The executive offices of the Corporation and the administrative offices of the Property and Casualty Group are in Warren, New Jersey. The Real Estate Group's corporate headquarters is located in Roseland, New Jersey. The Property and Casualty Insurance Group maintains zone administrative and branch offices in major cities throughout the United States and also has offices in Canada, Europe, Australia, the Far East and Latin America. Office facilities are leased with the exception of a building in Branchburg, New Jersey. Management considers its office facilities suitable and adequate for the current level of operations. See Note (12) of the notes to consolidated financial statements incorporated by reference from the Corporation's 1997 Annual Report to Shareholders.
The following discussion presents our past results and our expectations for the near term future. The supplementary financial information and the consolidated financial statements and related notes, all of which are integral parts of the following analysis of our results and our financial position, are incorporated by reference from the Corporation's 1997 Annual Report to Shareholders, pages 15, 16 and 38 through 59.
Operating income from continuing operations, which excludes realized investment gains and losses, was $701 million in 1997 compared with $434 million in 1996 and $584 million in 1995. Operating income in 1996 reflects a fourth quarter charge of $160 million after taxes related to the write-down of the carrying value of certain real estate assets.
In May 1997, the Corporation completed the sale of its life and health insurance operations to Jefferson-Pilot Corporation for $875 million in cash, subject to closing adjustments, none of which were material. The life and health insurance operations have been classified as discontinued operations.
Property and casualty earnings were substantially higher in 1997 than in 1996 and 1995. Property and casualty income after taxes was $670 million in 1997 compared with $561 million in 1996 and
Reported net premiums written amounted to $5.4 billion in 1997, an increase of 14% compared with 1996. Reported net premiums written increased 11% in 1996 compared with 1995. Personal coverages accounted for $1.3 billion or 24% of 1997 premiums written and commercial coverages for $4.1 billion or 76%. A portion of the increase in premiums written in both 1997 and 1996 was due to changes in certain reinsurance agreements, which are discussed below.
Premium growth in 1997 and 1996 was also due to the selective writing of new business, exposure growth on existing business and the purchase of additional coverages by current customers. The worldwide marketplace continued to be competitive, particularly in the commercial classes in the United States. Competitors continued to place significant pressure on pricing as they attempted to maintain or increase market share. As a result, price increases continued to be difficult to achieve. In this environment, we have focused on our specialty lines where we emphasize the added value we provide to our customers. Substantial premium growth in both years was achieved outside the United States from our international branch network.
Underwriting results were profitable in each of the past three years. The combined loss and expense ratio, the common measure of underwriting profitability, was 96.9% in 1997 compared with 98.3% in 1996 and 96.8% in 1995.
The loss ratio was 64.5% in 1997 compared with 66.2% in 1996 and 64.7% in 1995. The loss ratios continue to reflect the favorable experience resulting from the consistent application of our disciplined underwriting standards. Losses from catastrophes represented 1.1 percentage points of the loss ratio in 1997 compared with 3.1 percentage points in 1996 and 1.5 percentage points in 1995.
Our expense ratio was 32.4% in 1997 compared with 32.1% in both 1996 and 1995.
Reported premium growth in the first quarter of 1998 will be distorted when compared with 1997 due to the Sun Alliance related transactions in the first quarter of 1997. As a result, reported net premiums written are expected to show a decline in the first quarter of 1998.
During the fourth quarter of 1997, the Corporation began an activity value analysis process to identify and then eliminate low-value activities and to improve operational efficiency so that we can reduce expenses and redirect resources to those current activities and new initiatives that have the greatest potential to contribute to the future results of the Corporation. Implementation will commence in the second quarter of 1998. The cost control initiative will result in job reductions in both the home office and the branch network. While we have not yet fully quantified the impact of the initiative, we hope to achieve annual pre-tax savings in the $100 to $150 million range, beginning in 1999. Such savings are based on the elimination of certain payroll and payroll-related costs, lease costs and other operating costs.
The Corporation expects to record a restructuring charge in the first quarter of 1998 related to the implementation of the cost control initiative. The amount of the charge has not yet been quantified.
Reported premiums from personal insurance increased 26% in 1997 compared with a 20% increase in 1996. The effect on net premiums written of the changes to the reinsurance agreement with Sun Alliance was as follows:
Our personal insurance business produced substantial underwriting profits in each of the past three years. The combined loss and expense ratio was 83.1% in 1997 compared with 91.7% in 1996 and 87.1% in 1995.
