GRC Realty Corporation, also a wholly owned subsidiary of the Corporation, has retained title to the Group's former home office site in Greenwich, Connecticut. This site consists of approximately four acres of land and an office building which has about 160,000 square feet of office space that is rented to non-affiliates. The Greenwich site is subject to a mortgage expiring December 31, 1998, which had a remaining balance of $7 million at December 31, 1994.
(5) Excludes the investments of Cologne Re and GR-CK of $5,301 million as of December 31, 1994.
(6) The common share price information is based on the Corporation's daily closing price on the New York Stock Exchange.
Net income in 1994 was $665 million or $7.97 per share, a decrease of 3.7 percent over $8.28 per share earned in 1993. These results include after-tax realized gains of $.54 per share in 1994 and $1.10 per share in 1993. Net income in 1993 also included a cumulative benefit of $.17 per share resulting from the adoption of the accounting prescribed by the Emerging Issues Task Force for multiple-year, retrospectively rated reinsurance contracts. Excluding after-tax realized gains and cumulative-effect adjustments, after-tax income for the year ended December 31, 1994 was $7.43 per share, an increase of 6.0 percent over $7.01 per share in 1993.
Net income in 1993 was $711 million or $8.28 per share, an increase of 9.7 percent over $7.55 per share earned in 1992. These results include after-tax realized gains of $1.10 per share in 1993 and $1.54 per share in 1992. Net income in 1992 also includes a cumulative benefit of $.71 per share resulting from the adoption of SFAS 109. Excluding after-tax realized gains and cumulative-effect adjustments, income for 1993 was $7.01 per share, an increase of 32.3 percent over $5.30 per share in 1992.
Consolidated net investment income was $755 million in 1993, unchanged from 1992 levels, as the benefit from increased cash flow from operations available for investment was offset by lower investment portfolio yields. The consolidated pretax investment yield on invested assets (excluding GRFP's invested assets) of 6.5 percent in 1993 declined from 7.0 percent in 1992. Investment income for the domestic property/casualty operations was $705 million in 1993, a slight increase from the $703 million earned in 1992. Net investment income for the international property/casualty operations declined 8.5 percent to $43 million in 1993, compared with $47 million in 1992. The financial services operations had investment income of $7 million in 1993, compared with $5 million in 1992.
The statutory combined underwriting ratio is computed based on the relationship of losses and underwriting expenses to premiums. This ratio is the Corporation's principal indicator of underwriting performance, with 100 percent or lower generally indicating a statutory underwriting profit. In 1994, the combined ratio for the domestic property/casualty segment was 101.3 percent, compared to 101.5 percent in 1993 and 108.4 percent in 1992. The 1994 underwriting result fell short of the Corporation's objective of an underwriting profit primarily due to the Northridge earthquake. Improvement in the 1993 combined ratio over 1992 was largely attributable to lower catastrophe claims in 1993 as Hurricanes Andrew and Iniki adversely impacted 1992's underwriting result. While the 1993 underwriting result did not meet the Corporation's goal of an underwriting profit, the improvement over 1992 was achieved in a difficult environment for both the economy in general, and for insurers and reinsurers, specifically.
While the domestic primary insurance market grew by about 4 percent, General Reinsurance Corporation's ("GRC") premiums grew by 15.0 percent during 1994. The Corporation believes that the growth in its premiums written is due to its marketing efforts, the increase in insurance premiums written by medium and smaller-sized primary companies that generally purchase relatively more reinsurance, increased reinsurance cessions by primary companies seeking to deleverage their capital in response to rating agency concerns and increased demand by primary companies for reinsurance from better capitalized and more credit-worthy reinsurers.
Net income for the international property/casualty operations of $35 million in 1994 increased 152.9 percent over 1993 levels. Included in these results were after-tax realized gains of $6 million in 1994. Growth in the income for the international property/casualty operations resulted principally from an underwriting profit of $6 million in 1994, compared to an underwriting loss of $13 million in 1993. Underwriting results improved over 1993 due to stronger pricing and demand in higher margin businesses, particularly in the Corporation's European operations. International premiums written of $420 million in 1994 increased $171 million, or 69.0 percent, over 1993 premiums of $249 million. The premium growth reflects continued expansion of existing client relationships, an increase in reinsurance rates, and development of new reinsurance relationships, particularly in European operations. In 1994, the Corporation combined its subsidiaries located in the United Kingdom and Switzerland to enhance client service and to improve capital efficiency in the European markets. Premium growth in 1994 also resulted from expanded operations in Madrid and the opening of new offices in Cologne, Milan, Paris and Singapore during the past two years.
CKAG Group will receive an annual Class A cash dividend which is based on a formula and is estimated to be approximately DM 36 million. The Corporation will also receive an annual Class B cash dividend of 50.1 percent of GR-CK's distributable income, as defined in the joint venture agreement. It is expected that Cologne Re may increase its capital through an offering of equity securities in the first half of 1995. In connection with this equity offering, GR-CK anticipates it will use approximately DM 300 million of its funds to purchase additional Cologne Re shares. Since the closing occurred at the end of 1994, the transaction did not have a material effect on the Corporation's results from operations. Due to the ownership and control structure of GR-CK and Cologne Re, the Corporation has consolidated GR-CK and Cologne Re in its balance sheet at December 31, 1994.
