Financial Statements) and underwriting losses of $15 million, which reflected revised loss incurred and reinsurance benefit assumptions; b) a provision for reinsurance recoverable of $30 million; c) an increase in premium receivable allowances for TIG Re and Other Lines of $5 million and $3 million, respectively; and d) other pre-tax adjustments and expenses including severance for former employees of $15 million, Year 2000 expenditures of $8 million, and other adjustments of $11 million. 1997 results include a $145 million ($94 million after-tax) strengthening of current and prior year loss and LAE reserves by the Reinsurance operating segment (See Item 1.6 - Reserves). Excluding the 1998 adjustments and expenses and the 1997 strengthening of current and prior year loss and LAE reserves, income declined by approximately $60 million after-tax or $88 million pre-tax. The adjusted decline in 1998 pre-tax income was principally attributable to a decline in net investment income of $55 million, a $13 million increase in selling and administrative expenses (excluding items included in the adjustments and expenses described above) attributable to various system projects and other initiatives, a deterioration in investment gains and losses of $13 million and an increase in underwriting losses (excluding items included in adjustments and expenses described above) of $7 million.
Increased utilization of aggregate stop loss and other finite reinsurance coverages provided an additional underwriting benefit of approximately $21 million in 1998 as compared to 1997. The increased utilization of finite reinsurance coverages is partially in response to favorable market conditions and partially to mitigate the inherent financial volatility of a changing book of business. In addition, ceding commission income arising from the December 1997 sale of TIG's Independent Agents business benefited underwriting results by $20 million in 1998. As described below, both the sale of Independent Agents business and increased utilization of finite reinsurance has had a negative impact on investment income.
As previously mentioned, net investment income decreased $55 million in 1998 compared to 1997. Approximately $10 million of the decrease is attributable to net assets transferred in December 1997 in connection with the sale of Independent Agents business while approximately $29 million results from increased funds held interest expense resulting from additional utilization of finite reinsurance coverages. The remaining decrease in net investment income is principally attributable to declining gross market investment yields in 1998 and a repositioning of the portfolio in late 1998 in anticipation of strategic alternatives being pursued.
Net income decreased by $27 million or 34% in 1997 as compared to 1996 due primarily to the $145 million strengthening of current and prior year loss and LAE reserves by the Reinsurance operating segment as described above. Excluding the $100 million ($65 million after tax) restructuring charge recorded in 1996, net income would have decreased by $92 million in 1997 as compared to 1996. Interest expense increased by $11 million in 1997 over 1996 from the issuance of $125 million of mandatory redeemable capital securities in January 1997 (see Note H to the Consolidated Financial Statements at Item 8.). Corporate expenses increased by $7 million due primarily to expansion of corporate actuarial and underwriting staffs and system initiatives, including analysis of "Year 2000" exposures (see Item 7.10 - Year 2000).
Consideration of Strategic Alternatives. In October 1998, the Company made a public announcement that it was actively considering strategic alternatives with its investment banker, Goldman Sachs, including, among other alternatives, a sale of the Company. As a result, in December 1998, the Company signed a merger agreement with Fairfax Financial Holdings Limited ("Fairfax"), in which Fairfax will acquire TIG in a cash merger (see Note C to the Consolidated Financials Statements at Item 8).
Premium. The following table displays net premium written by operating segment:
Growth in on-going lines net premium written was 12% in 1998 and 19% in 1997 as compared to the corresponding prior year. The increase in Ongoing Lines' 1998 and 1997 net premium written is the result of TIG's marketing focus for all operating segments, particularly Commercial Specialty and Custom Markets, to develop "program" business. Programs are typically characterized as having a controlled production source, homogenous risks and a market niche. Management believes that programs, focused on specific market segments, have lower and more predictable loss costs relative to the total market, and a more variable cost structure, which will ultimately provide higher operating margins. The declines noted in Reinsurance operations are primarily attributable to competitive market conditions and TIG's unwillingness to accept underpriced risks.
Reserve strengthening for current and prior accident years recorded in 1997 for Reinsurance and in 1996 for Other Lines (see Item 1.6 - Reserves) increased both the loss and LAE ratio and combined ratio by 9.9 percentage points and 2.0 percentage points for 1997 and 1996, respectively, leading to the comparative decline in 1998. Favorable loss experience in Commercial Specialty and Custom Markets partially offset the TIG Re reserve strengthening in 1997. Increases in the commission ratio for 1998 and 1997 reflect a shift in business mix toward specialty programs produced by GAs. The 1998 and 1997 operating expense ratio increases are primarily due to start up costs incurred for new programs in each of the operating segments (see Items 7.2 - Reinsurance, 7.3 - Commercial Specialty and 7.4 - Custom Markets).
Restructuring Charges. In February 1996, TIG announced the reorganization of its commercial operations and plans to exit certain lines of business that failed to meet profitability standards. As a result of this reorganization, TIG took the following actions: 1) combined its Specialty Commercial and Workers' Compensation divisions to form a new operating segment called Commercial Specialty, 2) consolidated field offices, 3) identified lines of business for non-renewal or cancellation for which 1995 net premium written was approximately $190 million, 4) formed a run-off division (called "Other Lines") to administer contractually required policy renewals for run-off lines of business, and 5) outsourced to third party service providers or otherwise terminated the responsibilities of approximately 600 employees. TIG recorded a $100 million accrual in the first quarter of 1996 for estimated restructuring charges. The remaining reserve at December 31, 1998, is $3 million (see Note B to the Consolidated Financial Statements at Item 8 for further discussion).
Change in gross premium written was (8%) in 1998 and 3% in 1997 in comparison to the corresponding prior year. Competitive market conditions continued to intensify in 1997, especially in TIG Re"s core Specialty Casualty market. Re-underwriting initiatives instituted by TIG Re in response to soft market conditions and re-evaluations of current treaty profitability resulted in non-renewal or reduced participation in three significant Specialty Casualty programs.
New business comprised $109 million, $190 million and $135 million of net premium written in 1998, 1997 and 1996, respectively. The majority of new business is attributable to production in marketing segments established during the past several years such as the London Branch, Lloyd's Syndicate 1218, Facultative and Latin America. However, management believes that competitive market conditions will continue and that TIG Re's gross premium written may be lower in 1999 than 1998. During the first quarter of 1999, the Facultative business unit was sold to Gerling Global Reinsurance Corporation of America.