The profitability of our homeowners business each year is affected substantially by the amount of catastrophe losses we incur. Homeowners results were highly profitable in 1997, benefiting from modest catastrophe losses and reduced loss frequency. Results for this class were unprofitable in 1996 as catastrophe losses, particularly those caused by the winter storms, adversely affected results. Homeowners results were profitable in 1995 due to lower loss frequency. Catastrophe losses represented only 2.9 percentage points of the loss ratio for this class in 1997 compared with 16.7 percentage points in 1996 and 10.3 percentage points in 1995.
Other personal coverages, which include insurance for personal valuables and excess liability, were highly profitable in each of the past three years. Personal excess liability profitability increased in 1996 and again in 1997 due to favorable loss experience.
Net premiums written, as adjusted, increased 9% in 1997 compared with 1996 and 9% in 1996 compared with 1995. Premium growth in 1997 and 1996 for the excess liability component of our casualty coverages and for our executive protection coverages benefited from the changes to our casualty excess of loss reinsurance program. Premium growth in both years was also due to the selective writing of new accounts, exposure growth on existing business and the purchase of additional coverages by current customers. Premium growth was stronger outside the United States. Growth in the United States continues to be hindered by intense competition which has resulted in declining prices for several classes of business. Our strategy of working closely with our customers and our ability to differentiate our products have enabled us to renew a large percentage of our business.
Multiple peril results were unprofitable in each of the past three years due, in large part, to inadequate prices. Results for this class were also adversely affected in each of the past three years, but
Results for our casualty business were similarly unprofitable in each of the past three years. In each year, casualty results were adversely affected by increases in loss reserves for asbestos-related and toxic waste claims. The amount of such reserve strengthening in the casualty classes decreased in 1996 and again in 1997. The excess liability component of our casualty coverages has remained profitable due to favorable loss experience in this class. Results for the primary liability component were extremely unprofitable in 1997 and 1996 due to an increased frequency of losses. Results in the automobile component were unprofitable in 1997 compared with breakeven results in 1996 and profitable results in 1995. The deterioration in 1997 was due to an increase in the frequency of large losses.
Property and marine results were unprofitable in 1997 compared with profitable results in 1996 and 1995. Results in 1997 were adversely affected by an increase in the frequency of large losses, including several large overseas losses. Results in 1997 and 1996 were adversely affected by catastrophe losses which were insignificant in 1995. Catastrophe losses for this class represented 4.9 percentage points of the loss ratio in 1997 compared with 4.5 percentage points in 1996 and 0.8 of a percentage point in 1995.
Our executive protection results were highly profitable in each of the past three years due to favorable loss experience. Our financial institutions business was also profitable during the same period.
Results in our other commercial classes were profitable in 1997 compared with the near breakeven results in 1996 and unprofitable results in 1995. This improvement was primarily attributable to our surety business, which produced increasingly profitable results in 1996 and 1997 compared with unprofitable results in 1995 due to several large losses.
Reinsurance assumed is treaty reinsurance that was assumed from Sun Alliance. The reinsurance agreement with Sun Alliance was terminated effective January 1, 1997. However, due to the lag in our reporting of such business, net premiums written in the first quarter of 1997 included $90 million related to business we assumed from Sun Alliance for the second half of 1996. Net premiums written for this segment were reduced by $94 million and $65 million in the first quarter of 1997 and 1996, respectively, due to the effect of the portfolio transfers of unearned premiums back to Sun Alliance as of January 1 of each year. Net premiums written in 1996 were substantially lower than in 1995 due to the changes in the reinsurance agreement with Sun Alliance whereby we assumed less reinsurance from them.
Underwriting results for this segment in 1997, which represent our share of the Sun Alliance business for the last six months of 1996, were near breakeven. Underwriting results were also near breakeven in 1996 and 1995.
Loss reserves, net of reinsurance recoverable, increased by $809 million in 1997 compared with $141 million in 1996. The 1996 increase would have been greater except that loss reserves were reduced as the result of significant payments during the year related to the settlement of asbestos-related claims against Fibreboard Corporation, which is discussed below. Loss reserves included $549 million, $543 million and $999 million at year-end 1997, 1996 and 1995, respectively, related to the Fibreboard settlement. Loss and expense payments related to the settlement aggregated $462 million in 1996 and $60 million in 1995. There were no such payments in 1997.