GRFP is engaged as a dealer in derivative financial products, such as interest rate and foreign currency swaps, foreign exchange contracts, options, and swap options. GRFP's gross trading revenue was $135 million in 1994, compared with $142 million in 1993 and $41 million in 1992. During 1994, higher global interest rates reduced capital market activity, thus lowering demand for derivative products. In addition, the Corporation believes concerns regarding the appropriate use of derivative products by certain end users in the United States reduced the overall market demand for derivative products. Despite these limiting factors, GRFP's trading revenue in 1994 only decreased 5.2 percent as compared to 1993.
GRFP closely monitors its derivatives operations and actively manages its open positions to control its exposures. GRFP hedges its exposure to market risk (which includes foreign exchange, interest rate, swap spread, volatility, and yield curve risks) in connection with its dealer activities by purchasing or selling futures contracts, entering into forward foreign exchange contracts, purchasing or selling government securities or entering into offsetting transactions. Market risk is kept within conservative tolerance limits and is monitored on a daily basis across all swap and option products. In accordance with mark-to-market accounting, GRFP evaluates and records a fair-value adjustment against trading revenue to recognize counterparty credit exposure and future costs associated with administering each contract. The expected credit exposure for each trade is initially established on the trade date and is determined through the use of a proprietary credit exposure model that is based on historical default probabilities, market volatilities and, if applicable, the legal right of set off. These exposures are continually monitored and adjusted due to changes in the credit quality of the counterparty, changes in interest and currency rates or changes in other factors affecting credit exposure. The fair value allowance for counterparty credit exposures and future administrative costs on existing contracts was $55 million and $44 million at December 31, 1994 and 1993, respectively. GRFP has not experienced any counterparty defaults or writeoffs on such contracts.
The Corporation's insurance and reinsurance brokerage operations also contributed to the increased profitability of the financial services segment in 1994. In addition, investment management fees increased due to growth in the business of the Corporation's investment management subsidiary, GRAM. The Corporation's investment management clients are other insurance companies, primarily reinsurance clients, that seek the Corporation's expertise in managing insurance company investment portfolios.
At December 31, 1994, total assets were $29,597 million, compared with $19,419 million at December 31, 1993. Included in the December 31, 1994 balance sheet was $9,325 million of GR-CK assets related to the Cologne Re joint venture. Excluding the Cologne Re joint venture, total assets increased during 1994 by 7.4 percent, or $1,435 million, to $20,854 million at December 31, 1994. This growth in assets was attributable to an increase of $566 million in the total assets of the domestic property/casualty operations, $223 million in the international property/casualty operations and $646 million in the financial services segment.
Effective January 1, 1994, the Corporation adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. The Statement addresses accounting for investments in equity and debt securities and requires these investments to be classified into three categories. Debt securities that the Corporation has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading and reported at fair value, with unrealized gains and losses included in income. Other debt that is not classified as either held-to-maturity or trading and equity securities not classified as trading are included in available-for-sale securities and reported at fair value, with unrealized gains and losses, net of deferred income taxes, excluded from income and reported in a separate component of common stockholders' equity. The effect of Statement No. 115 decreased the reported fair value of invested assets by $123 million at December 31, 1994. The Statement's adoption had no effect on the Corporation's results from operations.
The overall pretax yield on domestic invested assets (excluding GRFP) was 5.9 percent in 1994, compared to 6.4 percent in 1993. The decline in the domestic investment portfolio's pretax yield reflects the shift in assets from taxable to tax-exempt bonds, the decline in market interest rates in recent years and the increased amount of calls of higher coupon investments during this period. The increase in market rates of interest during 1994 had a minimal impact on 1994's investment income.
Included in fixed maturities were mortgage-backed securities ("MBS") of $629 million (3.3 percent of consolidated invested assets) and asset-backed securities ("ABS") of $244 million (1.3 percent of consolidated invested assets) at December 31, 1994. These securities have interest and principal repayment patterns that differ from typical fixed maturities. MBS issued by quasi-federal agencies, federally supported institutions and corporations can either be direct pass-throughs of cash flows from the underlying mortgages or can be a
The Corporation continues to place strong emphasis on credit research. Credit considerations are an important part of the Corporation's fixed maturity investment strategy. At December 31, 1994, the Corporation had no bond issues in default. Bonds rated below investment grade represented less than .5 percent of the portfolio. The overall fixed-maturity portfolio continued to average a credit rating of AA. The distribution of the Corporation's domestic fixed-maturity portfolio by credit quality was as follows:
A small portion of the domestic investment portfolio was dedicated to non-traditional, private investments. These alternative investments, included in the balance sheet caption, "other invested assets", were $325 million (1.7 percent of consolidated invested assets) at December 31, 1994. Most of these investments are interests in limited partnerships run by professional managers. Over time, these investments are expected to provide a higher return than the overall portfolio. This segment, however, also may entail a greater amount of risk both in terms of limited liquidity and greater uncertainty of returns compared to the rest of the Corporation's investment portfolio. The Corporation evaluates the fair value of these alternative investments on a quarterly basis by reviewing available financial information of the investee and by performing other financial analyses in consultation with external advisers. Any changes in the fair value of limited partnerships are included as unrealized appreciation or depreciation in common stockholders' equity, unless a decline in fair value is considered other than temporary, resulting in a charge to income.