During 1998, TIG Re commuted various assumed and ceded treaties, including one with TIG Insurance, the effect of which was an increase to net loss and LAE incurred of $5 million. In addition, a favorable arbitration award and the benefit from an unplanned novation transaction reduced the 1998 incurred loss and LAE; the combined effect of theses two transactions was a benefit to net loss and LAE incurred of $5 million. The increase in other underwriting expense is partially attributable to an increase in the allowance for uncollectible premiums of $5 million, recorded during the third quarter of 1998. In addition, start-up and expansion costs of $4 million related to the London Branch, Syndicate 1218 and the Latin American initiatives are included in other underwriting expenses.
Premium. Commercial Specialty provides specialized insurance products through six main business units: Workers' Compensation, Sports & Leisure, Primary Casualty, Lloyd's Syndicates, Excess Casualty and Special Risk Operations. Most Commercial Specialty units are based in Irving, Texas. TIG's marketing strategy and distribution systems are described at Item 1.3 - Commercial Specialty. The table below shows the distribution of Commercial Specialty net premium written by business unit:
Commercial Specialty net premium written increased 26% in 1998 compared to 1997. This increase is primarily attributable to Workers' Compensation and Lloyd's Syndicates. The increase in Workers' Compensation is attributable to TIG entering into a strategic relationship in the third quarter of 1997 with a general agent that writes program business and also provides loss management services. This relationship contributed $97 million in net premium written in 1998 compared to $87 million in 1997. Also contributing to the increase in Workers' Compensation is an increase in the commission rate paid to producers in specific programs. The increased production in Lloyd's Syndicates is primarily due to increased participation in the capacity of the syndicates from approximately 18% in 1997 to 41% in 1998.
Commercial Specialty's underwriting results improved $7 million in 1997 compared to 1996. The improvement is primarily derived from favorable prior year loss reserve development in Workers' Compensation as discussed at Item 1.6 - Reserves. Also contributing to the improvement are generally improving loss trends in Workers' Compensation, including favorable involuntary results, as more states enacted workers' compensation reforms. Partially offsetting the favorable loss reserve development and loss trends is an increase in other underwriting expenses as a result of additional staff costs related to the startup of various Commercial Specialty programs.
Custom Markets net premium written increased by 51% in 1998 and 87% in 1997 as compared to the corresponding prior year. The increased production noted in Alternative Distribution, which includes the MBNA lines discussed in Item 1.4 - Custom Markets, is due to this unit having been formed in late 1996 with limited production in 1997. The increase noted in Non-standard Automobile is principally due to new general agent relationships in California and Texas.
Underwriting Results. The following table summarizes underwriting results for Custom Markets operations:
Custom Markets underwriting losses increased by $51 million in 1998 compared to 1997. This deterioration is principally due to $48 million of pre-tax adjustments and expenses related to the placement of the MBNA program in run-off in the third quarter of 1998. These adjustments and expenses included the recognition of a premium deficiency of $33 million (See Notes B and C to the Consolidated Financial Statements at Item 8), and underwriting losses of $15 million, which incorporated revised loss and reinsurance benefit assumptions. The premium deficiency adjustment was based on an analysis by management that estimated future earned premium from existing Custom Markets business and mandatory renewals related to the MBNA program. The estimate of future earned premium and related losses incorporated management's expectations that all filings relating to corrective pricing actions initiated in 1998 will be completed by April 1999. Should management's estimates of future earned premium and losses vary from actual results, future operating results could be impacted either positively or negatively by the MBNA program.
Underwriting Results. Other Lines underwriting gain of $18 million in 1998 compares to an underwriting gain in 1997 of $8 million. The results for 1998 include the following adjustments and expenses: $30 million in reinsurance recoverable allowances and write-offs; $10 million in additional losses to strengthen reserves for prior accident years; $3 million in premium receivable allowances; $3 million for the write-off of certain capitalized software; and a reduction in losses incurred of $34 million as a result of the commutation of a reinsurance treaty with TIG Re (see Item 7.2 - Reinsurance). In addition, 1998 results include $20 million in ceding commissions related to the sale of the Independent Agents unit and $29 million in net benefit from aggregate stop loss reinsurance. The results for 1997 include the following: $40 million in losses assumed from TIG Re as discussed at Item 1.6 - Reserves; $18 million in reserve releases relating to prior accident years; $37 million in net benefit from aggregate stop loss reinsurance; a $19 million underwriting gain in the Independent Agents unit; and an increase in losses incurred of $13 million as a result of the commutation of a reinsurance treaty.
Other Lines 1996 underwriting loss of $52 million includes the following: $31 million in loss and LAE reserve strengthening; $9 million in net benefit from aggregate stop loss reinsurance; and a $15 million underwriting loss in the Independent Agents unit. Excluding the reserve adjustments, Independent Agents underwriting results and net benefit from aggregate stop loss reinsurance from the results of both 1997 and 1996, and the commutation of a reinsurance treaty in 1997, Other Lines underwriting loss of $13 million in 1997 compares to an underwriting loss of $15 million in 1996. The improvement in results is primarily attributable to the general decline in underwriting expenses resulting from the overall decline noted in premium written and the elimination of overhead costs.
Both TIG Insurance and TIG Re work in concert in establishing reinsurance security standards to mitigate the credit exposure arising from potentially uncollectible reinsurance. The financial acceptability of these exposures is monitored vigorously and the Company removed a number of reinsurers from its approved list during 1998. Additionally, TIG Insurance implemented a Dispute Resolution Committee during 1998 to address any reinsurance recoverables, which are disputed due to coverage or interpretation issues. Reinsurance contract terms are reviewed annually and renegotiated in the interim if required to remain in compliance with program needs. Continuity in reinsurance relationships is a high priority for TIG. Reinsurers are subject to licensing and regulation in the jurisdictions in which they conduct business. Countries outside of the United States have varying levels of regulation of insurance and reinsurance companies. Many states allow financial statement credit for reinsurance ceded to a reinsurer that is licensed in another state or foreign jurisdiction, provided such reinsurance meets certain financial requirements or the insurer is provided with collateral (usually in the form of a letter of credit) to secure the reinsurer's obligations. To maintain its ability to receive financial statement credit, TIG typically requires its reinsurers to be licensed in the ceding insurer's state of domicile or to submit collateral in a form and in an amount sufficient to secure the reinsurer's obligations to TIG. Reinsurance does not legally discharge an insurer from its primary liability for the full amount of the policies it writes. If a reinsurer fails to meet its obligations under the reinsurance agreement, the ceding company is required to pay the loss. At December 31, 1998 and 1997, TIG had an allowance of $33 million and $9 million, respectively for potentially unrecoverable reinsurance.