Excluding the Fibreboard reserves and the effect of the portfolio transfers, loss reserves, net of reinsurance recoverable, increased by $517 million or 7% in 1997 compared with $562 million or 9% in 1996. Substantial reserve growth has occurred each year in those liability classes, primarily excess liability and executive protection, that are characterized by delayed loss reporting and extended periods of settlement.
The uncertainties relating to asbestos and toxic waste claims on insurance policies written many years ago are exacerbated by judicial and legislative interpretations of coverage that in some cases have tended to erode the clear and express intent of such policies and in other cases have expanded theories of liability. The industry is engaged in extensive litigation over these coverage and liability issues and is thus confronted with a continuing uncertainty in its efforts to quantify these exposures.
Our most costly asbestos exposure relates to an insurance policy issued to Fibreboard Corporation by Pacific Indemnity Company in 1956. In 1993, Pacific Indemnity Company, a subsidiary of the Corporation, entered into a global settlement agreement with Continental Casualty Company (a subsidiary of CNA Financial Corporation), Fibreboard Corporation, and attorneys representing claimants against Fibreboard for all future asbestos-related bodily injury claims against Fibreboard. This agreement is subject to final appellate court approval. Pursuant to the global settlement agreement, a $1.525 billion trust fund will be established to pay future claims, which are claims that
Our remaining asbestos exposures are mostly peripheral defendants, including a mix of manufacturers and distributors of certain products that contain asbestos as well as premises owners. Generally, these insureds are named defendants on a regional rather than a nationwide basis. We continue to
Legal guidelines regarding coverage for asbestos claims have begun to articulate more consistent standards regarding the extent of the insurers' coverage obligation and the method of allocation of costs among insurers. However, we still do not know the universe of potential claims. Therefore, uncertainty remains as to our ultimate liability for asbestos-related claims.
Litigation costs remain substantial, particularly for hazardous waste claims. A substantial portion of the funds we have expended to date has been for legal fees incurred in the prolonged litigation of coverage issues. Primary policies provide a limit on indemnity payments but many do not limit defense costs. This sometimes leads to the payment of defense costs in multiples of the policy limits.
The Year 2000 issue relates to computer programs that were written using two digits rather than four to define the applicable year. Such programs may recognize the date "00" as the year 1900 rather than the year 2000. This could result in a system failure or miscalculations causing disruptions of normal business activities or other unforeseen problems.
An additional concern to the Corporation is the potential future impact of the Year 2000 issue on insurance coverages written by our property and casualty subsidiaries. The Year 2000 issue is a risk for some of our insureds and needs to be considered during the underwriting process similar to any other risk to which our customers may be exposed. We have established a dedicated team to identify Year 2000 issues across all product lines. It is possible that Year 2000 related losses may emerge that would adversely affect operating results in future periods. The amount cannot be estimated at the present time.
Investment income after taxes increased 9% in 1997 compared with 7% in 1996. Growth was primarily due to increases in invested assets, which reflected strong cash flow from operations over the period, partially offset by lower average yields on new investments.
The effective tax rate on our investment income was 16.7% in 1997 compared with 15.8% in 1996 and 15.9% in 1995. The effective tax rate increased in 1997 as the percentage of our investment income subject to tax increased.
Generally, premiums are received by our property and casualty subsidiaries months or even years before losses are paid under the policies purchased by such premiums. These funds are used first to make current claim and expense payments. The balance is invested to augment the investment income
generated by the existing portfolio. Historically, cash receipts from operations, consisting of insurance premiums and investment income, have provided more than sufficient funds to pay losses, operating expenses and dividends to the Corporation.
New cash available for investment by the property and casualty subsidiaries was approximately $1,260 million in 1997 compared with $1,150 million in 1996 and $430 million in 1995. New cash in 1997 and 1996 included approximately $330 million and $40 million, respectively, received as the net result of the portfolio transfers of unearned premiums and loss reserves as of January 1 of each year related to the changes to the reinsurance agreements with Sun Alliance. New cash in 1996 also included $191 million received in January as a result of the commutation of a stop loss reinsurance agreement related to medical malpractice unpaid claims arising from business written prior to 1985. The substantially lower amount in 1995 was due to the designation of $480 million of new cash as funds held for asbestos-related settlement. Income on these assets accrued for the benefit of participants in the class settlement of asbestos-related bodily injury claims against Fibreboard.