The Corporation's international property/casualty subsidiaries held investment portfolios of $6,060 million at December 31, 1994. These portfolios include $4,719 million of Cologne Re's investments, $582 million of GR-CK investments and $759 million in pre-existing international operations. At December 31, 1994, Cologne Re's portfolio was invested approximately 70 percent in fixed maturities, 13 percent in equity securities and 17 percent in short-term and other investments. Cologne Re's investment portfolio is geographically diversified with most fixed maturities having terms of less than five years. Cologne Re's investments are primarily managed by internal investment managers and smaller portfolios are managed by local professional asset managers.
The investments held by GR-CK are all denominated in German marks as stipulated by the investment guidelines of the joint venture agreement.
The invested assets of the Corporation's pre-existing international subsidiaries were $759 million at December 31, 1994. This portfolio was invested approximately 75 percent in fixed maturities, 15 percent in equities
The Corporation's gross liability for claims and claim expenses, which provides for future obligations arising from current and prior property/casualty reinsurance and insurance transactions, amounted to $12,158 million at December 31, 1994. Growth in the liability of $3,706 million during 1994 is due to $3,135 million associated with the Cologne Re joint venture and $571 million from pre-existing international operations. In addition to the gross liability for property/casualty claim and claim expenses, the Corporation, through its interest in Cologne Re, has a gross liability for future policy benefits for life and health contracts of $1,960 million. The asset for reinsurance recoverable on paid and unpaid losses was $2,067 million at December 31, 1994, compared to $1,476 million at December 31, 1993. Growth of $591 million in the asset is due to $373 million associated with Cologne Re ($224 million for property/casualty business and $149 million related to life and health business) and $218 million from pre-existing operations.
The Corporation continually estimates its liabilities and related reinsurance recoveries for environmental and latent injury claims and claim expenses. These exposures do not lend themselves to traditional methods of loss development determination and therefore may be considered less reliable than reserves for standard lines of
business (e.g., automobile). The estimate is composed of four parts: known claims, development on known claims, IBNR and direct excess coverage litigation expenses. Although reliability is constrained by uncertainties, the Corporation has confidence in the reported, known claim liabilities, and based on alternative methods, has projected a fairly reliable estimate of development for these claims. The Corporation has also included an estimate for IBNR which is based on fitted curves of estimated future claim emergence; this estimate is less reliable than the estimated liability for reported claims. The effect of joint and several liability on the severity of claims and a provision for future claims inflation have been included in the loss development estimate.
The Corporation has established a liability for litigation costs associated with coverage disputes arising primarily from direct excess insurance policies. The Corporation's subsidiaries were parties in approximately 120 active direct coverage cases at December 31, 1994. Such coverage litigation expenses are estimated using an actuarial forecast of actionable items and their projected costs. The Corporation paid $10 million in such costs during 1994 and as of December 31, 1994 the liability for future litigation costs related to coverage disputes was $174 million (included in the table above). The Corporation has not recorded any reinsurance recoveries for these liabilities.
As coverage disputes are tried and verdicts rendered, the Corporation expects that settled case law will result in a downward trend in future coverage litigation expenses. Because reinsurance contracts generally contain arbitration clauses which control disputes between the ceding company and the reinsurer, the Corporation does not expect the future costs associated with reinsurance disputes to be material.
GRC, the principal domestic operating subsidiary, has a claims-paying rating of AAA from Standard & Poor's and a financial strength rating of Aaa from Moody's. GRC is also rated A++ by A.M. Best Company, a leading insurance industry rating agency. Each of these ratings represents the highest category for the respective rating agency.
The Corporation's cash flow from operations was $2,410 million in 1994, compared with negative $278 million in 1993, and positive $627 million in 1992. The Corporation's negative operating cash flow in 1993 was not a result of a deterioration in the Corporation's liquidity or profitability. Rather, the negative operating cash flow resulted from the requirement under generally accepted accounting principles to disaggregate GRFP's interrelated cash flows into operating, investing, and financing activities. GRFP hedges its open derivative product positions by the purchase or sale of government securities. These transactions are classified as operating activities in the statement of cash flows. GRFP finances its security purchases through collateralized repurchase agreements which are characterized as financing activities in the cash flow statement. The Corporation invests its short-term cash proceeds in securities purchased under agreements to resell ("reverse repos"), which are characterized as investing activities in the cash flow statement. The disaggregation of these interrelated cash flows for financial reporting purposes creates variability in reported operating cash flow of the financial services segment without a corresponding effect on results from operations.
1987. In February 1994, the Corporation's Board of Directors authorized an additional repurchase of up to $250 million of common stock. At December 31, 1994, the Corporation had $100 million available under Board authorized repurchase programs and additional standing authority to repurchase shares in anticipation of shares to be issued under various compensation plans. On February 8, 1995, the Board of Directors declared a regular quarterly dividend of $.49 per share on the common stock of the Corporation. This represents an increase of 2.1% over the $.48 per share dividend paid in prior quarters of 1994 and the 19th consecutive year in which the Corporation has had a dividend increase.