1) The ratings are taken from the Best's Key Rating Guide, 1998 Edition. 2) No independent A.M. Best rating has been assigned due to the sale of this company on December 31, 1997 to Nationwide Mutual Insurance Company.
Catastrophe Reinsurance. TIG is exposed to multiple insured losses arising out of a single occurrence, such as a natural or man-made catastrophe. Such an event may generate insured losses in any or all of TIG's operating segments. TIG's exposure to catastrophe losses arises principally from hurricane, windstorm, earthquake, fire and explosion. TIG Insurance manages its exposure to such losses from an underwriting perspective by limiting the accumulation of known risks in exposed areas, and from per risk and operating segment specific catastrophe reinsurance. Additionally, TIG utilizes the RMS Inc. IRAS model to monitor its exposure to various loss scenarios and gross and net probable maximum losses ("PML"). Initiatives are underway to expand the utilization of this analytical tool within TIG's underwriting operations.
No major catastrophe losses were incurred by TIG in 1998, 1997 or 1996. As with all property/casualty insurers, TIG expects to pay some losses related to catastrophes and prices its products accordingly. Total gross catastrophe losses aggregated $13 million, $5 million and $15 million in 1998, 1997 and 1996, respectively. Total net catastrophe costs, including reinsurance reinstatement premium, aggregated $1 million, $5 million and $11 million in 1998, 1997 and 1996, respectively.
TIG has consistently maintained aggregate stop loss protection in various forms since 1994. Coverages provide benefit of 70% to 100% of losses in excess of the attachment point. Premium cessions are generally made on a funds withheld basis. Funds withheld balances generally bear interest at rates of 6.75% to 8.50% (see Item 7.7 - Investments). At December 31, 1998 and 1997, funds withheld balances related to aggregate stop loss reinsurance contracts were $361 million and $264 million, respectively, while related reinsurance recoverable balances were $658 million and $466 million, respectively.
Other Transactions. During 1998, in response to favorable market conditions for obtaining reinsurance coverage and to mitigate the inherent financial volatility of a changing book of business, TIG increased the utilization of aggregate stop loss and other finite reinsurance coverages by entering into several new contracts with reinsurance providers. In addition to the loss portfolio reinsurance agreement mentioned above, the Company also purchased finite reinsurance for workers' compensation programs that allows TIG to stay competitive with other insurers whose state of domicile allow discounting of workers' compensation loss reserves. The Company also purchased finite reinsurance to provide aggregate stop loss coverage for all lines. The pre-tax net benefit provided by these contracts, including additional interest costs on withheld funds, was $36 million for 1998.
In response to favorable pricing conditions and to mitigate volatility in the Company's exposure to losses in new workers' compensation lines, TIG Insurance utilized reinsurance to reduce its net retention on most of its workers' compensation lines from $1 million to $100 thousand during 1998.
In 1998, TIG reduced its investment in high yield and mortgage-backed securities in favor of U.S. Treasuries and short-term investments. As a result, the book yield of the portfolio decreased to 7.0% for the year ended December 31, 1998 from 7.4% for the year ended December 31, 1997. Invested assets declined by $298 million at December 31, 1998, as compared to December 31, 1997 (see Item 7.8 - Liquidity and Capital Resources and Item 7.1 - Consolidated Results).
Investment Life and Duration. TIG's objective is to maintain the weighted average life of its investment portfolio between 8 and 12 years and the weighted-average duration between 4 and 7 years. At December 31, 1998, the weighted average life of TIG's investment portfolio was 12.0 years compared to 10.7 years at December 31, 1997. At December 31, 1998, the weighted average duration of TIG's investment portfolio was 6.8 years compared to 5.4 years at December 31, 1997.
Investment Income. The following table displays the components of TIG's investment income and mean after-tax investment yields. The yields include interest earned and dividends received and exclude realized investment gains and losses. These yields are computed using the average of the month-end asset balances during the period.
TIG minimizes the credit risk of its fixed maturity portfolio by investing primarily in investment grade securities; however, management has authorized the purchase of high yield, less than investment grade securities up to statutory limitations. The Company's high yield portfolio is comprised of bonds whose issuers are subjected to rigorous credit analysis, including tests of prospective profitability, liquidity, leverage, and interest coverage. This analysis is updated regularly as financial results are released, and bonds are constantly evaluated for their value. During the last half of 1998, Management significantly reduced the Company's investment in securities that are below investment grade in anticipation of the implementation of the strategic alternatives discussed in Note C to the Consolidated Financial Statements at Item 8. The funds obtained from the disposition of these securities were re-invested in higher quality, lower risk and lower yield securities.
Liquidity is a measure of an entity's ability to secure enough cash to meet its contractual obligations and operating needs. TIG requires cash primarily to pay policyholders' claims, operating expenses, policyholder dividends, and interest expense. Generally, premium is collected months or years before claims are paid under the policies purchased by the premium. These funds are used first to pay current claims and expenses. The balance is invested in securities to augment the investment income generated by the existing portfolio. Historically, TIG has had, and expects to continue to have, more than sufficient funds to pay claims, operating expenses, policyholder dividends, and interest expense.
Cash Flow From Operating Activities. The following table summarizes the significant components of cash flow from operations:
The reduction in Reinsurance operations cash flow in both 1998 and 1997 is primarily attributable to slowing premium production as a result of soft market conditions, the non-renewal or reduced participation on several large accounts, and an increase in paid losses. The increase in paid losses is due to a shift in business mix to lines with relatively shorter loss payout patterns and increased paid loss trends on accounts that have subsequently been non-renewed or participations reduced. In addition, the commutation of a reinsurance treaty with a third party increased paid losses for 1998 by $83 million, while the commutation of a reinsurance treaty between TIG Re and TIG Insurance decreased paid loss in 1998 by $36 million (see Item 7.2 - Reinsurance).
