On September 1, 2001, the Company vacated the 50 Prospect Street complex in Hartford, Connecticut in order to undertake a complete renovation thereof, which is expected to be completed by the end of 2003. Therefore, the Company has entered into the following lease arrangements in Hartford, Connecticut to temporarily house the displaced operations: 93,500 square feet at 90 State House Square, 82,000 square feet at 10 State House Square, 79,400 square feet at 50/58 State House Square, 79,800 square feet at One Constitution Plaza, and 100,200 square feet at Connecticut River Plaza. By year-end 2002, the Company completed its renovations to seven floors, which were in turn, occupied by its employees previously housed at CityPlace.
Citigroup assumed all of TPC’s third-party liabilities, other than liabilities relating to TIGHI and TIGHI’s active employees;
TPC effected a recapitalization whereby the previously outstanding shares of its common stock (1,500 shares), all of which were owned by Citigroup, were changed into 269.0 million shares of class A common stock and 500.0 million shares of class B common stock;
On August 20, 2002, in connection with the Citigroup Distribution, stock-based awards held by Company employees on that date under Citigroup’s various incentive plans were cancelled and replaced by awards under the Company’s own incentive programs (see note 11 of notes to the Company’s consolidated financial statements for a further discussion), which awards were granted on substantially the same terms, including vesting, as the former Citigroup awards. In the case of Citigroup Capital Accumulation Plan awards of restricted stock and deferred shares, the unvested outstanding awards were cancelled and replaced by awards comprising 3.1 million of newly issued shares of TPC class A common stock at a total market value of $53.3 million based on the closing price of TPC class A common stock on August 20, 2002. The value of these newly issued shares along with TPC class A and class B common stock received in the Citigroup Distribution on the Citigroup restricted shares, were equal to the value of the cancelled Citigroup restricted share awards. In the case of Citigroup stock option awards, all outstanding vested and unvested awards held by Company employees were cancelled and replaced with options to purchase TPC class A common stock. The total number of TPC class A common stock subject to the replacement option awards was 56.9 million shares of which 24.6 million shares were then exercisable. The number of shares of TPC class A common stock to which the replacement options relates and
the intrinsic value of each Citigroup option, which was the difference between the closing price of Citigroup’s common stock on August 20, 2002 and the exercise price of the Citigroup options, was preserved in each replacement option for TPC class A common stock, and
In February 2002, the Company also paid a dividend of $3.700 billion to Citigroup in the form of a note payable in two installments. This note was substantially prepaid following the offerings. The balance of $150.0 million was due on May 9, 2004. This note was prepaid on May 8, 2002.
In March 2002, the Company paid a dividend of $395.0 million to Citigroup in the form of a note. This note was prepaid following the offerings.
Prior to the Citigroup Distribution, the Company provided and purchased services to and from Citigroup affiliated companies, including facilities management, banking and financial functions, benefit coverages, data processing services and short-term investment pool management services. Charges for these shared services were allocated at cost. In connection with the Citigroup Distribution, the Company and Citigroup and its affiliates entered into a transition services agreement for the provision of certain of these services, tradename and trademark and similar agreements related to the use of trademarks, logos and tradenames in an amendment to the March 26, 2002 Intercompany Agreement with Citigroup. During the first quarter of 2002, Citigroup provided investment advisory services on an allocated cost basis, consistent with prior years. On August 6, 2002, the Company entered into an investment management agreement, which has been applied retroactive to April 1, 2002, with an affiliate of Citigroup whereby the affiliate of Citigroup is providing investment advisory and administrative services to the Company with respect to its entire investment portfolio for a period of two years and at fees mutually agreed upon, including a component based on performance. Charges incurred related to this agreement were $47.2 million for the period from April 1, 2002 through December 31, 2002. Either party may terminate the agreement effective on the end of a month upon 90 days prior notice. The Company and Citigroup also agreed upon the allocation or transfer of certain other liabilities and assets, and rights and obligations in furtherance of the separation of operations and ownership as a result of the Citigroup Distribution. The net effect of these allocations and transfers, in the
opinion of management, were not significant to the Company’s results of operations or financial condition.
On May 31, 2000, the Company completed the acquisition of the surety business of Reliance Group Holdings, Inc. (Reliance Surety), for $580.0 million. In connection with the acquisition, the Company entered into a reinsurance arrangement for pre-existing business, and the resulting net cash outlay for this transaction was approximately $278.4 million. This transaction included the acquisition of an intangible asset of approximately $450.0 million, which is being amortized over 15 years. Accordingly, the results of operations and the assets and liabilities acquired from Reliance Surety are included in the financial statements beginning June 1, 2000. This acquisition was accounted for as a purchase.
The Company’s discussions related to net income (loss) and operating income (loss) are presented on an after tax basis. All other discussions are presented on a pretax basis, unless otherwise noted.
Net income (loss) was $(27.0) million in 2002, $1.065 billion in 2001 and $1.312 billion in 2000 or $(0.03) per share in 2002, $1.39 per share in 2001 and $1.71 per share in 2000 (basic and diluted). Net loss for 2002 includes a $1.394 billion charge for strengthening asbestos reserves, net of the benefit from the Citigroup indemnification agreement. Net loss for 2002 also includes a charge of $242.6 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), which has been accounted for as a cumulative effect of a change in accounting principle. Net income for 2001 includes losses of $489.5 million related to the terrorist attack on September 11, 2001. Included in 2000 was minority interest of $60.1 million related to the January through April 2000 period when approximately 14.8% of TIGHI’s outstanding common stock was not owned by TPC. During April 2000, TPC completed a cash tender offer and merger, as a result of which TIGHI became TPC’s wholly-owned subsidiary. Net income (loss) also includes net realized investment gains of $99.0 million, $209.9 million and $30.6 million in 2002, 2001 and 2000, respectively. Included in net realized investment gains were impairment charges related to other than temporary declines in value of $184.7 million, $95.0 million and $20.2 million in 2002, 2001 and 2000, respectively.
Operating income of $118.2 million for 2002 decreased $737.5 million compared to $855.7 million for 2001. Operating income for 2002 reflects the impact of the fourth quarter asbestos charge taken by the Company while 2001 reflects the impact of the effects of the terrorist attack on September 11th. Operating income in 2002 reflects unfavorable prior year reserve development of $1.516 billion, which included $1.394 billion related to asbestos, net of the benefit from the Citigroup indemnification agreement, versus $9.4 million of favorable prior year reserve development in 2001, which included $122.7 million of unfavorable development related to asbestos. On January 14, 2003, the Company reported the results of its asbestos reserve study and the strengthening of its asbestos reserves to $3.404 billion, after reinsurance recoverables. The study involved an extensive review and assessment of the Company’s exposure to asbestos losses, particularly in light of the Company’s recent claims experience and industry-wide trends. The Company has now fully utilized the $800.0 million pretax benefit under the Citi-group indemnification agreement. For additional information see “- Asbestos Claims and Litigation.” Separately, the Company strengthened its environmental reserves in the fourth quarter by $100.0 million, bringing the total to $385.5 million, and reduced its reserves for cumulative injuries other than asbestos by $94.8 million to $553.6
Net investment income was $1.881 billion in 2002, a decrease of $153.5 million from 2001. The decline resulted from a reduction in investment yields to 6.0% in 2002 from 6.9% in 2001. The decrease in yields reflected reduced returns in the Company’s public equity investments and the lower interest rate environment. The impact of lower yields was partially offset by the rise in average invested assets due to the Northland and Associates acquisitions and increased cash flow from operations. Net investment income for Northland and Associates was $91.5 million in 2002, an increase of $68.4 million over 2001 which only includes the fourth quarter of 2001. Net investment income was $2.034 billion in 2001, a decrease of $127.6 million from 2000. This decrease largely reflects the increase in
Other revenues decreased to $112.3 million in 2002 from $115.7 million in 2001. Other revenues increased to $115.7 million in 2001 from $87.8 million in 2000. Other revenues principally include premium installment charges.
Commencing in 2002, the GAAP underwriting expense ratio has been computed using net earned premiums to provide more consistency in the underlying components of the computation. Previously, this ratio for GAAP purposes was computed using net written premiums. Prior periods have been restated to conform to this new presentation.
The deterioration in the 2002 GAAP combined ratio includes the impact of higher prior year reserve development, primarily due to asbestos-related incurrals, partially offset by lower catastrophe losses in 2002, especially the impact of the September 11, 2001 terrorist attack, and the elimination of goodwill amortization. The improvement in the GAAP combined ratios, excluding catastrophes, prior year reserve development, and goodwill amortization, from 2001 to 2002, reflects an improvement in the loss and LAE ratio and an improvement in the underwriting expense ratio. The improvement in the loss and LAE ratio is primarily attributed to the continued disciplined underwriting that achieved rate increases in excess of loss cost trends in both Commercial Lines and Personal Lines. The improvement in the underwriting expense ratio is primarily attributed to the benefit of premium rate increases.
Net income (loss) was $(246.2) million, $962.5 million and $1.172 billion in 2002, 2001 and 2000, respectively. Net loss for 2002 includes a $1.394 billion charge for strengthening asbestos reserves, net of the benefit from the Citigroup indemnification agreement. Net loss for 2002 also includes a charge of $242.6 million related to the initial adoption of FAS 142, which has been accounted for as a cumulative effect of a change in accounting principle. Net income for 2001 includes losses of $447.9 million related to the terrorist attack on September 11, 2001. Included in 2000 was minority interest of $48.2 million related to the January through April 2000 period when approximately 14.8% of TIGHI’s outstanding common stock was not owned by TPC. During April 2000, TPC completed a cash tender offer and merger, as a result of which TIGHI became TPC’s wholly-owned subsidiary. Commercial Lines net income (loss) also includes net realized investment gains of $122.2 million, $207.6 million and $30.8 million in 2002, 2001 and 2000, respectively.