The consolidated financial statements include estimated liabilities for unpaid claims and claim expenses of the Corporation's domestic and international property/casualty reinsurance subsidiaries. The provision for reported but unpaid claims and claim expenses is based on audited client reports and individual case estimates, including anticipated salvage and subrogation recoverable. A provision is included for incurred but not reported ("IBNR") claims and claim expenses on the basis of past experience. Historic premium, claim and claim expense data are organized in actuarial formats, analyzed for credibility, and processed through actuarial formulae. Using actuarial judgment, forecasts of IBNR claims and claim expenses are determined and tested for validity. The Corporation strives for accuracy in its reserving structure and monitors its predictions against actual claims and claim expense emergence. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and updated. All adjustments to the reserve structure (which encompasses claims from up to 50 years ago) are included in current operating results.
The actuary relied upon by management in forming the basis of its belief as to the adequacy of reserves is Lee R. Steeneck, FCAS, MAAA, a Vice President of GRC. In addition to the ongoing review by management, these liabilities are subject to independent review on a regular basis. The Corporation's independent public accountants use actuaries during their annual financial statement audit to review both current balance sheet liabilities and charges to the income statement. In addition, the Audit Committee of the Board of Directors has periodically engaged the services of an actuarial consulting firm to compare the reserve liabilities established by management with the estimates of an independent consulting actuary.
The table below provides a reconciliation of the beginning and ending claim and claim expense liability, net of reinsurance, for 1994, 1993 and 1992.
The Corporation discounts certain domestic workers' compensation loss reserves at an interest rate of 4.5 percent per annum, the same rate used for reporting to state regulatory authorities with respect to the same claim liabilities. These claims are characterized by periodic indemnity payments principally for wage loss and
medical/rehabilitation expenses which are generally fixed or determinable, both in amount and duration. The amortization of the discount is included in current operating results as part of the development of prior years' liabilities. The effect of discounting was to reduce liabilities for claims and claim expenses, net of reinsurance, as follows:
Table 3 reconciles the difference between liabilities for claims and claim expenses, net of reinsurance, reported in the consolidated financial statements under generally accepted accounting principles ("GAAP") with that reported in annual statements filed with state insurance regulators in accordance with SAP.
Table 4 presents the development of net balance sheet liabilities for the Corporation's property/casualty operations from 1984 through 1994. Table 5 presents the development of the gross balance sheet liability for the Corporation's property/casualty operations from 1992 through 1994. Reference is made to Exhibit 28, "Combined Domestic Property/Casualty Insurance Company Schedule P" for a more detailed review of SAP liabilities on an accident year basis. Claim and claim expense liabilities associated with the Cologne Re joint venture are included in the Corporation's liabilities in Table 4 and Table 5 at December 31, 1994, although the joint venture had no effect on claim development during 1994 and prior years. The accident-year information required to complete Table 4 and Table 5 for the Corporation's other international subsidiaries was not available in prior years. Although the related amounts were not significant to the consolidated total in prior years, these amounts have been included beginning in 1994. The net liabilities for unpaid claims and claim expenses of these international operations and percentages of the consolidated total were $378 million or 3.7 percent for 1994, $253 million or 3.6 percent for 1993 and $202 million or 3.0 percent for 1992.
A number of major trends occurred within the industry which have significantly affected the development of the Corporation's liabilities for claims and claim expenses displayed in Table 4. Starting in 1980, the Corporation considerably strengthened the liability for claims and claim expenses for latent injury (e.g., asbestos-related) and environmental (e.g., pollution) claims. When originally written, these exposures, some dating back to the 1940s, were not known to cause bodily harm or property damage. Coverage, if any, was provided to policyholders on a very limited basis. Liberal interpretations of very carefully worded insurance policy contract language have, in retrospect, created unanticipated liabilities for the property/casualty insurance industry. The cumulative deficiency in the Corporation's historical liabilities shown in Table 4 reflects development of environmental and latent injury damage claims. Adjustments to the Corporation's liabilities have been made in each year's current operating results since 1980 to reflect the evolution of case law which has widened the nature and extent of insurance and reinsurance coverage for these exposures.
Between 1983 and 1987, the Corporation strengthened its reserves for reinsurance of medical malpractice liability insurance business written on the occurrence form. The crisis in medical malpractice insurance led the Corporation to eliminate occurrence coverage and solely reinsure on a claims made basis. Reinsurance of other classes of professional liability coverage is also generally written on a claims made basis. Patterns of reinsurance liability emergence for claims made coverages differ substantially from such patterns for occurrence coverages.
The Corporation purchases reinsurance, in both the domestic and international markets, which provides protection from large property, liability or workers' compensation claims and allows the Corporation to offer greater capacity to clients for certain lines of business. The Corporation has increased its capacity over time by retaining more risk and by purchasing additional reinsurance protection above its retentions.
As discussed in Note 2 to the consolidated financial statements, the Corporation adopted Financial Accounting Standards No. 109, and accordingly, changed its method of accounting for income taxes in 1992.
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN MILLIONS, EXCEPT SHARE DATA)
In 1993, the Corporation adopted the accounting prescribed by the Emerging Issues Task Force for multiple-year, retrospectively rated reinsurance contracts. The pro forma effect of adopting the consensus would have resulted in net income of $618 million ($7.10 per share) in 1992.