Investment Liquidity. At December 31, 1998, TIG had $224 million in short-term investments compared to $308 million at December 31, 1997. In addition, as of December 31, 1998, TIG expects to realize $585 million, $440 million, and $304 million in cash flow from principal and interest payments over the next three years, respectively, from its investment portfolio. TIG has structured its investment portfolio to manage the impact of market interest rate fluctuations on liquidity. Investments and cash held at the holding company totaled $75 million as of December 31, 1998.
In December 1995, TIG Insurance Company entered into a five-year $50 million credit facility of which approximately $27 million and $24 million was outstanding as of December 31, 1998 and 1997, respectively. The facility is a direct financing arrangement with a third party related to the sale and leaseback of certain fixed assets. Interest of $1.6 million, $1.6 million and $1.4 million was paid on this facility in 1998, 1997 and 1996, respectively.
In addition, TIG Holdings had $98 million of 8.125% notes payable maturing in 2005 outstanding at December 31, 1998 and 1997. Interest of $8 million was paid in 1998, 1997 and 1996 on these notes.
In January 1997, TIG Capital Trust I, a statutory business trust created under Delaware law as a trust subsidiary of TIG Holdings, completed a private offering of $125 million of 8.597% mandatory redeemable capital securities. TIG Holdings issued $128.75 million in 8.597% Junior Subordinated Debentures to TIG Capital Trust I (including approximately $3.75 million with respect to the capital contributed to the Trust by TIG Holdings). All of the net proceeds received by TIG Holdings from the issuance of the debentures are being used for general corporate purposes which includes repurchases of TIG Holding's common stock. Interest of $10.7 million and $4.9 million was paid on the debentures in 1998 and 1997, respectively.
Ratings. Both TIG Insurance (including subsidiaries which cede 100% of net premium written to TIG Insurance) and TIG Re are rated "A" ("Excellent") by Best. Best's ratings are based on an analysis of the financial condition and operating performance of an insurance company as they relate to the industry in general. However, TIG Re's "A" rating is under review, reflecting potential business disruption created by market uncertainties during the upcoming renewal season. The review status is "developing", reflecting the favorable near-term implications of a committed owner with significant financial flexability in Fairfax (see Note C to the Consolidated Financial Statements at Item 8). The continuation of the "A" ratings is contingent upon the timely completion of the merger with Fairfax. A delay, non-closure or material change in the terms of the transaction as announced would cause A.M. Best to revisit the rating. An "A" rating is Best's third highest of 15 rating classifications.
The Company's notes payable are rated "Baa2" and the mandatory redeemable capital securities are rated "Ba1" by Moody's Investor Services, Inc.
Specific information technology systems that are utilized by TIG, and by third parties with whom TIG has business relationships, include policy, claim and reinsurance processing and administration, accounting, payroll, financial reporting, product development, rate and form development and maintenance, business planning, tax, accounts receivable, accounts payable and numerous word processing and spreadsheet programs. In addition, TIG and third parties with which TIG has a business relationship are dependent on many non-information technology based systems, such as utility, communication and security systems.
The Cost to Address TIG's Year 2000 Issues. TIG budgeted a total of $10 million for costs related to Year 2000 system modifications. As of year end 1998, $9.5 million has been expensed in the year incurred. The remainder (approximately $500 thousand) will be expensed in 1999. The 1999 amount represents less than 1.5% of the annual TIG Information Systems budget. These costs primarily represent costs to assess, remediate code, and test such code changes.
Although the Company has taken the actions described above to address the Year 2000 problem, a most reasonable likely worst case scenario indicates that there is always a possibility that the Company may suffer some disruptions as a result of the Year 2000 problem.
* changes in the frequency and severity of catastrophes which could impact net income, reinsurance costs and cash flow
* changes in estimated overall adequacy of loss and LAE reserves which could impact net income, statutory surplus adequacy and management's decision to continue certain product lines
* inability of the Company or third parties with whom the Company has material relations to address Year 2000 issues on a timely basis
* change in strategic business plans due to sale, restructure or recapitalization of the Company
Aggregate Stop Loss Reinsurance: A form of reinsurance that generally provides protection on all business or a specified portion of business for losses and LAE incurred in excess of a specified loss retention ratio. This form of reinsurance is often used as "umbrella" protection that is utilized after all other specific reinsurance coverages have been exhausted.
Catastrophe reinsurance: A form of excess of loss property reinsurance which, subject to a specified limit, indemnifies the ceding company for the aggregate amount of losses in excess of a specified retention for losses resulting from a particular catastrophic event. The actual reinsurance document is called a "catastrophe cover."
Ceded reinsurance; Ceding company: When a company reinsures its risk with another, it "cedes" business and is referred to as the "ceding company."
Direct premium written: Premium for insurance written on a company's policy forms during a given period.
Facultative reinsurance: The reinsurance of all or a portion of the insurance coverage provided by a single policy. Each policy reinsured is separately negotiated.
General Agent: A licensed property/casualty broker/agent who under the terms of a written contract with an insurer manages the transaction of one or more classes of insurance written by the insurer and generally has the power to 1) appoint, supervise, and terminate local agents, 2) accept or decline risks and 3) collect premium moneys from producing broker/agents or from the insured.
Incurred losses: The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses include a provision for claims that have occurred but have not yet been reported to the insurer.
Independent Agent: A licensed property/casualty agent who usually represents two or more insurance companies in a sales and service capacity typically for personal lines homeowners and automobile coverages and is paid on a commission basis.
Loss adjustment expenses ("LAE"): The expenses of settling claims, including legal and other fees, and the portion of general expenses allocated to claim settlement costs.
Loss and LAE ratio: The ratio of incurred losses and LAE to earned premium, determined in accordance with statutory accounting practices.
Net premium earned: The portion of net premium written in a particular period that is recognized for accounting purposes as income during that period.
Property insurance: Insurance that provides coverage to a person with an insurable interest in tangible property for that person's property loss, damage or loss of use.
Reinstatement premium: The premium charged for the restoration of the reinsurance limit of a catastrophe treaty to its full amount after payment by the reinsurer of losses as a result of an occurrence.
Reserve strengthening: The building or enhancement of loss reserves to an actuarially determined level considered adequate to cover all future claims for policies in force, generally for a specific accident year or line of business.