Operating loss of $125.8 million for 2002 decreased $878.0 million compared to operating income of $752.2 million for 2001. The decrease in 2002 operating income reflects unfavorable prior year reserve development in 2002 of $1.535 billion, net of the benefit from the Citigroup indemnification agreement, versus $10.8 million of unfavorable prior year reserve development in 2001. The 2002 prior year reserve development includes a $1.394 billion charge related to asbestos, net of the benefit from the Citigroup indemnification agreement, versus a charge of $122.7 million in 2001. On January 14, 2003, the Company reported the results of its asbestos reserve study and the strengthening of its asbestos reserves to $3.404 billion, after reinsurance recoverables. The study involved an extensive review and assessment of the Company’s exposure to asbestos losses, particularly in light of the Company’s recent claims experience and industry-wide trends. The Company has now fully utilized the $800.0 million pretax benefit under the Citigroup indemnification agreement. For additional information see “- Asbestos Claims and Litigation.” Separately, the Company strengthened its environmental reserves in the fourth quarter by $100.0 million, bringing the total to $385.5 million, and reduced its reserves for cumulative injuries other than asbestos by $94.8 million to $553.6 million. These actions were taken as a result of recent payment and settlement experience. In addition, the Company strengthened prior year reserves for certain run-off lines of business including assumed reinsurance, and experienced favorable current year development in certain ongoing businesses. Despite the benefit of higher average invested assets resulting from strong cash flows from underwriting, net investment income of $1.123 billion was $69.5 million lower than 2001 due to reduced returns in the Company’s public equity investments and the lower interest rate environment. Operating income in 2002 was favorably impacted by no catastrophe losses compared to $470.5 million of catastrophe losses in 2001, including $447.9 million related to the terrorist attack on September 11, 2001. The elimination of goodwill amortization also benefited 2002 operating income. Underwriting gain (loss), excluding catastrophes, prior year reserve development and goodwill amortization increased $200.8 million to $265.5 million in 2002. The 2002 underwriting results reflect the benefit of the favorable premium rate environment in excess of loss cost trends, higher production levels, higher retention and selective growth in new business.
Operating income of $752.2 million for 2001 was down $437.1 million compared to operating income of $1.189 billion in 2000. The 2001 decrease in operating income compared to 2000 reflects the impact of catastrophe losses of $447.9 million associated with the terrorist attack on September 11th. Operating income in 2001 was also unfavorably impacted by weather-related catastrophe losses of $22.6 million compared to no catastrophe losses in 2000. The decrease in 2001 operating income reflects unfavorable asbestos prior year reserve development in 2001 of $122.7 million versus $32.5 million in 2000. This was partially offset by $111.9 million of favorable other prior year reserve development in 2001 compared to $9.7 million of favorable other prior year reserve development in 2000. Also contributing to the 2001 decrease in operating income was a $62.0 million decrease in net investment income from 2000, which largely reflects the increase in dividends and debt repayments to Citigroup, lower fixed income interest rates and lower returns from private equity investments. Underwriting gain (loss), excluding catastrophes, prior year reserve development and goodwill amortization increased $76.4 million to $64.7 million in 2001. The 2001 underwriting results reflect the benefit of premium rate increases and higher fee income, partially offset by increased loss cost trends, including increased medical costs, auto repair costs and reinsurance costs.
Earned premiums were $6.801 billion in 2002 compared to $5.447 billion in 2001 and $4.747 billion in 2000. The increase in earned premiums in 2002 was primarily due to premium rate increases and the full-year inclusion of Northland and Associates in 2002. Earned premiums related to Northland and Associates were $846.1 million in 2002, an increase of $642.9 million over 2001 which only includes the fourth quarter of 2001. The 2001 increase in earned premiums was primarily due to rate increases, the full-year impact of the ongoing business associated with the Reliance Surety acquisition and the renewal rights for the Reliance Middle Market and Frontier businesses, and the inclusion of Northland and Associates in the fourth quarter of 2001. The inclusion of Northland and Associates in the fourth quarter of 2001 added $203.2 million to full year 2001 earned premiums.
Commercial Accounts serves primarily mid-sized businesses for casualty products and large, mid-sized and small businesses for property products through a network of independent agents and brokers. Commercial Accounts net written premiums increased 48% to $3.556 billion in 2002. The increase was significantly impacted by the inclusion in 2002 of the full year results of Northland and Associates. Net written premiums related to Northland and Associates were $824.8 million and $167.4 million in 2002 and 2001, respectively. Northland and Associates net written premiums include an increase of approximately $115.0 million related to the termination of certain reinsurance contracts. Excluding the impact of Northland and Associates, net written premiums increased 22% or $491.6 million for 2002, primarily driven by renewal price changes averaging 22% for 2002 and strong growth in new business. All major product lines - commercial automobile, property and general liability - contributed to the rise in renewal pricing. Renewal price change represents the estimated average change in premium on policies that renew, including rate and exposure changes, versus the average premium on those same policies for their prior term. The one area not showing adequate rate improvement, however, is the workers’ compensation line and, accordingly, Commercial Accounts has not grown this business. New business premiums in Commercial Accounts for 2002 were $733.0 million compared to $507.0 million in 2001. The business retention ratio for 2002 was 75%, up from 71% for 2001. For Commercial Lines, retention represents the estimated percentage of premium available for renewal which renewed in the current period. This renewal price change, new business and retention information excludes Northland and Associates for comparison purposes. Commercial Accounts net written premiums of $2.407 billion in 2001 were $308.2 million above 2000 premium levels. This increase reflected renewal price changes of 19%, favorable new business in national property and the inclusion of Northland and Associates in the fourth quarter of 2001.
Select Accounts serves small businesses through a network of independent agents. Select Accounts net written premiums were $1.870 billion in 2002 compared to $1.713 billion in 2001 and $1.575 billion in 2000. The increase in Select Accounts net written premiums primarily reflected renewal price changes averaging 17% for 2002. New business premiums in Select Accounts for 2002 were $306.5 million compared to $275.8 million in 2001. The business retention ratio for 2002, which was 80%, remained strong and consistent with 2001. Select’s retention remains strongest for small commercial business handled through the Company’s Service Centers, while premium growth has been greatest in the commercial multiperil and property lines of business. The 2001 increase in Select Accounts net written premiums primarily reflected price increases. This increase was partially offset by the Company’s continued disciplined approach to underwriting and risk management. Renewal price changes averaged 14% for 2001 and retention levels were favorable and averaged 80%.
Bond provides a variety of fidelity and surety bonds and executive liability coverages to clients of all sizes through independent agents and brokers. Bond net written premiums of $629.9 million in 2002 was $39.7 million higher than 2001. The 2002 amount is reduced by $17.5 million due to a change in the Bond Executive Liability excess of loss reinsurance treaty that was effective January 1, 2002. In addition, the 2001 amount is increased by $34.1 million due to the termination of the Master Bond Liability reinsurance treaty effective January 1, 2001. Excluding these two reinsurance adjustments, Bond net written premiums increased $91.3 million during 2002 compared to 2001. This increase reflects a favorable premium rate environment and strong production growth in executive liability product lines, which target middle and small market private accounts. In addition, the surety product lines benefited from higher premium rates in 2002. Bond net written premiums of $590.2 million in 2001 were $234.4 million above 2000, after an adjustment of $130.7 million in 2000 due to a reinsurance transaction associated with the acquisition of the Reliance Surety business. The $234.4 million increase was primarily due to the full-year impact of the ongoing business associated with the Reliance Surety acquisition and production growth in Bond’s Executive Liability product line group, specifically its fidelity, directors’ and officers’ liability and packaged product lines. The packaged product lines combine fidelity insurance, employment practices liability insurance, directors’ and officers’ liability insurance, other related professional liability insurance and fiduciary liability insurance into one product with either individual or aggregate limits. Bond’s Executive Liability product lines target middle and small market private accounts as well as not-for-profit accounts. The growth in these product lines is reflective of Bond’s strategy to further enhance its product and customer diversification through the faster growing and larger executive liability market.
The deterioration in the 2002 GAAP combined ratio includes the impact of higher prior year reserve development, primarily due to asbestos, partially offset by no catastrophe losses in 2002 compared to the impact of the terrorist attack on September 11th on 2001, and the elimination of goodwill amortization. The improvement in the GAAP combined ratio, excluding catastrophes, prior year reserve development and goodwill amortization, from 2001 to 2002, reflects an improvement in the loss and LAE ratio and an improvement in the underwriting expense ratio. The improvement in the loss and LAE ratio is primarily due to the benefit of the favorable rate environment and improved profitability from the Company’s continued effort to adjust business mix to areas generating rate adequacy. The improvement in the underwriting expense ratio is primarily attributed to the benefit of premium rate increases.
offset by a deterioration in the underwriting expense ratio. The improvement in the loss and LAE ratio is primarily due to premium growth related to rate increases, the full-year impact of the ongoing business associated with the Reliance Surety acquisition, the purchase of the renewal rights for the Reliance Middle Market and Frontier businesses partially offset by increased loss cost trends. The deterioration in the underwriting expense ratio is primarily due to the impact of the Bond business acquisition of the Reliance Surety business, which generally has a higher underwriting expense ratio.
Net income in 2002 was $316.8 million compared to $242.4 million in 2001 and $343.6 million in 2000. Included in 2001 was a net loss of $41.6 million related to the terrorist attack on September 11, 2001. Included in 2000 was minority interest of $16.6 million related to the January through April 2000 period when approximately 14.8% of TIGHI’s outstanding common stock was not owned by TPC. During April 2000, TPC completed a cash tender offer and merger, as a result of which TIGHI became TPC’s wholly-owned subsidiary. Personal Lines net income also includes net realized investment gains (losses) of $(28.5) million, $4.3 million and $(0.3) million in 2002, 2001 and 2000, respectively.