In 1997, new cash was invested primarily in tax-exempt bonds and, to a lesser extent, corporate bonds and mortgage-backed securities. In addition, $250 million of foreign bonds were sold in the first quarter, due to the reduction in foreign liabilities resulting from the termination of the reinsurance agreements with Sun Alliance, with the proceeds invested in U.S. dollar denominated securities. In 1996, we invested new cash primarily in mortgage-backed securities and tax-exempt bonds. In 1995, we invested new cash primarily in tax-exempt bonds. In each year, we tried to achieve the appropriate mix in our portfolio to balance both investment and tax strategies.
information about the Corporation's fixed maturity investments denominated in these two currencies at December 31, 1997. The table presents cash flows of principal amounts in U.S. dollars by expected maturity dates. Actual cash flows could differ from the expected amounts.
In October 1996, the Corporation announced that it was exploring the possible sale of all or a significant portion of its real estate assets. In March 1997, the Corporation entered into an agreement with a prospective purchaser to perform due diligence in anticipation of executing a contract for the sale of substantially all of its commercial properties. Because the plan to pursue the sales of these assets in the near term represented a significant change in circumstances relating to the manner in which these assets would be used, we reassessed the recoverability of their carrying value as of December 31, 1996. As a result, we recorded an impairment loss of $255 million, or $160 million after tax, in the fourth quarter of 1996 to reduce the carrying value of these assets to their estimated fair value.
We plan to retain approximately $375 million of undeveloped land which we expect will be developed in the future. In addition, we plan to retain certain properties and land parcels under lease.
Real estate operations resulted in a loss after taxes of $5 million in 1997 compared with a loss of $147 million in 1996 and income of $6 million in 1995. The loss in 1996 reflects the $160 million after tax impairment charge. Results in 1996 benefited from the sale of several rental properties and a decrease in interest expense caused by lower average interest rates. Results in 1995 benefited from a land sale. Results in both 1996 and 1995 also benefited from increases in earnings from residential sales. In each of the last three years, results were adversely affected by a high proportion of interest costs charged directly to expense rather than being capitalized.
Real estate activities have been funded with short-term credit instruments, primarily commercial paper, and debt issued by Chubb Capital Corporation as well as with term loans and mortgages. The weighted average interest cost on short-term credit instruments approximated 5 1/4% in 1997, 5 1/2% in 1996 and 6% in 1995. In 1997, interest rates on term loans approximated 7 1/2% and for mortgages the range of interest rates was 5% to 12%.
Proceeds from the November 1997 sale were used to repay the outstanding short term debt and certain term loans and mortgages as well as to reduce intercompany borrowings from Chubb Capital. In February 1998, the remaining $300 million of intercompany borrowings from Chubb Capital was converted into preferred stock of the real estate subsidiary.
As a result of the November 1997 sale, real estate revenues will be significantly reduced in the future. The reduction in revenues will be substantially offset by significant reductions in interest expense due to the decrease in debt outstanding and in payroll costs and other operating expenses.
Changes in unrealized market appreciation of fixed maturities were due to fluctuations in interest rates.
On May 13, 1997, the Corporation completed the sale of Chubb Life Insurance Company of America to Jefferson-Pilot Corporation for $875 million in cash, subject to various closing adjustments, none of which were material.
In 1996, the Corporation recognized a loss of $22 million related to the sale of the life and health insurance operations. The purchase price was not adjusted to reflect results of operations subsequent to December 31, 1996. Therefore, the discontinued life and health insurance operations did not affect the Corporation's net income in 1997 and will not affect net income in future periods. Earnings from the discontinued life and health insurance operations were $49 million and $42 million in 1996 and 1995, respectively, including realized investment gains of $8 million and $14 million.
At December 31, 1997, Chubb Capital had outstanding $150 million of 6% notes due in 1998 and $100 million of 6 7/8% notes due in 2003. The notes are unsecured and are guaranteed by the Corporation. A substantial portion of the proceeds were used to support our real estate operations. The debt due in 1998 was repaid in February using proceeds from the real estate sales.
Consolidated financial statements of the Corporation at December 31, 1997 and 1996 and for each of the three years in the period ended December 31, 1997 and the Report of Independent Auditors thereon and the Corporation's unaudited quarterly financial data for the two-year period ended December 31, 1997 are incorporated by reference from the Corporation's 1997 Annual Report to Shareholders, pages 38 through 61.