Statutory accounting practices ("SAP"): Rules and procedures prescribed or permitted by state insurance regulatory authorities for recording transactions and preparing financial statements. Statutory accounting principles generally reflect a liquidating, rather than a going concern, concept of accounting.
Template underwriting: A process by which homogeneous business can be underwritten using standardized guidelines.
Treaty reinsurance: The reinsurance of a specified type or category of risks defined in a reinsurance agreement (a "treaty") between a primary insurer or other reinsured and reinsurers. Typically, in treaty reinsurance, the primary insurer or reinsured is obligated to offer and the reinsurer is obligated to accept a specified portion of all such type or category of risks originally underwritten by the primary insurer or reinsured.
Unallocated loss adjustment expenses ("ULAE"): The expenses incurred in connection with investigation and adjustment of claims that cannot be directly allocated to any specific claims.
Underwriting: The insurer's process of reviewing applications submitted for insurance coverage, deciding whether to accept all or part of the coverage requested and determining the applicable premium.
Underwriting results: The measure of profitability of the insurance operations of an insurer, calculated as the result of earned premium, less losses, loss expenses, and underwriting expenses. Underwriting results is an indicator of a company's underwriting success.
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 1998.....................................................60
Consolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended December 31, 1998 ....................................................61
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of TIG Holdings, Inc. and subsidiaries at December 31, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Reinsurance. TIG's reinsurance operations are conducted through TIG Reinsurance Company ("TIG Re"). Reinsurance is a form of insurance whereby the reinsurer (i.e., TIG Re) agrees to indemnify another insurance company (the "ceding company") for all or a portion of the insurance risks underwritten by the ceding company under an insurance policy or policies. TIG Re writes both pro-rata and excess of loss coverages. TIG Re provides pro-rata coverages when the ceding company's underwriting capabilities are considered superior and where the relationship with the ceding company provides an opportunity for long-term profitability. TIG Re's primary strategy for excess of loss treaties is to take large participations in working layers of a limited number of programs. By assuming a significant participation in each treaty, TIG Re exercises significant control over the terms and structure of each treaty. TIG Re's predominant source of business is through reinsurance intermediaries. Net premium written for the Reinsurance operating segment comprised 29%, 36% and 36% of consolidated net premium written for the years ended December 31, 1998, 1997 and 1996, respectively.
Financial statements prepared in accordance with GAAP require management to make estimates and assumptions that affect amounts reported in the financial statements and accompanying notes. Such estimates and assumptions could change in the future as more information becomes available, which could impact the amounts reported and disclosed herein.
Investments. Fixed maturity investments are classified as available for sale, as TIG has no positive intent to hold such securities until maturity, and are carried at market value. Equity securities and other long-term investments are also carried at market value while short-term investments are carried at cost, which approximates market value. Market value is based principally upon quoted market prices. Quoted market prices are available for substantially all fixed maturity investments and equity securities. The difference between the aggregate market value and amortized cost of securities, after deferred income tax effect, is reported in accumulated other comprehensive income as unrealized gain or loss and, accordingly, has no effect on net income (see Note D - Investments).
Deferred Policy Acquisition Costs. Acquisition costs that vary with and are primarily related to the production of new business consist principally of commissions, premium taxes, and other expenses incurred at policy issuance and renewal. The costs are generally deferred and amortized ratably over the terms of the underlying policies. Anticipated losses, loss expenses, and remaining costs of servicing the policies are considered in determining the amount of costs to be deferred. Anticipated investment income is considered in determining whether a premium deficiency exists. Amortization of deferred policy acquisition costs totaled $425 million, $391 million and $347 million for the years ended December 31, 1998, 1997 and 1996, respectively.
Participating Insurance Business. Dividends to policyholders, which relate primarily to workers' compensation policies, are accrued during the period in which the related premium is earned. Approximately 7%, 7% and 4% in 1998, 1997 and 1996, respectively, of TIG's total gross written premium was subject to participation in such dividends.
Other Assets. Property, leasehold improvements and furniture and equipment with a cost of $44 million and $40 million at December 31, 1998 and 1997, respectively, are included in other assets. These balances are carried at cost less accumulated depreciation of $31 million and $24 million at December 31, 1998 and 1997, respectively. Depreciation is computed under the straight-line method over the estimated useful lives of the assets over periods ranging from three to ten years. Depreciation expense, including amortization of assets under capital lease, totaled $9 million in 1998, 1997 and 1996. Goodwill and other intangible assets with a cost of $21 million are also included in other assets net of accumulated amortization of $4 million and $3 million at December 31, 1998 and 1997, respectively. These balances are amortized on a straight-line basis over periods ranging from 10 to 20 years. Amortization expense totaled $1.4 million, $0.6 million and $0.5 million in 1998, 1997 and 1996, respectively. TIG's accounting policy governing the measurement of goodwill impairment includes an annual analysis of the recoverability of goodwill as of each balance sheet date.
Guaranty Funds and Similar Assessments. TIG is assessed amounts by state guaranty funds to cover losses of policyholders of insolvent or rehabilitated insurance companies, by state insurance oversight agencies to cover the operating expenses of such agencies and by other similar legislated entities. These mandatory assessments may be partially recovered through a reduction in future premium taxes in certain states. The Company currently expenses these assessments as they are levied. Effective January 1, 1999, the Company will be required to adopt the provisions of AICPA Statement of Position 97-3 ("SOP 97-3"), under which these assessments are required to be accrued in the period in which they have been incurred. The effects of initially adopting SOP 97-3 will be recorded as the cumulative effect of a change in accounting principle. TIG has not determined the impact that the adoption of SOP 97-3 will have on its financial condition or results of operations.
Premium Deficiencies Recognition. In third quarter 1998, a contract dispute arose between the Company and MBNA America Bank, N.A., the producer of an automobile insurance program within the Custom Markets division ("the MBNA program"). The dispute related to certain underwriting and pricing changes made by TIG to produce contractually guaranteed rates of return. In September 1998, the MBNA program was terminated. The producer elected under the termination provisions of the agency contract to require TIG to provide a renewal market through September 1, 1999. As a result, TIG recognized a premium deficiency of $33 million in third quarter 1998 related to future earned premium from existing Custom Markets business and mandatory renewals through September 1, 1999, for the MBNA program. The premium deficiency was recorded in TIG's third quarter 1998 income statement by expensing all Custom Markets deferred policy acquisition costs, which totaled $19 million, and establishing additional loss reserves of $14 million. At December 31, 1998, $7 million of this additional loss reserve remained. Net premium written for the MBNA program was $88 million and $30 million for the years ended December 31, 1998 and 1997, respectively.