The major components of operating income and a reconciliation of operating income to net income is as follows:
Operating income of $241.0 million for 2001 was down $119.5 million compared to operating income of $360.5 million in 2000. The decrease in operating income in 2001 reflects a net loss of $41.6 million related to the impact of the terrorist attack on September 11th. Operating income in 2001 was favorably impacted by natural catastrophe losses of $44.5 million compared to $53.6 million of natural catastrophe losses in 2000. Operating income in 2001 was also impacted by lower favorable
Revenues of $4.775 billion in 2002 increased $321.4 million from 2001. The increase in revenues reflected growth in earned premiums due to premium rate increases and the full-year inclusion of Northland in 2002, partially offset by realized investment losses in 2002 compared to realized investment gains in 2001 and a decrease in net investment income. Total revenues for Northland were $123.0 million in 2002, an increase of $99.9 million over 2001 which only includes the fourth quarter of 2001. Revenues in 2001 were $4.454 billion, an increase of $222.0 million compared to $4.232 billion in 2000. The increase was primarily attributable to a $248.5 million growth in earned premiums primarily due to rate increases and $6.3 million of realized investment gains in 2001, compared to $0.6 million realized investment losses in 2000. This was partially offset by a $35.9 million decrease in net investment income from 2000, which largely reflects the increase in dividends and debt repayments to Citigroup and lower fixed income interest rates. The inclusion of Northland in the fourth quarter of 2001 added $23.1 million to full-year 2001 revenues.
Earned premiums increased $390.2 million to $4.354 billion in 2002 from $3.964 billion in 2001. The increase in earned premiums in 2002 was primarily due to rate increases in all product lines and the full-year inclusion of Northland in 2002. Earned premiums for Northland were $112.1 million in 2002, an increase of $91.2 million over 2001 which only includes the fourth quarter of 2001. Earned premiums increased $248.5 million to $3.964 billion in 2001 from $3.715 billion in 2000 primarily due to rate increases. The inclusion of Northland in the fourth quarter of 2001 added $20.9 million to full-year 2001 earned premiums.
Net investment income was $384.7 million in 2002, a decrease of $25.5 million from 2001. The decline resulted from reduced returns in the Company’s public equity investments and the lower interest rate environment, mostly offset by the benefit of higher average invested assets resulting from strong cash flows from operations. Net investment income was $410.2 million in 2001, a decrease of $35.9 million from 2000. This decrease largely reflects the increase in dividends and debt repayments to Citigroup and lower fixed income interest rates.
Personal Lines had approximately 5.5 million, 5.4 million and 5.4 million policies in force at December 31, 2002, 2001 and 2000, respectively.
Homeowners and Other net written premiums increased 14% to $1.732 billion in 2002. Excluding the impact of Northland, which contributed $13.5 million and $1.6 million to 2002 and 2001, respectively, Homeowners and Other net written premiums increased 13% to $1.719 billion. Renewal price changes averaged 15% for 2002. Retention levels also remained favorable and averaged 80%. Homeowners and Other net written premiums increased 5% to $1.517 billion in 2001. Renewal price changes averaged 10% for 2001 and retention levels were favorable and averaged 80%.
Production through the Company’s independent agents in Personal Lines, which represents over 81% of Personal Lines total net written premiums, was up 13% to $3.736 billion for 2002, including the impact of Northland. Net written premiums through channels other than independent agents was up 5% to $839.4 million for 2002 as the favorable impact of renewal price changes was offset in part by a reduction in policies in force due to underwriting actions taken to eliminate marginally profitable businesses. Production through the Company’s independent agents in Personal Lines was up 9% to $3.308 billion in 2001. Net written premiums through channels other than independent agents was up 2% to $800.0 million in 2001.
Catastrophe losses, net of taxes and reinsurance, were $54.7 million, $86.1 million and $53.6 million in 2002, 2001 and 2000, respectively. Catastrophe losses in 2002 were primarily due to winter storms in the Midwest and New York in the first quarter, wind and hailstorms in the mid Atlantic region in the second and third quarters, and Tropical Storm Lili and wind, hail and icestorms in the Southeast in the fourth quarter. Catastrophe losses in 2001 were primarily due to the terrorist attack on September 11th, Tropical Storm Allison and wind and hailstorms in the Midwest and Texas in the second quarter. Catastrophe losses in 2000 were primarily due to Texas, Midwest and Northeast wind and hailstorms in the second quarter and hailstorms in Louisiana and Texas in the first quarter.
The improvement in the 2002 GAAP combined ratio includes the impact of slightly higher natural catastrophes in 2002, the impact of the terrorist attack on September 11th on 2001, slightly lower favorable prior year reserve development and the elimination of goodwill amortization. The improvement in the GAAP combined ratio excluding catastrophes, prior year reserve development and goodwill amortization, from 2001 to 2002, reflects an improvement in both the loss and LAE ratio and the underwriting expense ratio. The improvement in the loss and LAE ratio is primarily attributed to rate increases and the moderation in loss cost trends. The improvement in the underwriting expense ratio is primarily attributed to the benefit of premium rate increases. An increase in contingent commissions, resulting from the improved underwriting results, offset an overall reduction in other expenses.
The deterioration in the 2001 GAAP combined ratio includes the impact of September 11th, and lower favorable prior year reserve development partially offset by lower natural catastrophes in 2001. The deterioration in the GAAP combined ratio, excluding catastrophes, prior year reserve development and goodwill amortization, from 2000 to 2001, reflects a deterioration in both the loss and
The primary component of net loss before minority interest for 2002, 2001 and 2000 was after-tax interest expense of $99.6 million, $133.2 million and $192.1 million, respectively. Net loss in 2000 reflects minority interest of $4.7 million related to the January through April 2000 period when approximately 14.8% of TIGHI’s outstanding common stock was not owned by TPC. During April 2000, TPC completed a cash tender offer and merger, as a result of which TIGHI became TPC’s wholly owned subsidiary. The reduction in interest expense in 2002 is due to lower average interest-bearing debt levels primarily related to the repayment of debt obligations to Citigroup in the 2002 first quarter. The decrease in interest expense in 2001 is due to lower outstanding debt and lower interest rates. Included in 2001 net loss was the after tax benefit of a $5.7 million dividend from an investment that was sold to Citigroup in 2002.
Increasingly, policyholders have been asserting that their claims for asbestos-related insurance are not subject to aggregate limits on coverage and that each individual bodily injury claim should be treated as a separate occurrence under the policy. The Company expects this trend to continue. It is difficult to predict whether these policyholders will be successful on both issues or whether the Company will be successful in asserting additional defenses. To the extent both issues are resolved in policyholders’ favor and other additional Company defenses are not successful, the Company’s coverage obligations under the policies at issue would be materially increased and bounded only by the applicable per occurrence limits and the number of asbestos bodily injury claims against the policyholders. Accordingly, it is difficult to predict the ultimate size of the claims for coverage not subject to aggregate limits.
Many coverage disputes with policyholders are only resolved through settlement agreements. Because many policyholders make exaggerated demands, it is difficult to predict the outcome of settlement negotiations. Settlements involving bankrupt policyholders may include extensive releases which are favorable to the Company and which could result in settlements for larger amounts than originally anticipated. As in the past, the Company will continue to pursue settlement opportunities.
In addition, proceedings have been launched directly against insurers, including the Company, challenging insurers’ conduct in respect of asbestos claims, including in some cases with respect to previous settlements. The Company anticipates the filing of other direct actions against insurers, including the Company, in the future. Particularly in light of jurisdictional issues, it is difficult to predict the outcome of these proceedings, including whether the plaintiffs will be able to sustain these actions against insurers based on novel legal theories of liability. See “- Legal Proceedings.”
The Company’s asbestos study segmented asbestos exposures into the following categories: policyholders with settlement agreements, other policyholders with active claims, assumed reinsurance and reserves for unallocated incurred but not reported (IBNR) claims. The following table displays asbestos reserves by policyholder category:
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 agreements. Structured agreements are arrangements under which policyholders and/or plaintiffs agree to fixed financial amounts to be paid at scheduled times. In August 2002, the Company entered into a settlement agreement with Shook & Fletcher Insulation Co. (Shook) settling coverage litigation under insurance policies which the Company issued to Shook. After payments made in the fourth quarter of 2002 under this settlement, the remaining obligations are valued at approximately $99.2 million (after reinsurance and discounting). 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 based upon substantial progress in negotiations during the fourth quarter of 2002. The Company’s single payment contribution to the proposed settlement, expected in June 2004, is approximately $388.8 million after
reinsurance. Coverage in place arrangements represent agreements with major policyholders on specified amounts of coverage to be provided. Payments may include annual maximums and are only made when valid claims are presented. Wellington accounts refer to the 35 remaining defendants that were parties to a 1985 settlement agreement settling their asbestos claims. This agreement is similar to a coverage in place arrangement in which the parties have agreed on specific amounts of coverage and the terms on which the coverage can be accessed.
Assumed reinsurance exposure primarily consists of reinsurance of excess coverage, including various pool participations. In addition to amounts in reserve for specific policyholders or groups of policyholders, as described above, the Company has established an unallocated IBNR reserve to respond to adverse development for existing policyholders, new claims from policyholders reporting claims for the first time and for policyholders for which there is, or may be litigation.
The duration of the Company’s investigation and review of these claims and the extent of time necessary to determine an appropriate estimate, if any, of the value of the claim to the Company, vary significantly and are dependent upon a number of factors. These factors include, but are not limited to, the cooperation of the policyholder in providing claim information, the pace of underlying litigation or claim processes, the pace of coverage litigation between the policyholder and the Company and the willingness of the policyholder and the Company to negotiate, if appropriate, a resolution of any dispute pertaining to these claims. Because these factors vary from claim-to-claim and policyholder-by-policyholder, the Company cannot provide a meaningful average of the duration of an environmental claim. However, based upon the Company’s experience in resolving these claims, the duration may vary from months to several years.
As a result of the processes and procedures described above, management believes that the reserves carried for asbestos and environmental claims at December 31, 2002 are appropriately established based upon known facts, current law and management’s judgment. However, the uncertainties surrounding the final resolution of these claims continue, and it is presently not possible to estimate the ultimate exposure for asbestos and environmental claims and related litigation. As a result, the reserve is subject to revision as new information becomes available. The continuing uncertainties include without limitation, the risks and lack of predictability inherent in major litigation, any impact from the bankruptcy protection sought by various asbestos producers and other asbestos defendants, a further increase or decrease in asbestos and environmental claims which cannot now be anticipated, the role of any umbrella or excess policies the Company has issued, the resolution or adjudication of some disputes pertaining to the amount of available coverage for asbestos claims in a manner inconsistent with the Company’s previous assessment of these claims, the number and outcome of direct actions against the Company, and future developments pertaining to the Company’s ability to recover reinsurance for asbestos and environmental claims. It is also not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. This development will be affected by future court decisions and interpretations, as well as changes in applicable legislation. It is also difficult to predict the ultimate outcome of large coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. Also see “- Legal Proceedings.”