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN MILLIONS)
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1994, 1993 AND 1992 (IN MILLIONS)
BASIS OF PRESENTATION: The Corporation's consolidated financial statements have been prepared on the basis of generally accepted accounting principles. The consolidated financial statements include the Corporation and its subsidiaries. All significant intercompany transactions have been eliminated. Certain international subsidiaries report their results on a quarter lag. This practice has no material effect on the consolidated financial statements.
Certain reclassifications have been made to 1993 and 1992 balances to conform to the 1994 presentation.
INVESTMENTS: Effective for 1994, fixed maturity securities that the Corporation has both the ability and intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. Fixed maturity securities that the Corporation may sell prior to maturity in response to changes in market interest rates, changes in liquidity needs, or other factors and equity securities are classified as available-for-sale and carried at fair value, with unrealized gains and losses, net of deferred income taxes, excluded from income and reported in a separate component of common stockholders' equity. Fixed maturity securities that are held for resale are classified as trading and carried at fair value, with unrealized gains and losses included in income. In 1993, fixed maturity securities that the Corporation might have sold prior to maturity in response to changes in market interest rates, changes in liquidity needs or other factors were carried at the lower of aggregate amortized cost or fair value. These securities, which are shown in the balance sheet as comparable to the available-for-sale category utilized in 1994, are carried at fair value commencing in 1994. See Note 2, "Accounting Changes", for additional discussion of the Corporation's adoption of Statement of Financial Accounting Standards No. 115.
unexpired portion of premiums written. Such liabilities are computed by pro rata methods based on statistical data and reports received from ceding companies. Premium adjustments on contracts and audit premiums are accrued on an estimated basis throughout the contract term. Premiums are net of retrocessions.
ACQUISITION COSTS: Acquisitions costs, consisting principally of commissions and brokerage expenses incurred at contract issuance, are deferred and amortized over the contract period in which the related premiums are earned, generally one year. Deferred acquisition costs are reviewed to determine that they do not exceed recoverable amounts, after considering investment income.
DEFERRED CHARGES: Deferred charges ($41 million and $48 million at December 31, 1994 and 1993, respectively), which arose from certain reinsurance contracts, are amortized over the periods in which the related investment income is expected to be earned.
CLAIMS AND CLAIM EXPENSES: The liability for claims and claim expenses is based on reports and individual case estimates received from ceding companies. The liability also includes incurred but not reported losses, which are based on past experience and is reduced by anticipated salvage and subrogation recoverable. The methods of determining such estimates and establishing the related liabilities are regularly reviewed and updated, and any resulting adjustments are currently included in income. Reinsurance recoveries on unpaid claims and claim expenses, net of uncollectible amounts, are recognized as assets at the same time and in a manner consistent with the Corporation's method for establishing the related liability. Workers' compensation liabilities, after deduction of reinsurance recoverable for unpaid losses, were $1,186 million and $1,212 million at December 31, 1994 and 1993, respectively, after being discounted at an interest rate of 4.5 percent.
PRESENT VALUE OF FUTURE PROFITS: In conjunction with the formation of the Cologne Re joint venture, the Corporation obtained the right to receive future profits from life reinsurance contracts existing at the date of the joint venture's formation. The value of these profits is the actuarially determined present value of the projected profits from the obtained reinsurance contracts. The calculation of the estimated profits includes anticipated future premiums, benefit payments, lapse rates, expenses and related investment income. The present value of future profits was determined using risk adjusted discount rates ranging primarily from 10 percent through 16 percent. The interest rates selected for the valuation were determined based on the applicable interest rates in the country of risk and the risk inherent in the realization of the estimated future profits. The present value of future profits of $132 million will be amortized over the duration of the related life business, approximately 20 years, based upon the assumed underlying profits of the business acquired.
GOODWILL: The Corporation amortizes on a straight-line basis goodwill recorded in connection with its business combinations. Included in the balance sheet caption "other assets", was goodwill of $509 million at December 31, 1994, which is principally related to the Cologne Re joint venture and is being amortized over the expected life of the operations acquired, not exceeding 40 years.
FOREIGN CURRENCY TRANSLATION: Revenues and expenses in foreign currencies are translated at the rate of exchange at the transaction date. Assets and liabilities are translated at the rate of exchange in effect at the close of the period. Gains or losses resulting from translating foreign currency financial statements are accumulated in a separate component of common stockholders' equity. Gains or losses resulting from foreign currency transactions (transactions denominated in a currency other than the entity's functional currency) are included in net income. The net effect of foreign currency transactions on operating results during 1994, 1993 and 1992 was immaterial.
DEPOSITS: Reinsurance contracts that do not indemnify the ceding company against loss or liability are recorded as deposits. These deposits are treated as financing transactions and are credited or charged with interest income or expense according to contract terms.
ALLOWANCE FOR DOUBTFUL ACCOUNTS: The Corporation establishes an allowance for uncollectible reinsurance recoverables and other doubtful receivables. The allowance was recorded as a valuation account that reduces the corresponding asset. The allowance was $121 million and $79 million at December 31, 1994 and 1993, respectively.