Closing of Offices. During 1998, the Company decided to close its executive offices in New York City, consolidating corporate functions with its corporate headquarters in Irving, Texas. In addition, the Company decided to close its staff counsel offices located throughout the United States and outsource the supervision of claims litigation previously performed by these offices. In conjunction with these closings, accruals for lease obligations and severance and related costs totaling $15 million were recorded as Corporate Expense in 1998.
TIG routinely enters into commitments to purchase securities on a "To Be Announced" ("TBA") basis for which the interest rate risk remains with TIG until the date of delivery and payment. Delivery and payment of securities purchased on a TBA basis can take place a month or more after the date of the transaction. These securities are subject to market fluctuations during this period and it is the Company's policy to recognize any gains or losses only when they are realized. TIG maintains cash and short-term investments with a fair value exceeding the amount of its TBA purchase commitments. At December 31, 1998, there were no TBA purchase commitments, compared to TBA commitments of $24 million with a fair value of $26 million at December 31, 1997.
In 1997, TIG recognized unfavorable prior year loss and LAE reserve development of $75 million, of which unfavorable development of $106 million was attributable to TIG Re reserve strengthening and favorable development of $31 million was attributable to TIG Insurance. The reserve strengthening by TIG Re in December 1997 was based on actuarial evaluations of loss data through September 30, 1997, which incorporated enhancements to TIG Re's actuarial process and previously unavailable data. This intensive actuarial review indicated that reserving issues were concentrated in a limited number of large proportional programs, the majority of which were restructured or non-renewed effective January 1, 1997. TIG Re also increased 1997 accident year reserves by $39 million as a result of the September 30, 1997 actuarial study. The total $145 million reserve increase recorded by TIG Re in December 1997 was net of corporate aggregate stop loss reinsurance coverage, including $40 million under a 1995 intercompany agreement with TIG Insurance. The favorable prior year loss reserve development of $31 million for primary lines written by TIG Insurance was principally attributable to continuing favorable workers' compensation development. The majority of this favorable development was reallocated to the 1997 accident year for workers' compensation and various other lines for statutory reporting purposes. The assumption by TIG Insurance in Other Lines of $40 million in losses under the aforementioned intercompany reinsurance agreement was principally offset by a $27 million cession to a corporate aggregate stop loss reinsurance treaty.
The unfavorable loss and LAE reserve development for prior years in 1996 of $16 million is due primarily to adverse development in Other Lines. In connection with the February 1996 restructuring, TIG completed a re-evaluation of loss and LAE reserves related to run-off lines using additional loss development data received during the first quarter of 1996. This data confirmed adverse loss development trends observed in the second half of 1995 and was a consideration in the decision to exit certain lines of business, as discussed at Note B - Summary of Significant Accounting Policies. As a result of this re-evaluation and management's belief that the restructuring decision will make the claims settlement process less consistent and more volatile, TIG increased loss and LAE reserves by $31 million in the first quarter of 1996 for run-off lines, principally for long haul trucking and large accounts. This reserve strengthening was partially offset by continuing favorable development of 1993 and prior years' workers' compensation reserves.
Effective January 1, 1998, the Company entered into a loss portfolio reinsurance agreement on a funds held basis for loss and LAE reserves of $265 million related to certain run-off programs. The gain of $22 million was deferred and will be amortized into income as losses are paid. Amortization of the deferred gain of $8 million was recorded as a reduction of incurred losses in 1998. The contract covers 80% of any adverse loss development incurred in excess of $280 million up to a maximum of $343 million. Any additional future benefit from the contract triggered by adverse loss development will also be deferred and amortized into income as the related losses are paid. Funds held bear interest at 1.7% per quarter beginning April 1, 1998. Related interest on funds held of $10 million was recorded as a reduction of net investment income in 1998.
Under this reinsurance arrangement, the reinsurer has the right to convert the treaty to a funds transferred basis from a funds held basis if the S&P rating for TIG falls below A+. As a result of this provision, and the downgrading of TIG's rating to below A+, effective January 1, 1999, TIG Insurance established a trust agreement of $177 million with Norwest Bank for the benefit of the reinsurer, in lieu of funds transferred.
During 1998, the Company commuted certain reinsurance treaties, including one between TIG Insurance and TIG Re, as well as others with third parties, that generated a net benefit for TIG Insurance of $34 million and a net benefit for TIG Re of $2 million.
TIG files a consolidated federal income tax return. At December 31, 1998, TIG had a net operating loss carryover of $261 million, of which $34 million will expire in 2008, $96 million will expire in 2009, $6 million will expire in 2011, $110 million will expire in 2012, and $15 million will expire in 2013. Additionally, TIG has a $1 million capital loss carryover, which will expire in 2003. For the tax years ended December 31, 1998, 1997 and 1996, TIG made tax payments of $1 million, $40 million (related to the $40 million advance payment discussed below), and $1 million, respectively.
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of TIG's deferred tax assets and liabilities as of December 31, 1998 and 1997 are shown in the following table:
In accordance with the provisions of Statement of Financial Accounting Standard No. 109, "Accounting for Income Taxes", TIG's management has reviewed its deferred tax asset balance and concluded that it is more likely than not the entire deferred tax asset will be realized. Management's conclusion is based on its expectation that sufficient taxable income will be generated in future periods within the carryforward period. TIG has reported profits in 1997, 1996, 1995 and 1994, and is expected to be profitable in the future. If TIG does not achieve its anticipated earnings level in future periods but maintains the earnings level sustained over the past four years and converts all of its tax-exempt securities into taxable securities, it anticipates that all of its net operating loss and 90% of its existing deferred tax asset will be utilized by the year 2002.