At December 31, 2002, approximately 77% (approximately $425.0 million) of the net CIOTA reserve represents incurred but not reported losses for which the Company has not received any specific claims. The balance, approximately 23% of the net aggregate reserve (approximately $128.6 million), is for pending CIOTA claims.
The Company’s invested assets at December 31, 2002 totaled $38.425 billion, including $3.599 billion of securities in process of settlement, of which 91% was invested in fixed maturity and short-term investments, 2% in common stocks and other equity securities, 1% in mortgage loans and real estate held for sale and 6% in other investments. Adjusting for the effect of securities in process of settlement, invested assets at December 31, 2002 totaled $34.826 billion, of which 90% was invested in fixed maturity and short-term investments, 2% in common stocks and other equity securities, 1% in mortgage loans and real estate held for sale and 7% in other investments. Excluding the impact of securities lending, unrealized investment gains and losses, receivables for investment sales and payables on investment purchases, the pre-tax average yield was 6.0%, 6.9% and 7.6% for the years ended December 31, 2002, 2001 and 2000, respectively, and the after-tax average yield was 4.4%, 5.0% and 5.5% for the years ended December 31, 2002, 2001 and 2000, respectively.
The 2002 year saw a significant increase in the number of downgrades by rating agencies for property casualty insurance companies. Many competitors are experiencing pressure on their capitalization levels due to underperforming investment portfolios and the need to strengthen prior year reserves, especially for asbestos liabilities. This pressure has caused many competitors to sell, discontinue or shrink certain books of business and has significantly reduced the acquisition activity of the industry.
A variety of other factors continue to affect the property and casualty insurance market and the Company’s core business outlook, including improvement in pricing in the commercial lines marketplace, a continuing highly competitive personal lines marketplace, inflationary pressures on loss cost trends, including medical inflation and auto loss costs, asbestos related developments and rising reinsurance and litigation costs.
In National Accounts, where programs include risk management services, such as claims settlement, loss control and risk management information services, generally offered in connection with a large deductible or self-insured program, and risk transfer, typically provided through a guaranteed cost or retrospectively rated insurance policy, pricing improved during 2002 and 2001. The Company has benefited from higher rates and believes that pricing will continue to stay firm into 2003. However, the Company will still continue to selectively reject business that is not expected to produce acceptable returns. The Company anticipates that the premium and fee income growth experienced in 2002 will continue into 2003. Included in National Accounts is service fee income for policy and claim administration of various states’ Workers’ Compensation Residual Market pools. After several years of depopulation, these pools began to repopulate in 2000 and continue to grow significantly as the primary market is firming. Premium that the Company services for these pools grew 91% in 2002 compared to 2001 and is expected to continue to grow.
Commercial Accounts achieved double-digit price increases on renewal business during 2002 and 2001, improving the overall profit margin in this business, more than offsetting the impacts of rising loss cost and medical inflation, reinsurance costs and lower investment yields. New business levels also increased during 2002 across most products but especially for property coverages where Commercial Accounts benefited from the Company’s property underwriting specialization, financial strength and limits capacity. The Company will continue to seek significant rate increases in 2003, as pricing in some areas and business segments, such as workers’ compensation, still has not improved to the point of producing acceptable returns. However, the rate of increase may decline modestly as compared to the past two years.
Also in Commercial Accounts, during 2002 the operations of American Equity and Associates were determined to be non-strategic. Accordingly, these operations were placed in run-off during the first and fourth quarters of 2002, respectively, which included non-renewals of inforce policies and a cessation of writing new business, where allowed by law. These operations were acquired in the fourth quarter of 2001 from Citigroup as part of the Northland and Associates acquisitions discussed above. Net written premium for these combined operations was $86.8 million in 2002.
Personal Lines strategy is to profitably grow its customer base in the independent agent and additional distribution channels, control operating expenses, keep prices competitive and aligned with loss trend, and manage its exposure to catastrophe losses.
Market conditions for property insurance changed in 2002, as the industry experienced significant rate increases, scaled back coverages, and reduced new business initiatives to improve profitability. Personal Lines had implemented these actions in the past several years, and has achieved significantly improved profit results relative to the industry. Personal Lines will maintain its underwriting discipline and will continue to increase property rates as needed to achieve acceptable returns and to offset inflationary pressures.
The Company’s principal asset is the capital stock of TIGHI and its insurance subsidiaries.
and claim adjustment expense payments and operating expenses. Catastrophe claims, the timing and amount of which are inherently unpredictable, may create increased liquidity requirements. 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. Additional sources of cash flow include the sale of invested assets and financing activities. It is the opinion of the Company’s management that the Company’s future liquidity needs will be met from all of the above sources.
Net cash flows are generally invested in marketable securities. The Company closely monitors the duration of these investments, and investment purchases and sales are executed with the objective of having adequate funds available to satisfy its maturing liabilities. As the Company’s investment strategy focuses on asset and liability durations, and not specific cash flows, asset sales may be required to satisfy obligations and/or rebalance asset portfolios. The Company’s invested assets at December 31, 2002 totaled $38.425 billion, including $3.599 billion of securities in process of settlement, of which 91% was invested in fixed maturity and short-term investments, 2% in common stocks and other equity securities, 1% in mortgage loans and real estate held for sale and 6% in other investments. Adjusting for the effect of securities in process of settlement, invested assets at December 31, 2002 totaled $34.826 billion, of which 90% was invested in fixed maturity and short-term investments, 2% in common stocks and other equity securities, 1% in mortgage loans and real estate held for sale and 7% in other investments.
Notes payable to former affiliates at December 31, 2002 was as follows:
At December 31, 2001, TPC had a note payable to Citigroup in the amount of $1.198 billion. In conjunction with the purchase of TIGHI’s outstanding shares in April 2000, TPC entered into a note agreement with Citigroup. On February 7, 2002, this note agreement was replaced by a new note agreement. Under the terms of the new note agreement, interest accrued on the aggregate principal amount outstanding at the commercial paper rate (the then current short-term rate) plus 10 basis points per annum. Interest was compounded monthly. This note was repaid following the offerings.
In December 2002, TPC entered into a loan agreement with an unaffiliated lender and borrowed $550.0 million under a promissory note due in January 2004. The Promissory Note carried a variable interest rate of LIBOR plus 25 basis points per annum. On February 5, 2003, TPC issued $550.0 million of Floating Rate Notes due in February 2004. The proceeds from these notes were used to repay the promissory note. The Floating Rate Notes also carry a variable interest rate of LIBOR plus 25 basis points per annum and are callable by the Company after August 5, 2003. The Company expects to repay substantially all of this new debt by the end of 2003.
The Company’s principal insurance subsidiaries are domiciled in the State of Connecticut. The insurance holding company law of Connecticut applicable to the Company’s subsidiaries requires notice to, and approval by, the state insurance commissioner for the declaration or payment of any dividend that together with other distributions made within the preceding twelve months exceeds the greater of 10% of the insurer’s surplus as of the preceding December 31, or the insurer’s net income for the twelve-month period ended the preceding December 31, in each case determined in accordance with statutory accounting practices. This declaration or payment is further limited by adjusted unassigned surplus, as determined in accordance with statutory accounting practices. The insurance holding company laws of other states in which the Company’s subsidiaries are domiciled generally contain similar, although in some instances somewhat more restrictive, limitations on the payment of dividends. A maximum of $727.7 million is available by the end of 2003 for such dividends without prior approval of the Connecticut Insurance Department. However, the payment of a portion of this amount is likely to be subject to approval by the Connecticut Insurance Department in accordance with the formula described above, depending upon the amount and timing of the payments.
TPC has the option to defer interest payments on its convertible junior subordinated notes for a period not exceeding 20 consecutive quarterly interest periods. If TPC elects to defer interest payments on the notes, it will not be permitted, with limited exceptions, to pay dividends on its common stock during a deferral period. In addition, the ability of TIGHI to pay dividends to TPC is subject to the terms of the TIGHI trust mandatorily redeemable securities which prohibit TIGHI from paying dividends in the event it has failed to pay or has deferred dividends or is in default under the trust mandatorily redeemable securities.
Under the terms of the Tax Allocation Agreement between TPC and Citigroup, TPC is financially responsible for adverse tax consequences on the tax-free status of the Citigroup Distribution as a result of actions taken by TPC. One of the potential post Citigroup Distribution actions by TPC, which could adversely impact the tax status of the Citigroup Distribution, is the issuance of additional common
The NAIC adopted RBC requirements for property casualty companies to be used as minimum capital requirements by the NAIC and states to identify companies that merit further regulatory action. The formulas have not been designed to differentiate among adequately capitalized companies that operate with levels of capital higher than RBC requirements. Therefore, it is inappropriate and ineffective to use the formulas to rate or to rank these companies. At December 31, 2002, all of the Company’s insurance subsidiaries had adjusted capital in excess of amounts requiring any company or regulatory action.
Total claims and claim adjustment expense reserves were $33.736 billion at December 31, 2002. The Company maintains property and casualty loss reserves to cover estimated ultimate unpaid liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability, but instead represent estimates, generally utilizing actuarial projection techniques at a given accounting date. These reserve estimates are expectations of what the ultimate settlement and administration of claims will cost based on the Company’s assessment of facts and circumstances then known, review of historical settlement patterns, estimates of trends in claims severity, frequency, legal theories of liability and other factors. Variables in the reserve estimation process can be affected by both internal and external events, such as changes in claims handling procedures, economic inflation, legal trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant reporting lags between the occurrence of the policyholder event and the time it is actually reported to the insurer. Reserve estimates are continually refined in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. Adjustments to reserves are reflected in the results of the periods in which the estimates are changed. Because establishment of reserves is an inherently uncertain process involving estimates, currently established reserves may not be sufficient. If estimated reserves are insufficient, the Company will incur additional income statement charges.