FINANCIAL SERVICES: Acting as a dealer, the Corporation engages in interest rate and currency swaps, forward rate agreements, forward foreign exchange, option, and synthetic security transactions. These contracts were accounted for as contractual commitments and were carried at estimated fair value based on then current interest, currency rates, and security values. Securities owned, securities sold but not yet purchased and futures contracts were carried at fair value. Realized and unrealized gains or losses from selling or valuing securities and contractual commitments at fair value were included in "Other revenues". Purchases of securities under agreements to resell and sales of securities under agreements to repurchase are accounted for as collateralized investing and financing transactions and were recorded at their contractual resale or repurchase amounts, plus accrued interest. Included in the balance sheet caption, trading account assets and liabilities, were the unrealized gains and losses on interest rate and currency swaps, forward currency commitments and option products.
December 31, 1994, the Corporation adopted FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. The Interpretation modified the accounting in Interpretation No. 39 to permit offsetting in the balance sheet of payables and receivables for repurchase and reverse repurchase agreements when certain conditions are met. The Corporation has reclassified amounts on the December 31, 1993 balance sheet to conform to the new Interpretations. The combined effect of adopting Interpretations 39 and 41 increased reported assets and liabilities by approximately $950 million at December 31, 1993 and $1,747 million at December 31, 1994. Adoption of these Interpretations had no impact on results from operations or common stockholders' equity.
In 1994, the Corporation adopted Statement of Financial Accounting Standards No. 119, Disclosure about Derivatives Financial Instruments and Fair Value of Financial Instruments. The Statement provides new disclosure requirements for derivative financial instruments (see Notes 14 and 15).
Effective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other than Pensions. See Note 8 for additional details on the adoption of this Statement.
On December 28, 1994, the Corporation and Colonia formed a new company that acquired 75 percent of the common shares and approximately 30 percent of the preferred shares of Cologne Re, which collectively represents a 66.3 percent economic interest in Cologne Re. In exchange for its Cologne Re shares, Colonia, for itself and as trustee for Nordstern Allgemeine Versicherungs AG (collectively the "CKAG Group"), received 100 percent of the Class A shares of the new company, General Re-CKAG Reinsurance and Investment S.A.R.L. ("GR-CK"). The Corporation initially contributed $884 million (DM 1,377 million) to GR-CK in exchange for 100 percent of the Class B shares of GR-CK. On December 30, 1994, GR-CK paid $302 million (DM 475 million) to a subsidiary of the Corporation in exchange for notes in the principal amount of DM 475
The acquisition of the shares of Cologne Re through GR-CK has been accounted for as a purchase. As a result of the ownership and control structure, the Corporation consolidated GR-CK and Cologne Re in its financial statements and recorded as minority interests the share of the CKAG Group in GR-CK and of the other stockholders in Cologne Re. Since the closing occurred at the end of 1994, the transaction did not have a material effect on the Corporation's results from operations in 1994. In future years, the Corporation's operating results will include its proportional share of Cologne Re's operations, which will be reported on a quarter lag. The cost of the acquisition has been preliminarily allocated on the basis of the estimated fair value of the assets acquired and the liabilities assumed in the transaction. The allocation of the purchase price will be finalized during 1995 with any resulting change adjusting goodwill.
The following unaudited, pro forma information was prepared assuming the transaction with Cologne Re had occurred as of the beginning of the periods presented. These results were prepared for informational purposes and do not purport to be the actual results of the entities had they been combined at that time. The pro forma information includes all significant adjustments to the historical results that were directly attributable to the transaction and were expected to have a continuing effect on the Corporation.
On December 30, 1994, General Reinsurance Corporation ("GRC") exchanged its 50 percent partnership interest in Engineering Insurance Group to EIG Co. ("EIG"), a machinery breakdown insurer, for non-voting preferred stock in EIG having a value of $20 million. The preferred stock pays dividends at a rate of 6.5 percent per annum and matures on December 30, 2004.
In 1993, the Corporation entered into a joint venture with W.R. Berkley Corporation to form Signet Star Holdings, Inc. ("SSH"), which acquired the common stock of North Star Reinsurance Corporation ("North Star"), a wholly owned subsidiary of the Corporation, and Signet Reinsurance Company, a wholly owned subsidiary of W.R. Berkley Corporation. Under the agreement, the Corporation acquired shares representing 40 percent of the equity interest of SSH, $36 million of 6.96 percent convertible debt due in January 2003 and $40 million of 9.80 percent senior debt due in January 2000. The Corporation accounts for its interest in SSH under the equity method.
- --------------- (1) Cost is amortized cost for short-term investments and fixed maturities and original cost for equity securities and other invested assets.
Gross gains of $57 million, $120 million and $140 million and gross losses of $120 million, $22 million and $10 million were realized on sales of available-for-sale fixed maturities in 1994, 1993 and 1992, respectively. The contractual maturities of fixed maturity investments are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay certain obligations.
Income taxes were established on a consolidated basis for all domestic and foreign subsidiaries of the Corporation. No provision has been made for U.S. income taxes on that portion of cumulative undistributed income of international subsidiaries of $107 million at December 31, 1994, which is considered permanently reinvested.
Income taxes paid were $138 million, $142 million and $117 million in 1994, 1993 and 1992, respectively.