The components of benefit (expense) for total deferred income taxes are as follows:
TIG's Federal income tax returns are routinely audited by the Internal Revenue Service (IRS) and provisions are made in the financial statements in anticipation of the results of these audits. Following a routine federal income tax audit by the IRS, in September 1997, the IRS issued a Statutory Notice of Deficiency for the tax year 1993 and a Revenue Agents Report for 1994 asserting a tax liability of approximately $170 million excluding interest. The IRS's asserted tax adjustments principally relate to the acquisition made by TIG under the Section 338(h)(10) election of April 27, 1993 in conjunction with TIG's IPO and primarily generate temporary differences by creating income in 1993 with corresponding deductions in 1993 and future tax years. TIG strongly disagrees with the IRS's position and, on December 11, 1997, TIG filed a Tax Court Petition challenging it. In connection with the Statutory Notice of Deficiency issued by the IRS for the 1993 tax year, TIG made a $40 million advance tax payment in December 1997 that has been reflected as a current tax asset. While the timing of cash tax payments may be impacted, management believes that revisions to TIG's recorded tax liability, if any, arising from the IRS audit will not materially impact consolidated net income or financial condition.
In March 1996, TIG entered into settlement agreements with the IRS on several outstanding audit assessments, resulting in a redetermination of certain tax liabilities related to tax years prior to TIG's initial public offering in April 1993. A $20 million deferred tax benefit was recognized in first quarter of 1996 as a result of the redetermination.
Notes Payable. In April 1995, TIG Holdings issued $100 million of 8.125% Notes maturing in 2005. Interest is payable on a semi-annual basis, and a lump sum principal repayment for the non-callable notes is due April 15, 2005. Included in the restrictive covenants are limitations on the disposition of the stock of TIG Insurance Company ("TIC"), limitations on liens and conditions on the merger of the Company. If the merger of the Company with Fairfax is consummated, management expects these conditions will be met. Interest expensed and paid was $8 million in 1998, 1997 and 1996. These Notes are the senior debt of the Company and have liquidation preference over other debt.
Line of Credit. In December 1995 (as amended and restated in 1997), TIG established an unsecured revolving line of credit with maximum borrowings of $250 million. Included in the restrictive covenants are limitations on the disposition of significant subsidiaries of TIG, limitations on liens and limitations on the merger of the Company. The merger of the Company with Fairfax (see Note C - Significant Transactions and Events) would create an "event of default", and as such, the Company intends to terminate the facility prior to completion of the sale. During the first quarter of 1998, TIG borrowed $70 million against this facility. The full amount of the five-year credit facility was available for general corporate purposes as of December 31, 1998. Interest of $2.5 million was expensed and paid in 1998. The interest rate on the facility is determined at the time of each individual borrowing and is based upon a senior debt ratings grid, currently either LIBOR plus 30 basis points, Prime or CD rate plus 42.5 basis points. For utilization greater than 50%, the LIBOR and CD rates increase by 5 basis points.
Class A Common Stock. In April 1993, TIG Holdings issued 224,600 shares of Class A common stock of which 81,191 had been canceled as of April 1996. In accordance with the terms of their issuance, the remaining 143,409 Class A common shares were converted to common shares in 1996 (see Note K - Incentive Compensation Plans). As of December 31, 1998, no shares of Class A common stock are outstanding.
Subsidiary Dividend Restrictions. Payment of dividends to TIG Holdings by its insurance subsidiaries is subject to certain restrictions. State insurance laws limit the amount that may be paid without prior notice or approval by insurance regulatory authorities. As of December 31, 1998, $96 million of dividends are currently available for payment to TIG Holdings from its insurance subsidiaries during 1999 without restriction. Cash dividends paid by the insurance subsidiaries in 1998, 1997 and 1996 were $175 million, $145 million and $130 million, respectively.
As of December 31, 1998, the Company has three stock based compensation plans, which are described below. The Company adopted Statement 123 effective January 1, 1996 and has elected to continue to account for employee stock-based compensation as prescribed by APB Opinion No. 25 (See Note B - Summary of Significant Accounting Policies). If the merger of the Company with Fairfax is consummated (see Note C - Significant Transactions and Events), participants will become fully vested, cash distributions will be made and these plans will terminate.
The 1993 Long-Term Incentive Plan. The 1993 Long-Term Incentive Plan (the "1993 Plan") provides for awards of stock options, stock appreciation rights, restricted stock grants and/or performance units (collectively referred to as "awards"). These awards are not to exceed 15 million shares in the aggregate. As of December 31, 1998, there were no stock appreciation rights or performance units outstanding. The 1993 Plan terminated May 2, 1996, except with respect to outstanding awards, with the approval of the 1996 Plan. Stock options under the 1993 Plan originally had a term of ten years from the date of grant and vested in equal annual installments over four years, while restricted stock grants vested in equal annual installments over three years.
In connection with the IPO, TIG and Transamerica agreed that TIG employees could surrender their options to purchase Transamerica common stock by May 14, 1993, and receive options to purchase TIG Holdings common stock, retaining the taxable spread, vesting schedule and term of the surrendered Transamerica stock options as of the IPO closing date. Options relating to 820,498 shares of common stock were issued in connection with this agreement and are included in outstanding options in the following table.
A summary of the status of the Company's three stock based compensation plans as of December 31, 1998 and changes during the three years ended December 31, 1998 is presented below:
The weighted average option exercise price was $25.74, $25.06 and $22.74 for options outstanding at December 31, 1998, 1997 and 1996, respectively. The weighted average option exercise price was $30.50 for options granted during 1998, $21.95 for options exercised in 1998 and $29.11 for options forfeited in 1998.
The weighted average fair value of options granted during 1998 was $8.48. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1998, 1997 and 1996, respectively: dividend yield of 2.95 percent, 1.70 percent and 1.75 percent; expected volatility of .289, .220, and .201; risk free interest rate of 5 percent, 6 percent and 7 percent and expected life of 7 years for all years. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. If the merger of the Company with Fairfax is consummated, all outstanding options will be cancelled.