Reserves for losses and loss adjustment expenses on a statutory basis were $23.280 billion, $20.215 billion and $19.428 billion at December 31, 2002, 2001 and 2000, respectively. The increase from December 31, 2001 to December 31, 2002 is primarily due to the increase in asbestos reserves of $2.584 billion during the year. The increase from December 31, 2000 to December 31, 2001 includes the impact of the terrorist attack on September 11th and the inclusion of Northland and Associates as of October 2001. These increases were partially offset by net payments of $578.0 million and $426.6 million for asbestos, environmental and other cumulative injury claims during the years ended December 31, 2002 and 2001, respectively.
Under agreements with Citigroup, TPC assumed liabilities for nonqualified pension, post-retirement health care and life insurance benefit liabilities related to active Company plan participants as of August 20, 2002. Because Citigroup assumed liabilities for the same benefits for retired or inactive plan participants, the Company transferred short-term securities of $171.1 million and recorded a payable of $13.5 million in 2002 to Citigroup affiliated companies, and reduced other liabilities and deferred taxes by $284.0 million and $99.4 million, respectively, related to retired or inactive employees, pending final agreements on the amounts. Final agreement on settlement amounts was reached and an additional $2.2 million is expected to be paid to Citigroup during the first quarter of 2003.
The principal assumptions used in determining pension and postretirement benefit obligation are as follows:
The principal assumptions are considered appropriate given the underlying investment portfolio asset mix, nature of liabilities which are primarily for active employees, expected compensation and health care cost trends. The expected long-term rate of return on assets of 8% is based on the current and expected asset mix which is approximately 60% in equity investments and 40% in fixed income investments. The discount rate of 6.75% was based on an analysis of current and historical interest rates and the duration of plan obligations.
This report contains, and oral statements by management of the Company may contain, certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, may be forward-looking statements. Specifically, the Company has forward-looking statements about the Company’s results of operations, financial condition, liquidity, and the sufficiency of the Company’s asbestos reserves under the heading “Outlook” and elsewhere.
Many risks and uncertainties may impact the matters addressed in these forward-looking statements. Actual results may differ materially from those expressed or implied. In particular, the sufficiency of the Company’s asbestos reserves, as well as the Company’s results of operations, financial condition and liquidity, to the extent impacted by the sufficiency of the Company’s asbestos reserves, is subject to a number of potential adverse developments including, among others, adverse developments involving asbestos claims and related litigation, the willingness of parties, including the Company, to settle disputes, the impact of aggregate policy coverage limits, and the impact of bankruptcies of various asbestos producers and related businesses.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Travelers Property Casualty Corp. and subsidiaries as of December 31, 2002 and 2001, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America.
Includes foreign currency translation adjustments, hedged futures contracts and the cumulative effect of the change in accounting for derivative instruments and hedging activities.
The consolidated financial statements include the accounts of Travelers Property Casualty Corp. (TPC) and its subsidiaries (collectively, the Company). Certain reclassifications have been made to prior years’ financial statements to conform to the current year’s presentation. Significant intercompany transactions and balances have been eliminated.
TPC was reorganized in connection with its initial public offering (IPO) on March 21, 2002. Pursuant to the reorganization, which was completed on March 19, 2002, TPC’s consolidated financial statements have been adjusted to exclude the accounts of certain formerly wholly-owned TPC subsidiaries, principally The Travelers Insurance Company (TIC) and its subsidiaries (U.S. life insurance operations), certain other wholly-owned non-insurance subsidiaries of TPC and substantially all of TPC’s assets and certain liabilities not related to the property casualty business.
On August 20, 2002, Citigroup made a tax-free distribution to its stockholders (the Citigroup Distribution), of a portion of its ownership interest in TPC, which, together with the shares issued in the IPO, represented more than 90% of TPC’s common equity and more than 90% of the combined voting power of TPC’s outstanding voting securities. For each 100 shares of Citigroup outstanding common stock, approximately 4.32 shares of TPC class A common stock and 8.88 shares of TPC class B common stock were distributed. At December 31, 2002, Citigroup held 9.95% of TPC’s common equity and 9.98% of the combined voting power of TPC’s outstanding voting securities. Citigroup received a private letter ruling from the Internal Revenue Service that the Citigroup Distribution is tax-free to Citigroup, its stockholders and TPC. As part of the ruling process, Citigroup agreed to vote the shares it continues to hold following the Citigroup Distribution pro rata with the shares held by the public and to divest the remaining shares it holds within five years following the Citigroup Distribution.
On August 20, 2002, in connection with the Citigroup Distribution, stock-based awards held by Company employees on that date under Citigroup’s various incentive plans were cancelled and replaced by awards under the Company’s own incentive programs. See note 11.
In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Standards No. 148 “Accounting for Stock-Based Compensation - Transition and Disclosure” (FAS 148), an amendment to FASB Statement No. 123 “Accounting for Stock-Based Compensation” (FAS 123). Provisions of this Statement provide two additional alternative transition methods: modified prospective method and retroactive restatement method, for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. The Statement eliminates the use of the original FAS 123 prospective method of transition alternative for those entities that change to the fair value based method in fiscal years beginning after December 15, 2003. It also amends the disclosure provisions of FAS 123 to require prominent annual disclosure about the effects on reported net income in the Summary of Significant Accounting Policies and also requires disclosure about these effects in interim financial statements. These provisions are effective for financial statements for fiscal years ending after December 15, 2002. Accordingly, the Company has adopted the applicable disclosure requirements of this statement for year-end reporting. The transition provisions of this statement apply upon adoption of the FAS 123 fair value based method. See Stock-Based Compensation in note 1 for discussion of adoption of FAS 123 and transition alternative.
The Company stopped amortizing goodwill on January 1, 2002. Net income and earnings per share adjusted to
The Company had customer-related intangible assets with a gross carrying amount of $470.6 million as of both December 31, 2002 and 2001, and with accumulated amortization of $90.8 million and $55.4 million as of December 31, 2002 and 2001, respectively, which are included in other assets in the consolidated balance sheet. Amortization expense was $35.4 million, $34.5 million and $20.9 million for the years ended December 31, 2002, 2001 and 2000, respectively. Intangible assets amortization expense is estimated to be $35.4 million, $34.2 million, $31.3 million, $29.6 million and $29.6 million in 2003, 2004, 2005, 2006 and 2007, respectively.
Effective January 1, 2002, the Company adopted FASB Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (FAS 144). FAS 144 establishes a single accounting model for long-lived assets to be disposed of by sale. A long-lived asset classified as held for sale is to be measured at the lower of its carrying amount or fair value less cost to sell and depreciation (amortization of the asset) ceases. Impairment is recognized only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and fair value of the asset. Long-lived assets to be abandoned, exchanged for a similar productive asset, or distributed to owners in a spin-off are considered held and used until disposed of. Accordingly, discontinued operations are no longer to be measured on a net realizable value basis, and future operating losses are no longer recognized before they occur. The provisions of the new standard are to be applied prospectively. The adoption of FAS 144 did not have a significant effect on results of operations, financial condition or liquidity.
Effective January 1, 2001, the Company adopted FASB Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (FAS 133). FAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a recognized asset or liability or a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available for sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair
value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation. See note 14.
In September 2000, the FASB issued Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125” (FAS 140). Provisions of FAS 140 primarily relating to transfers of financial assets and securitizations that differ from provisions of “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (FAS 125) are effective for transfers taking place after March 31, 2001. Special purpose entities (SPEs) used in securitizations that are currently qualifying SPEs under FAS 125 will continue to be treated as qualifying SPEs as long as they issue no new beneficial interests and accept no new asset transfers after March 31, 2001, other than transfers committed to prior to that date. Under FAS 140, qualifying SPEs are not consolidated by the transferor. FAS 140 also amends the accounting for collateral and requires new disclosures for collateral, securitizations and retained interests in securitizations. These provisions were effective for financial statements for fiscal years ending after December 15, 2000. The accounting for collateral, as amended, requires (a) certain assets pledged as collateral to be separately reported in the consolidated balance sheet from assets not so encumbered and (b) disclosure of assets pledged as collateral that have not been reclassified and separately reported. The adoption of FAS 140 did not have a significant effect on results of operations, financial condition or liquidity. See note 4.
Fixed maturities include bonds, notes and redeemable preferred stocks. Fixed maturities are valued based upon quoted market prices or dealer quotes, or if quoted market prices or dealer quotes are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment. Also included in fixed maturities are loan-backed and structured securities, which are amortized using the retrospective method. The effective yield used to determine amortization is calculated based upon actual historical and projected future cash flows, which are obtained from a widely-accepted securities data provider. Fixed maturities, including instruments subject to securities lending agreements (see note 4), are classified as “available for sale” and are reported at fair value, with unrealized investment gains and losses, net of income taxes, charged or credited directly to shareholders’ equity.
Equity securities, which include common and nonredeemable preferred stocks, are classified as available for sale and carried at fair value based on quoted market prices. Changes in fair values of equity securities are charged or credited directly to shareholders’ equity, net of income taxes.
Mortgage loans are carried at amortized cost. A mortgage loan is considered impaired when it is probable that the Company will be unable to collect principal and interest amounts due. For mortgage loans that are determined to be impaired, a reserve is established for the difference between the amortized cost and fair market value of the underlying collateral. In estimating fair value, the Company uses interest rates reflecting the current real estate financing market returns. Impaired loans were not significant at December 31, 2002 and 2001.