The Corporation provides pension benefits for certain employees above amounts allowed under tax qualified plans, through unfunded plans. The Corporation also provides postretirement retainers through unfunded plans for members of the Board of Directors.
The Corporation has a leveraged Employee Savings and Stock Ownership Plan (ESSOP) in which substantially all United States employees may participate. The ESSOP borrowed from the Corporation $150 million at 9.25%, payable annually through 2014. The proceeds of this borrowing were used by the ESSOP to purchase 1,754,386 shares of 7.25% ($6.20 dividend per share) cumulative convertible preferred stock of the Corporation. All preferred stock outstanding is held by the ESSOP and is convertible into common stock. The preferred stock is held by the ESSOP trustee as collateral for the loan from the Corporation. The Corporation makes contributions to the ESSOP which, together with the dividend on shares of the preferred stock, are
sufficient to make loan interest and principal repayments back to the Corporation. As interest and principal are repaid, a portion of the preferred stock is allocated to participating employees.
The Plan also permits the granting of restricted stock awards to key executives and managerial employees. Shares of restricted stock become outstanding when granted, receive dividends and have voting rights identical to other outstanding shares of common stock. Restrictions lapse upon termination of the restriction period or upon death, disability or normal retirement. During 1994, 1993 and 1992, the Corporation made aggregate restricted stock awards of 17,250, 38,250, and 31,000 shares, respectively. The cost of restricted stock awards is based on the market value of the common stock at the date of grant and is recognized as expense over the restriction period. The expense of the restricted stock plan was $2 million in 1994, and $1 million in 1993 and 1992.
The Corporation and its subsidiaries lease office space and data processing equipment under non-cancelable leases expiring in various years through 2010. Several of the leases have renewal options with various terms and rental rate adjustments. Rental expense was $32 million in 1994 and $33 million in 1993 and 1992. The future minimum annual rental commitments under non-cancelable leases at December 31, 1994 were as follows:
The results of GRFP's trading activities are summarized by category of products in the following table. Trading revenue includes any associated gains and losses on hedging instruments. Trading revenue was included in "other revenues" in the income statement.
Interest rate and currency swaps are agreements between two parties to exchange, at particular intervals, payment streams calculated on a specified notional amount. The parties to a currency swap typically exchange a principal amount in two currencies at inception of the contract, agreeing to reexchange the currencies at a future date and agreed exchange rate.
Interest rate and currency options grant the purchaser, for a premium payment, the right to either purchase from or sell to the writer a specified financial instrument under agreed terms. Interest rate caps and floors require the writer to pay the purchaser at specified future dates the amount, if any, by which the option's underlying market interest rate exceeds the fixed cap or falls below the fixed floor rate, applied to a notional amount.
A summary of contract and notional amounts of interest rate contracts at December 31, 1994, and 1993 is included in the table below. For swap and option transactions, the contract and notional amounts represent the principal volume, which is referenced by the counterparties in computing payments to be exchanged, and are not indicative of GRFP's exposure to market or credit risk, future cash requirements or receipts from such transactions. Approximately 77% of the notional volume outstanding for swap and option contracts at December 31, 1994 have a term of five years or less and substantially all of the instruments have a term of less than ten years.
The table below discloses the net fair value at the reporting date for each class of derivative financial instrument held or issued by GRFP for dealer or risk management purposes, as well as the average fair value during the year, based on monthly observations. The aggregate fair value of swap and option contracts represents the net unrealized gain or loss on all swap and option contracts of GRFP.
GRFP's components of market risk include foreign exchange risk, interest rate risk, swap spread risk, volatility risk and yield curve risk. These are monitored on a daily basis across all swap and option products by
calculating the profit and loss impact of potential changes in market risks over a one week period. Based on historical market volatility data and informed judgment, GRFP sets market risk limits for each type of risk based on a 95 percent probability that movements in market rates will not exceed the limits. GRFP also monitors its consolidated market risk across all trading books on a weekly basis and has established limits designed to withstand simultaneous losses of two market risk components, each at the 95 percent confidence level. GRFP's aggregate weekly market risk limit across all trading books was $10 million. Since inception, GRFP has not experienced a weekly position change exceeding this aggregate limit. In addition to these daily and weekly assessments of risk, GRFP prepares periodic stress tests to assess its exposure to extreme movements in various market risk factors.
In connection with certain purchases and sales of government securities, GRFP enters into collateralized repurchase and reverse repurchase agreements, which may result in credit losses in the event the counterparty to the transaction is unable to fulfill its contractual obligations. Principally all of these transactions are collateralized by government securities. GRFP's exposure to credit risks associated with the non-performance of counterparties in fulfilling these contractual obligations can be directly affected by market fluctuations, which may impair the counterparties' ability to satisfy their obligations. It is GRFP's policy to take possession of securities purchased under agreements to resell. GRFP monitors the market value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral when appropriate. Counterparties to repurchase agreements and futures transactions are commercial banks and securities brokers and dealers.
GRFP enters into futures contracts for delayed delivery of foreign currencies or securities in which the seller/purchaser agrees to make/take delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise from the inability of the exchange to meet the terms of the contracts and from counterparties inability to remit additional margin.