The following table summarizes information about stock options outstanding and exercisable at December 31, 1998:
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Special Severance Plan. Under this plan, which became effective as of June 18, 1998, each designated participant (each an officer or key employee) will be entitled to receive special severance benefits (in lieu of normal severance) if his or her employment with the Company or its affiliates is terminated under specified circumstances within two years following a Change in Control of the Company. The amount of each participant's special severance has been determined by the Compensation Committee of the Board of Directors. In addition to this severance benefit, each participant will be entitled to receive an amount equal to the sum of (x) the unvested portion (if any) of his or her accounts under the Company's qualified and nonqualified defined contribution plans and (y) the contributions which the Company would have made or credited to such participant's plan accounts (based upon the amounts contributed or credited to such accounts in the year prior to the year in which the participant terminates employment, or, in the case of qualified and nonqualified savings (401(k)) accounts, based upon the then current employer matching contributions being made to such accounts) for a specified period following employment termination. The participant will also be eligible to continue to participate (on the same basis as if still actively employed) in the Company's health, dental and life insurance plans for a finite period following employment termination. The maximum aggregate amount of severance benefits that would be payable in cash pursuant to this severance plan is approximately $16 million.
Retention and Bonus Plan. In addition, pursuant to a Retention and Bonus Plan approved by the Board in July 1998, the designated participants are entitled to certain payments if they continue their employment until the earlier of June 30, 2000 or a Change of Control of the Company. The maximum aggregate amount of benefits that would be payable in cash pursuant to this plan is approximately $5 million.
ESOP Restoration Plan. The TIG Holdings, Inc. ESOP Restoration Plan is an unfunded plan for the purpose of providing deferred compensation for a select group of management or highly compensated employees whose allocations under the qualified ESOP plan are limited by annual restrictions as determined by the Internal Revenue Code. Highly compensated employees whose allocations under the qualified plan are limited by the Internal Revenue Code restrictions will be eligible for participation immediately upon the date of hire if annual earnings, including bonus in the year paid, exceed a specified threshold. The threshold for each year will be the amount of the cap on compensation that may be taken into account under the qualified plan for that year, or such greater amount as may be determined by the TIG Holdings, Inc. Benefits Committee in its discretion. A Participant vests 25% after one year of service, 50% after two years of service and 100% after three years of service. Participants' accounts are credited in dollar amounts for the difference between the cash value of the stock that would have been allocated to the participant's account under the qualified ESOP plan and the cash value of the stock that would have been allocated in the absence of the restrictions noted above. Participants' accounts are adjusted for gains, losses and earnings as if invested in the same manner as such associate's account under the qualified ESOP plan. Liabilities due to the participants were less than $1 million as of December 31, 1998, 1997 and 1996. If the merger of the Company with Fairfax is consummated, TIG expects to merge the ESOP Restoration Plan into the DS&PSP Restoration Plan.
The weighted average annual assumed rate of increase in the health care cost trend rate is 6.0 percent for 1998 and will decrease to 5.0 percent in 1999 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported.
Increasing the trend rate by one percentage point would increase the actuarial present value obligation for postretirement medical benefits as of December 31, 1998, by $2 million, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by $0.2 million for 1998. Decreasing the trend rate by one percentage point would decrease the actuarial present value obligation for postretirement medical benefits as of December 31, 1998, by $2 million, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by $0.2 million for 1998. The weighted average discount rate used in determining the postretirement benefit obligation was 7.0% at December 31, 1998 and 1997.
Leases. Future minimum rental commitments as of December 31, 1998 for all noncancelable operating leases are as follows:
Substantially all of the leases are for rental of office space, the initial terms of which range from one to 20 years. Total rental expense for 1998, 1997, and 1996 was $22 million, $18 million and $17 million, respectively. As a result of the reorganization of TIG's commercial operations in the first quarter of 1996, certain lease termination costs in the amount of $18 million were incurred and are included in the $100 million restructuring charges recorded in 1996 as discussed in Note B - Summary of Significant Accounting Policies.
On December 9, 1998, a purported shareholder class action was commenced in the Delaware Court of Chancery against the Company, its directors and Fairfax. The complaint alleges, inter alia, that the consideration to be paid pursuant to the Merger Agreement is unfair and inadequate and that the terms of the Merger Agreement were arrived at without a full and thorough investigation by the directors. The complaint seeks injunctive relief, including a judgment enjoining the transaction, and the award of unspecified compensatory damages. The Company believes that the action is without merit and intends to defend the action vigorously.
On December 11, 1997, TIG filed a Tax Court Petition challenging an IRS Statutory Notice of Deficiency for the tax year 1993 and a Revenue Agents Report for 1994 (see Note G - Income Taxes).
London Market Activity. Through various indirect subsidiaries, the Company became a limited liability participant in the Lloyd's of London ("Lloyd's") market in 1997. As a prerequisite to admittance to the Lloyd's market, irrevocable letters of credit totaling $123 million, collateralized by $105 million of the Company's investment securities, were provided in favor of the Society and Council of Lloyd's at December 31, 1997. At December 31, 1998, the irrevocable letters of credit were collateralized by $137 million of the Company's investment securities. The letters of credit effectively secure the syndicate's 1998 results and future contingent obligations of the Company should the Lloyd's underwriting syndicates in which the Company participates incur net losses. The Company's contingent liability to the Society and Council of Lloyd's is limited to the amount of the letters of credit.
The following table reconciles the underwriting results for the operating segments to income before income tax benefit (expense) as reported in the Consolidated Statements of Income:
The company writes premium primarily in the United States, Canada and Great Britain, as reflected in the following table:
A large portion of the Company's premium is produced through Aon Corporation and its subsidiaries (Aon). Premium produced through Aon accounted for 34%, 32% and 23% of consolidated net premium written for 1998, 1997 and 1996, respectively, and has been reported throughout the Reinsurance, Commercial Specialty and Custom Markets segments.
The Year 2000 issue relates to the ability or inability of systems (including computer hardware, software and embedded microprocessors) to properly interpret date information relating to the year 2000 and beyond. Many existing systems, including many of TIG's existing systems, use only the last two digits to refer to a year (i.e., "98" is used for 1998). Therefore, these systems may not properly recognize a year that begins with "20" instead of "19". If not corrected, these systems could fail or create erroneous results.
The Y2K Project has caused no significant deferrals of other IT projects which in any way impact the financial condition or results of operations of TIG.
The Risks of TIG's Year 2000 Issues. There has not been any material processing disruptions to date. Internal testing provides TIG with a high level of confidence that in a most reasonably likely worst case scenario these systems will not cause material disruption on a forward-looking basis.
Although the Company has taken the actions described above to address the Year 2000 problem, a most reasonably likely worst case scenario indicates that there is always a possibility that the Company may suffer some disruptions as a result of the Year 2000 problem.