Real estate held for sale is carried at the lower of cost or fair value less estimated costs to sell. Fair value is established at the time of acquisition by internal analysis or external appraisers, using discounted cash flow analyses and other acceptable techniques. Thereafter, an impairment
Realized investment gains and losses are included as a component of pretax revenues based upon specific identification of the investments sold on the trade date. An investment in a debt or equity security is impaired if its fair value falls below its book value and the decline is considered other than temporary. Factors considered in determining whether a loss is other than temporary include the length of time and extent to which fair value has been below cost; the financial condition and near term prospects of the issuer; and, the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery. A debt security is impaired if it is probable that the Company will not be able to collect all amounts due under the security’s contractual terms. Equity investments are impaired when it becomes apparent that the Company will not recover its cost over the expected holding period. Other-than-temporary declines in fair value of investments are included in realized investment gains and losses.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. Such recoverables are reported net of an allowance for estimated uncollectible reinsurance recoverables and amounts due from known reinsurer insolvencies. The Company evaluates and monitors the financial condition of its reinsurers under voluntary reinsurance arrangement to minimize its exposure to significant losses from reinsurer insolvencies. See note 5.
Amounts which vary with and are primarily related to the production of new insurance contracts, primarily commissions and premium taxes, are deferred and amortized pro rata over the contract periods in which the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future income, and if not, are charged to expense. Future investment income attributable to related premiums is taken into account in measuring the recoverability of the carrying value of this asset. All other acquisition expenses are charged to operations as incurred.
Company’s acquisition of The Northland Company and its subsidiaries (see note 2) included goodwill and intangible assets of $242.6 million, which were amortized on a straight-line basis over a 20-year period for goodwill and periods of 15 to 20 years for the intangible assets. The Company’s acquisition of the surety business of Reliance Group Holdings, Inc. (Reliance Surety) (see note 2) included an intangible asset of $450.0 million, which is being amortized on a straight-line basis over a 15-year period.
administrative rules applicable to all insurance enterprises domiciled in a particular state. Permitted statutory accounting practices include practices not prescribed by the domiciliary state, but allowed by the domiciliary state regulatory authority. The impact of any permitted accounting practices on statutory surplus of the Company is not material.
Recoveries from former affiliate consist of the recoveries under the Citigroup indemnification agreement. See note 6.
Other revenues include revenues from premium installment charges, which are recognized as collected, revenues of noninsurance subsidiaries other than fee income and gains and losses on dispositions of assets and operations other than realized investment gains and losses.
The Company has an employee stock incentive compensation plan that includes stock option programs and restricted stock programs. See note 11.
The Company accounts for these programs under the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees”, and related interpretations. Under APB 25 the restricted stock awards are valued based upon fair value at the date of issuance and charged to compensation expense ratably over the vesting period. Prior to the Citigroup Distribution, the restricted stock awards were in Citigroup common stock. The after-tax compensation cost charged to earnings for these restricted stock awards was $17.0 million, $19.4 million and $16.3 million for the years ended December 31, 2002, 2001, and 2000, respectively.
The 2002 pro forma fair value of stock-based employee compensation in the Company’s class A common shares is as follows:
Effective January 1, 2003, the Company adopted the fair value based method of accounting for its employee stock-based compensation plans as defined in FAS 123. FAS 123 indicates that the fair value based method is the preferred method of accounting. The Company has elected to use the prospective recognition transition alternative of FAS 148. Under this alternative only the awards granted, modified or settled after January 1, 2003 will be accounted for in accordance with the fair value method. The Company does not expect the impact of adopting the FAS 123 fair value based method to be significant in 2003.
Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares available during the period. The computation of diluted EPS reflects the effect of potentially dilutive securities, principally the incremental shares which are assumed to be issued under the Company’s 2002 Incentive Plan (see note 11). Excluded from the computation of diluted EPS were 38.6 million of potentially dilutive shares related to convertible junior subordinated notes (see note 8) because the contingency conditions for their issuance have not been satisfied. Shares have been adjusted for all periods to give effect to the recapitalization in March 2002, prior to the IPO, whereby the outstanding shares of common stock (1,500 shares) were changed into 269.0 million shares of class A common stock and 500.0 million shares of class B common stock.
In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46). FIN 46 clarifies the application of Accounting Research Bulletin No. 51, “Consolidated Financial Statements”, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. It separates entities into two groups: (1) those for which voting interests are used to determine consolidation and (2) those for which variable interests are used to determine consolidation (the subject of FIN 46). FIN 46 clarifies how to identify a variable interest entity and how to determine when a business enterprise should include the assets, liabilities, noncontrolling interests and results of activities of a variable interest entity in its consolidated financial statements. FIN 46 is effective immediately for variable interest entities created after January 31, 2003. It also applies to interim periods beginning after June 15, 2003 and to variable interest entities acquired before February 1, 2003. If it is reasonably possible that an enterprise will consolidate or disclose information about a variable interest entity when FIN 46 becomes effective, the enterprise is required to disclose in all financial statements issued after January 31, 2003, the nature, purpose, size and activities of the variable interest entity and the enterprise’s maximum exposure to loss as a result of its involvement with the variable interest entity.
Equity investments that are reported at fair value and have a carrying value of $39.1 million on the balance sheet and private equity investments that are accounted for under the equity method of accounting and have a carrying value of $483.3 million on the balance sheet. The Company’s unfunded commitments associated with private equity investments were $9.7 million.
The Company is currently assessing the impact, if any, that the consolidation provisions of FIN 46 may have on the consolidated financial statements.
In June 2001, the FASB issued Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (FAS 143). FAS 143 changes the measurement of an asset retirement obligation from a cost-accumulation approach to a fair value approach, where the fair value (discounted value) of an asset retirement obligation is recognized as a liability in the period in which it is incurred and accretion expense is recognized using the credit-adjusted risk-free interest rate in effect when the liability was initially recognized. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset and subsequently amortized into expense. The pre-FAS 143 prescribed practice of reporting a retirement obligation as a contra-asset will no longer be allowed. The Company does not expect the impact of this new standard, which will take effect on January 1, 2003, to be significant.
In June 2002, the FASB issued Statement of Financial Accounting Standards No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (FAS 146). FAS 146 requires that a liability for costs associated with exit or disposal activities be recognized when the liability is incurred. Existing generally accepted accounting principles
Commercial Lines is organized into five marketing and underwriting groups, each of which focuses on a particular client base or product grouping to provide products and services that specifically address customers’ needs. The Core marketing and underwriting groups include National Accounts, Commercial Accounts and Select Accounts, and Specialty includes Bond and Gulf.
Commercial Accounts serves primarily mid-sized businesses for casualty products and large, mid-sized and small businesses for property products. Commercial Accounts sells a broad range of property and casualty insurance products, with an emphasis on guaranteed cost products, through a large network of independent agents and brokers. Within Commercial Accounts the Company has a specialty unit which primarily writes coverages for the trucking industry and has dedicated operations that exclusively target the construction industry, providing insurance and risk management services for virtually all areas of construction. These dedicated operations reflect the Company’s focus on industry specialization.
Gulf markets products to national, mid-sized and small customers, and distributes them through both wholesale brokers and retail agents. Gulf provides a diverse product and program portfolio of specialty insurance lines, with particular emphasis on management and professional liability insurance. Products include various types of directors’ and officers’ insurance, fiduciary, employment practices liability insurance, errors and omissions coverages, and fidelity and commercial crime coverages.
Personal Lines writes virtually all types of property and casualty insurance covering personal risks. The primary coverages in Personal Lines are personal automobile and homeowners insurance sold to individuals. These products are distributed through independent agents, sponsoring
Personal 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 man-made 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.
On August 1, 2002, Commercial Insurance Resources, Inc. (CIRI), a subsidiary of the Company and the holding company for the Gulf Insurance Group (Gulf), completed its previously announced transaction with a group of outside investors and senior employees of Gulf. Capital investments made by the investors and employees included $85.9 million of mandatory convertible preferred stock, $49.7 million of convertible notes and $3.6 million of common equity, representing a 24% ownership interest, on a fully diluted basis. The dividend rate on the preferred stock is 6.0%. The interest rate on the notes is 6.0% payable on an interest-only basis. The notes mature on December 31, 2032. Trident II, L.P., Marsh & McLennan Capital Professionals Fund, L.P., Marsh & McLennan Employees’ Securities Company, L.P. and Trident Gulf Holding, LLC (collectively, Trident) invested $125.0 million, and a group of approximately 75 senior employees of Gulf invested $14.2 million. Fifty percent of the CIRI senior employees’ investment was financed by CIRI. This financing is collateralized by the CIRI securities purchased and is forgivable if Trident achieves certain investment returns. The applicable agreements provide for registration rights and transfer rights and restrictions and other matters customarily addressed in agreements with minority investors. Gulf’s results, net of minority interest, are included in the Commercial Lines segment.
On October 1, 2001, the Company paid $329.5 million to Citigroup for The Northland Company and its subsidiaries and Associates Lloyds Insurance Company. These entities
had a combined net book value of $572.1 million. The excess of this net book value over the purchase price was reflected as a contribution to the Company. In addition, on October 3, 2001, the capital stock of Associates Insurance Company, with a net book value of $356.5 million, was contributed to the Company. These acquisitions were accounted for as transfers of net assets between entities under common control. The prior period financial statements were not restated due to immateriality.
In the third quarter of 2000, the Company purchased the renewal rights to a portion of Reliance Group Holdings, Inc.’s commercial lines middle-market book of business. The Company also acquired the renewal rights to Frontier Insurance Group, Inc.’s environmental, excess and surplus lines casualty businesses and certain classes of surety business. The final purchase price for these transactions, which was dependent on the level of business renewed by the Company, was approximately $26.2 million.
At December 31, 2002 and 2001, TPC’s insurance subsidiaries had $2.052 billion and $1.668 billion, respectively, of securities on deposit at financial institutions in certain states pursuant to the respective states’ insurance regulatory authorities.
Proceeds from sales of fixed maturities classified as available for sale were $14.699 billion, $14.469 billion and $12.507 billion in 2002, 2001 and 2000, respectively. Gross gains of $570.9 million, $599.3 million and $267.2 million and gross losses of $148.4 million, $158.6 million and $273.4 million, respectively, were realized on those sales.
Proceeds from sales of equity securities were $127.2 million, $469.7 million and $2.355 billion in 2002, 2001 and 2000, respectively, resulting in gross realized gains of $18.1 million, $61.1 million and $154.3 million and gross realized losses of $13.7 million, $33.4 million and $74.1 million, respectively.