GRFP regularly consults with internal and external legal counsel (in relevant jurisdictions) to determine legality and enforceability of various transactions with different types of counterparties. When there is a perceived risk that a proposed counterparty may lack legal capacity to enter into a transaction, the relevant statutes, regulations, and consents are examined.
Other invested assets -- The fair value of investments in limited partnerships, which were included in other invested assets on the consolidated balance sheet, was determined by reviewing available financial information of the investee and by performing other financial analyses in consultation with external advisors. Fair values for investments in real estate were determined using discounted cash flow analyses for each property. Fair value disclosures for reinsurance ventures were included at the Corporation's proportionate share in the entity's shareholders' equity as the cost of determining fair value exceeds the benefits derived.
Mortgage and loans receivable/payable -- The fair value of the Corporation's mortgage and notes receivable/payable was estimated using discounted cash flow analyses, based on the Corporation's current incremental borrowing rates for similar types of arrangements. The fair value of the Corporation's 9.0 percent debenture due 2009 was based on a market quote.
Contract deposit assets/liabilities -- The fair value of contract deposit assets and liabilities approximate their carrying value.
The lawsuit was originally dismissed on motion by the United States District Court for the Northern District of California on September 20, 1989. The United States Court of Appeals for the Ninth Circuit reversed the dismissal and remanded the case to the District Court for further proceedings. On October 5, 1992, the United States Supreme Court granted, in part, defendants' petition for certiorari. On June 28, 1993, the Supreme Court affirmed in part and reversed in part the decision of the Court of Appeals and remanded the Case to the Court of Appeals for further action. On October 6, 1993, the Court of Appeals remanded the case to the District Court for trial in accordance with the opinion of the Supreme Court. There was no finding of any wrongdoing or illegality by any defendant in this civil action.
The Corporation and its subsidiaries have been named as defendants in litigation in the ordinary course of conducting an insurance business. These lawsuits generally seek to establish liability under insurance or reinsurance contracts issued by the subsidiaries, and occasionally seek punitive or exemplary damages. The Corporation's reinsurance subsidiaries are also indirectly involved in coverage litigation. In those cases, plaintiffs seek coverage for their liabilities under insurance policies from insurance companies reinsured by the Corporation's reinsurance subsidiaries. In the judgment of management, none of these cases, individually or collectively, is likely to result in judgments for amounts which, net of claim and claim expense liabilities previously established and applicable reinsurance, would be material to the financial position, results of operations or cash flow of the Corporation.
The Corporation continually estimates its liabilities and related reinsurance recoveries for environmental and latent injury claims and claim expenses. These exposures do not lend themselves to traditional methods of loss development determination and, therefore, may be considered less reliable then reserves for standard lines of business (e.g., automobile). The estimate is composed of four parts: known claims, development on known claims, IBNR and direct excess coverage litigation expenses. Although reliability is constrained by uncertainties, the Corporation has confidence in the reported known claim liabilities and, based on alternative methods, has projected a fairly reliable estimate of development for these claims. The Corporation has also included an estimate for IBNR that is based on fitted curves of estimated future claim emergence. This estimate is less reliable than the estimated liability for reported claims. The effect of joint and several liability on the severity of losses and a provision for future claim inflation have been included in the loss development estimate. The Corporation has established a liability for litigation costs associated with coverage disputes arising out of direct excess insurance policies, rather than from reinsurance assumed. Direct excess coverage litigation expenses are estimated using a modified count and amount actuarial study.
The gross liability for environmental and latent injury claims and claim expenses and the related reinsurance recoverable were $1,478 million and $382 million, respectively, at December 31, 1994. These amounts are management's best estimate of future claim and claim expense payments and recoveries that are expected to develop over the next thirty years. The Corporation continues to monitor evolving case law and its effect on environmental and latent injury claims. Changing government regulations and legislation, newly identified toxins, newly reported claims, new theories of liability, new contract interpretations, and other factors could significantly affect future claim development. While the Corporation has recorded its current best estimate of its liabilities for unpaid claims and claim expenses, it is reasonably possible that these estimated liabilities, net of estimated reinsurance recoveries, may increase in the future and that the increase may be material to the Corporation's results of operations, cash flows and financial position. It is not possible to estimate reliably the amount of additional net loss, or the range of net loss, that is reasonably possible.
The Corporation conducts its operations principally through the following business segments:
PROPERTY/CASUALTY -- The domestic property/casualty operations of the Corporation include reinsurance of most property/casualty lines of business, including general liability, property, workers' compensation and auto liability in the United States and Canada. In addition, the Corporation conducts excess and surplus lines insurance business.
International property/casualty operations are conducted as of December 31, 1994 through subsidiaries and branch offices located in Argentina, Australia, Barbados, Bermuda, France, Germany, Hong Kong, Italy, Ireland, Latvia, Mexico, Denmark, the Netherlands, New Zealand, Singapore, South Africa, Spain, Switzerland, Sweden, United Kingdom and Venezuela, and include reinsurance of property/casualty business in those countries and elsewhere outside the United States and Canada. At the end of 1994, the Corporation acquired an ownership interest in Cologne Re. See Note 3 for a further discussion of this transaction. Cologne Re was not included in the Corporation's results from operations during 1994 but was consolidated in the December 31, 1994 balance sheet, and therefore, it has been included in the total asset information under the property/casualty segment in this note.