Aggregate annual maturities on mortgage loans are $35.8 million, $28.3 million, $9.0 million, $15.8 million, $40.0 million and $129.0 million for 2003, 2004, 2005, 2006, 2007 and 2008 and thereafter, respectively. There are no mortgage loans that are past due.
Underperforming mortgage loans, which include delinquent loans, loans in the process of foreclosure and loans modified at interest rates below market, were not significant at December 31, 2002 and 2001.
Prior to the Citigroup Distribution, the Company participated in a short-term investment pool maintained by a former affiliate. See note 16.
Included in fixed maturities are below investment grade assets totaling $1.945 billion and $1.748 billion at December 31, 2002 and 2001, respectively. The Company defines its below investment grade assets as those securities rated “Ba1” or lower by external rating agencies, or the equivalent by internal analysts when a public rating does not exist. Such assets include publicly traded below investment grade bonds and certain other privately issued bonds that are classified as below investment grade loans.
Included in net realized investment gains were impairment charges related to other than temporary declines in value of $284.1 million, $146.2 million and $30.9 million for the years ended December 31, 2002, 2001 and 2000, respectively.
In 1996, Lloyd’s of London (Lloyd’s) restructured its operations with respect to claims for years prior to 1993 and reinsured these into Equitas Limited (Equitas). Amounts recoverable from unaffiliated insurers at December 31, 2002 and 2001 include $296.5 million and $247.9 million, respectively, recoverable from Equitas. The outcome of the restructuring of Lloyd’s is uncertain and the impact, if any, on collectibility of amounts recoverable by the Company from Equitas cannot be quantified at this time. It is possible that an unfavorable impact on collectibility could have a material adverse effect on the Company’s results of operations in a future period. However, in the opinion of the Company’s management, it is not likely that the outcome could have a material adverse effect on the Company’s financial condition or liquidity.
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, and other relevant factors. Amounts deemed to be uncollectible, including amounts due from known insolvent reinsurers, are written off and charged against the allowance for estimated uncollectible reinsurance recoverables. Any subsequent collections of amounts previously written off are reported as part of underwriting results.
The allowance for estimated uncollectible reinsurance recoverables was $329.1 million and $286.2 million at December 31, 2002 and 2001, respectively.
In 2001, estimated claims and claim adjustment expenses for claims arising in prior years was a net favorable development of $41.0 million which included $14.4 million of net favorable development which impacted results of operations, primarily related to certain Commercial Lines coverages. The $14.4 million includes favorable development in commercial multi-peril and other claim adjustment expenses partially offset by unfavorable development in general liability, commercial auto liability and specialty businesses. Included in the net unfavorable development in Commercial Lines general liability was $188.8 million for asbestos claims and $45.7 million for environmental claims partly reduced by favorable development of $44.9 million for CIOTA claims. In addition, estimated claims and claim adjustment expenses for claims arising in prior years included net favorable loss development of $43.0 million on Commercial Lines loss sensitive policies in various lines; however, since the business to which it relates is subject to premium adjustments, there is no impact on results of operations.
In 2000, estimated claims and claim adjustment expenses for claims arising in prior years was a net favorable development of $247.0 million which included $76.1 million of net favorable development which impacted results of operations, primarily relating to certain Commercial Lines coverages, predominantly in the commercial multi-peril line of business, and in certain Personal Lines coverages, predominantly personal umbrella coverages. Included in the $76.1 million net favorable development was the impact of unfavorable development of $50.0 million for asbestos claims, $64.4 million for environmental claims and $15.9 million for CIOTA claims. In 2000, Commercial Lines experienced favorable loss development of $53.4 million on loss sensitive policies in various lines; however, since the
The claims and claim adjustment expense reserves included $3.790 billion and $1.216 billion for asbestos and environmental-related claims, net of reinsurance, at December 31, 2002 and 2001, respectively.
It is difficult to estimate the reserves for asbestos and environmental-related claims due to the vagaries of court coverage decisions, plaintiffs’ expanded theories of liability, the risks inherent in major litigation and other uncertainties, including without limitation, those which are set forth below.
Because each policyholder presents different liability and coverage issues, the Company generally evaluates the exposure presented by each policyholder on policyholder-by-policyholder basis. In the course of this evaluation, the Company considers: available insurance coverage, including the role any umbrella or excess insurance the Company has issued to the policyholder; limits and deductibles; an analysis of each policyholder’s potential liability; the jurisdictions involved; past and anticipated future claim activity and loss development on pending claims; past settlement values of similar claims; allocated claim adjustment expense; potential role of other insurance; the role, if any, of non-asbestos claims or potential non-asbestos claims in any resolution process; and applicable coverage defenses or determinations, if any, including the determination as to whether or not an asbestos claim is a products/completed operation claim subject to an aggregate limit and the available coverage, if any, for that claim. Once the gross ultimate exposure for indemnity and related claim adjustment expense is determined for each policyholder by each policy year, the Company calculates a ceded reinsurance projection based on any applicable facultative and treaty reinsurance, as well as past ceded experience. Adjustments to the ceded projections also occur due to actual ceded claim experience and reinsurance collections. Conventional actuarial methods are not utilized to establish asbestos reserves. The Company’s evaluations have not resulted in any meaningful data from which an average asbestos defense or indemnity payment may be determined.
At December 31, 2002, asbestos reserves were $3.404 billion, an increase of $2.584 billion compared to $820.4 million as of December 31, 2001. Net incurred losses and loss adjustment expenses were $2.945 billion for 2002 compared to $188.8 million for 2001. This charge was partially offset by an after tax benefit of $520.0 million, included in revenues, related to recoveries from full utilization of the Citigroup indemnification agreement. The increase in reserves is based on the Company’s analysis of asbestos claims and litigation trends. As part of a periodic, ground-up study of asbestos reserves, the Company studied the implications of these and other significant developments, with special attention to major asbestos defendants and non-products claims alleging that the Company’s coverage obligations are not subject to aggregate limits. In addition, Company management expanded its historical methodology in response to recent trends. This included further categorization of policyholders, conducting a detailed examination of recent claim activity from policyholders reporting claims for the first time, and conducting a detailed review of past settlements.
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 based upon substantial progress in negotiations during the fourth quarter of 2002. The Company’s single payment contribution to the proposed settlement, expected in June 2004, is approximately $388.8 million after reinsurance.
At December 31, 2001, TPC had a note payable to Citigroup in the amount of $1.198 billion, in conjunction with the purchase of TIGHI’s outstanding shares in April 2000 (see note 2). On February 7, 2002, this note payable was replaced by a new note agreement. Under the terms of the new note agreement, interest accrued on the aggregate principal amount outstanding at the commercial paper rate (the then current short-term rate) plus 10 basis points per annum. Interest was compounded monthly. This note was prepaid following the offerings.
At December 31, 2000, TPC had a note payable to Citigroup, which had a principal balance outstanding of $287.0 million. Interest accrued at a rate of 5.06%, compounded semi-annually. On March 29, 2001, this note was repaid in its entirety, plus accrued interest.
been presented herein or in any separate reports filed with the Securities and Exchange Commission because management has determined that such financial statements would not be material to holders of TIGHI debt. The guarantees pertain to the $150.0 million 6.75% Notes due 2006 and the $200.0 million 7.75% Notes due 2026 included in long-term debt and the $900.0 million of TIGHI-obligated mandatorily redeemable securities of subsidiary trusts holding solely junior subordinated debt securities of TIGHI (TIGHI Securities). TIGHI has the right, at any time, to defer distributions on the TIGHI Securities for a period not exceeding 20 consecutive quarterly interest periods (though such distributions would continue to accrue interest during any such extended payment period). TIGHI cannot pay dividends during such deferments.
Additional tax benefits attributable to employee stock plans allocated directly to shareholders’ equity were $2.6 million, $.3 million and $.4 million for the years ended December 31, 2002, 2001 and 2000, respectively.
The current federal income tax payable at December 31, 2002 and 2001 was $179.5 million and $155.3 million, respectively.
TIGHI formed statutory business trusts under the laws of the state of Delaware, which exist for the exclusive purposes of (i) issuing Trust Securities representing undivided beneficial interests in the assets of the Trust; (ii) investing the gross proceeds of the Trust Securities in Junior Subordinated Deferrable Interest Debentures (Junior Subordinated Debentures) of its parent; and (iii) engaging in only those activities necessary or incidental thereto. These Junior Subordinated Debentures and the related income effects are eliminated in the consolidated financial statements. The financial structure of each of Travelers P&C Capital I and Travelers P&C Capital II (the subsidiary trusts) at December 31, 2002 and 2001 was as follows:
The subsidiary trusts will use the proceeds from any redemption of TIGHI Securities to redeem a like amount of TIGHI Debentures.
On January 23, 2003, the Company, through its Capital Accumulation Program (CAP), issued 1,943,627 shares of class A common stock in the form of restricted stock to participating officers and other key employees. The fair market value per share of the class A common stock was $16.18. The restricted stock generally vests after a three-year period. See note 11.
Ten business days after the announcement that a person is making a tender or exchange offer for 15% or more of the Company’s general voting power or acquires 15% or more of the Company’s general voting power (other than as a result of repurchases of stock by the Company or through inadvertence by certain shareholders that subsequently divest all excess shares as set forth in the rights agreement), the Rights detach from the common stock and become freely tradable and exercisable, entitling a holder to purchase one-thousandth of a share in the Company’s series A junior participating preferred stock at $77.50, subject to adjustment.
If a person becomes the beneficial owner of 15% or more of the Company’s general voting power, each Right will entitle its holder to purchase $155 market value of the Company’s common stock for $77.50. If the Company subsequently merges with another entity or transfers 50% or more of its assets, cash flow or earnings power to another entity, each Right will entitle its holder to purchase $155 market value of such other entity’s common stock for $77.50. The Company may redeem the Rights, at its option, at $0.01 per Right, prior to any person acquiring beneficial ownership of at least 15% of the Company’s common stock. The shareholder rights plan is designed primarily to encourage anyone seeking to acquire the Company to negotiate with the Board of Directors.
During September 2002, the Board of Directors approved a $500.0 million share repurchase program. Purchases of class A and class B common stock may be made from time to time through September 2004 in the open market, and it is expected that funding for the program will principally come from operating cash flow. There were no shares repurchased under this plan in 2002.
The Company also has a commitment in conjunction with the Citigroup Distribution, for which it prepaid $15.1 million, to acquire class A and class B common stock Distribution shares held by the Citigroup Capital Accumulation Program (CAP) upon forfeiture of plan participants. See note 11. This commitment expires over three years upon vesting of the Citigroup CAP participants. At December 31, 2002, TPC had acquired $1.3 million of its common stock pursuant to this arrangement.
Shares acquired under these plans are authorized and unissued and are reported as treasury stock in the consolidated balance sheet.
Statutory net income (loss) of TPC’s insurance subsidiaries was ($973.6) million, $1.090 billion and $1.368 billion for the years ended December 31, 2002, 2001 and 2000, respectively. Statutory capital and surplus of TPC’s insurance subsidiaries was $7.287 billion and $7.687 billion at December 31, 2002 and 2001, respectively. Effective January 1, 2001, the Company began preparing its statutory basis financial statements in accordance with the NAIC Accounting Practices and Procedures Manual subject to any deviations prescribed or permitted by its domiciliary insurance commissioner (see note 1, Summary of Significant Accounting Policies, Permitted Statutory Accounting Practices). The impact of this change was an increase to the statutory capital and surplus of the TPC’s insurance subsidiaries of approximately $350.0 million. In addition, the acquisition of The Northland Company and Associates Lloyds Insurance Company and the contribution of Associates Insurance Company (see note 2) increased the statutory capital and surplus of TPC’s insurance subsidiaries by approximately $340.0 million as of December 31, 2001.
Certain equity investments were reclassified to other investments at December 31, 2002. See note 1. As a result of this change, the realized gains/(losses) from these investments are reported in net income beginning in 2002.
On August 20, 2002, in connection with the Citigroup Distribution, Citigroup stock option awards held by Company employees on that date under Citigroup’s various stock option plans were cancelled and replaced with stock option awards (replacement awards) to purchase the Company’s class A common stock under the Company’s own incentive plan. These replacement awards were granted on substantially the same terms, including vesting, as the former Citigroup awards. The total number of the Company’s class A common stock subject to the replacement awards was 56.9 million shares of which 24.6 million shares were then exercisable. The number of shares of the Company’s class A common stock to which the replacement options relate and the per share exercise price of the replacement options were determined so that:
the intrinsic value of each Citigroup option, which was the difference between the closing price of Citigroup’s common stock on August 20, 2002 and the exercise price of the Citigroup options, was preserved in each replacement option for the Company’s class A common stock; and
the ratio of the exercise price of the replacement option 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.
The Company, through its Capital Accumulation Program (CAP) established pursuant to the 2002 Incentive Plan, issues shares of the Company’s common stock in the form of restricted stock awards to eligible officers and key employees. Certain CAP participants may elect to receive part of their awards in restricted stock and part in stock options. The number of shares included in the restricted stock award is calculated at a 25% discount from the market price at the time of the award and generally vest in full after a three-year period. Except under limited circumstances, during this period the stock cannot be sold or transferred by the participant, who is required to render service to the Company during the restricted period.
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 2002.
The after-tax compensation cost charged to earnings for these restricted stock awards was $17.0 million, $19.4 million and $16.3 million for the years ended December 31, 2002, 2001 and 2000, respectively.
On August 20, 2002, in connection with the Citigroup Distribution, the Company established a 401(k) savings plan under which substantially all employees are eligible to participate. The Company matches employee contributions up to 3% of eligible pay but not more than $1,500 annually. The expense related to this plan was $17.0 million for the year ended December 31, 2002. Prior to the IPO and the Citigroup Distribution, substantially all the Company employees were eligible to participate in a 401(k) savings plan sponsored by Citigroup, for which there was no Company matching contribution for substantially all employees.
The fair value effect of stock options reported in note 1, Stock-Based Compensation, is derived by application of a variation of the Black-Scholes option pricing model.
In accordance with FAS 123, the exchange of options in conjunction with a spinoff is considered a modification and therefore the modification guidance was applied to the replacement awards issued on August 20, 2002. For vested replacement options, any excess of the fair value of the modified options issued over the fair value of the original options at the date of exchange was recognized as additional compensation cost. For nonvested replacement options, any excess of the fair value of the modified options issued over the fair value of the original options at the date of exchange is added to the remaining unrecognized compensation cost of the original option and recognized over the remaining vesting period.
Awards issued prior to 2002 were granted in Citigroup stock options. The fair value effect of stock options reported in note 1, Stock-Based Compensation, for 2001 and 2000 applied assumptions underlying the Citigroup stock option plan. The significant assumptions used for prior years in estimating the fair values for Citigroup stock options were as follows:
All original and reload stock options granted under the TPC stock option programs had an exercise price equal to the market value of the Company’s class A common stock on the date of the grant. The replacement awards granted on August 20, 2002 retained the intrinsic value of the awards immediately prior to conversion and therefore the exercise price either exceeded the market value or was less than the market value on August 20, 2002. The following table presents the weighted average exercise price and
weighted average grant date fair value information with respect to these grants:
Beginning August 20, 2002, TPC sponsors qualified and nonqualified non-contributory defined benefit pension plans covering substantially all employees. These plans provide benefits under a cash balance formula, except that employees satisfying certain age and service requirements remain covered by a prior final pay formula. TPC also provides postretirement health and life insurance benefits for employees satisfying certain age and service requirements who retire after the Citigroup Distribution. Prior to the Citigroup Distribution, substantially similar benefits were provided to TPC employees through plans sponsored by Citigroup.
Under agreements with Citigroup, TPC assumed liabilities for nonqualified pension, postretirement health care and life insurance benefit liabilities related to active Company plan participants as of August 20, 2002. The initial projected benefit obligation of the Company’s nonqualified pension plan at August 20, 2002 was $21.3 million. Because Citigroup assumed liabilities for the same benefits for retired or inactive plan participants, the Company transferred short-term securities of $171.1 million and recorded a payable of $13.5 million in 2002 to Citigroup affiliated companies, and reduced other liabilities and deferred taxes by $284.0 million and $99.4 million, respectively, related to retired or inactive employees, pending final agreements on the amounts. Final agreement on settlement amounts was reached and an additional $2.2 million is expected to be paid to Citigroup during the first quarter of 2003.
The following tables summarize the funded status and amounts recognized in the consolidated balance sheet for TPC’s plans.
As an indicator of sensitivity, increasing the assumed health care cost trend rate by 1% would have increased the accumulated postretirement benefit obligation as of December 31, 2002 by $.8 million and the aggregate of the service and interest cost components of 2002 net postretirement benefit expense by less than $.1 million. Decreasing the assumed health care cost trend rate by 1% would have decreased the accumulated postretirement benefit obligation as of December 31, 2002 by $.7 million and the aggregate of the service and interest cost components of 2002 net postretirement benefit expense by less than $.1 million.
The Company uses derivative financial instruments, including interest rate swaps, equity swaps, credit derivatives, options, financial futures and forward contracts, as a means of hedging exposure to interest rate, equity price change and foreign currency risk. The Company’s insurance subsidiaries do not hold or issue derivatives for trading purposes.
Beginning January 1, 2001, the Company adopted FAS 133, which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities. It requires that an entity recognizes all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. Where applicable, hedge accounting is used to account for derivatives.
For fair value hedges, changes in the fair value of derivatives are reflected in realized investment gains (losses), together with changes in the fair value of the related hedged item. The Company did not utilize fair value hedges during the years ended December 31, 2002 and 2001.
Derivatives that are either hedging instruments that are not designated or do not qualify as hedges under the new rules are also carried at fair value with changes in value reflected in realized investment gains (losses). The Company has certain foreign currency forward contracts, which are not designated as hedges at December 31, 2002 and 2001.
At December 31, 2002 and 2001, investments in fixed maturities had a fair value, which equaled carrying value, of $30.003 billion and $25.851 billion, respectively. The fair value of investments in fixed maturities for which a quoted market price or dealer quote are not available was
At December 31, 2002 and 2001, the carrying value of $700.0 million and $1.698 billion, respectively, of the notes payable to former affiliates approximated their fair value. Fair value is based upon discounted cash flows.
In the normal course of business, the Company has unfunded commitments to partnerships, joint ventures and certain private equity investments in which it invests. These commitments were $864.3 million and $1.025 billion at December 31, 2002 and 2001, respectively.
The Company is involved in numerous lawsuits, other than asbestos and environmental claims, arising mostly in the ordinary course of business operations either as a liability insurer defending third-party claims brought against insureds or as an insurer defending coverage claims brought against it. While the ultimate resolution of these legal proceedings could be significant to the Company’s results of operations in a future quarter, in the opinion of the Company’s management it would not be likely to have a material adverse effect on the Company’s results of operations for a calendar year or on the Company’s financial condition or liquidity.
Prior to the Citigroup Distribution, a former affiliate maintained a short-term investment pool in which the Company participated. The positions of each company participating in the pool were calculated and adjusted daily. At December 31, 2001, the total of the pool and the Company’s share of the pool were $5.632 billion and $2.406 billion, respectively. Subsequent to the Citigroup Distribution, the former affiliate, which provides investment and advisory services to the Company (see note 1), established a separate investment pool for the Company.
Included in revenues in the consolidated statement of income (loss) is $520.0 million from the Citigroup indemnification agreement in 2002. At December 31, 2002, other assets in the consolidated balance sheet include a $360.6 million receivable under the Citigroup indemnification agreement. See note 6.
At December 31, 2000, the Company had a note payable to Citigroup of $287.0 million. This was repaid during 2001. Interest expense included in the consolidated statement of income was $3.5 million and $48.8 million in 2001 and 2000, respectively. See note 8.
Due to the averaging of shares, quarterly earnings per share may not add to the total for the full year.