TIG's business properties include 53 leased locations, one owned facility in Battle Creek, Michigan and two locations where client office space is utilized. The leased locations represent approximately 0.9 million square feet, and the owned location occupies approximately 220,000 square feet.
TIG occupies approximately 275,000 square feet of space in Irving, Texas for which the lease expires in 2009 and may be extended by TIG for two renewal periods of five years each. All of TIG's other existing leases expire by the end of 2007.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - - -------------------------------------------------------------------------------- 7.1 CONSOLIDATED RESULTS ================================================================================
The following discussion provides management's assessment of financial results and material changes in financial position for TIG Holdings, Inc. ("TIG Holdings") and its subsidiaries (collectively "TIG") and presents management's expectations for the near term future. The analysis focuses on the performance of TIG's three major operating divisions, Reinsurance, Commercial Specialty and Retail, and its investment portfolio, which are discussed at Items 7.2, 7.3, 7.4 and 7.7, respectively. Lines of business that have been de-emphasized ("Other Lines") are discussed at Item 7.5. For a better understanding of this analysis, reference should be made to Item 1 - Description of Business and to
Consolidated Statements of Income for each of the three years in the period ended December 31, 1996 .......................................40
Consolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended December 31, 1996 ...........42
We have audited the accompanying consolidated balance sheets of TIG Holdings, Inc. and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedules listed in the Index at Item 14(a). These financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of TIG Holdings, Inc. and subsidiaries at December 31, 1996 and 1995, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
TIG Holdings is primarily engaged in the business of property/casualty insurance and reinsurance through its 16 insurance subsidiaries collectively "TIG" or "the Company". Of direct premium written by TIG in 1996, 26% was written in California, 8% in Michigan, 6% in New York and 7% each in Hawaii and Texas. No other geographical area, including foreign operations, accounted for more than 5% of direct premium written. A description of each operating division's principal products follows (see also Note O - Business Segments).
BASIS OF PRESENTATION. The consolidated financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") and include the accounts of TIG Holdings, Inc. and its subsidiaries. Financial statements prepared in accordance with GAAP require the use of management's estimates. Intercompany transactions are eliminated in consolidation. Certain reclassifications of prior years' amounts have been made to conform with the 1996 presentation.
EARNINGS PER SHARE ("EPS"). Primary earnings per share is calculated based upon the weighted average common shares outstanding during the period. In order to calculate EPS, unallocated ESOP shares and treasury shares are deducted from the outstanding common shares. Class A common stock and the common stock options (See Note K - Incentive Compensation Plans) are considered common stock equivalents and are included in EPS calculations to the extent that they are dilutive. To obtain net income attributable to common shareholders for EPS computations, the annual preferred stock dividend is deducted from net income.
INVESTMENTS. Fixed maturities are classified as available for sale, as TIG has no positive intent to hold such securities until maturity, and are carried at market value. Equity securities are also carried at market value while short-term investments are carried at cost, which approximates market value. Market value is principally based upon quoted market prices. Quoted market prices are available for substantially all equity securities. The difference between the aggregate market value and amortized cost of securities, after deferred income tax effect, is reported as unrealized gain or loss directly in shareholders' equity and, accordingly, has no effect on net income.
ADOPTION OF SFAS 123. TIG adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") effective January 1, 1996. SFAS 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. TIG elected to continue to account for employee stock-based compensation as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" and to provide pro forma disclosures in the Notes to Financial Statements of the effects of SFAS 123 on net income and earnings per share. There was no effect on net income as a result of adopting SFAS 123.
RECOGNITION OF PREMIUM REVENUES. Premium is earned principally on a pro rata basis over the terms of the policies which are generally not more than one year. Unearned premium represents the portion of premium written applicable to the unexpired terms of policies in force.
LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES. The liability for loss and loss adjustment expenses is based on an evaluation of reported losses and on estimates of incurred but unreported losses. The reserve liabilities are determined using adjusters' individual case estimates and statistical projections. The liability is reported net of estimated salvage and subrogation recoverables of $29 million and $31 million at December 31, 1996 and 1995, respectively. The liability is considered to be adequate to cover all payments that will ultimately be made in settling the claims. However, final claim payments may differ from these reserves. Adjustments to the reserves resulting from subsequent developments or revisions to the estimate are reflected in results of operations in the period in which such adjustments become known. While there can be no assurance that the reserves at any given date are adequate to meet TIG's
PARTICIPATING INSURANCE BUSINESS. Dividends to policyholders, which relate primarily to workers' compensation policies, are accrued during the period in which the related premium is earned. Approximately 4%, 5% and 9% in 1996, 1995 and 1994, respectively, of TIG's total premium was subject to participation in such dividends.
OTHER ASSETS. Property, leasehold improvements and furniture and equipment of $41 million and $42 million at December 31, 1996 and 1995, respectively, are included in other assets. These balances are carried at cost less accumulated depreciation of $38 million and $28 million at December 31, 1996 and 1995, respectively. Depreciation is computed under the straight-line method over the estimated useful lives of the assets. Goodwill and other intangible assets of $2 million and $3 million at December 31, 1996 and 1995, respectively, are also included in other assets. These balances are amortized on a straight-line basis over periods ranging from 10 to 40 years. TIG's accounting policy governing the measurement of goodwill impairment includes an annual analysis of the recoverability of goodwill as of each balance sheet date.
SALE OF AGENCY SUBSIDIARIES. On May 1, 1995, TIG sold 100% of the outstanding common stock of certain agency subsidiaries which market force-placed collateral protection insurance to financial institution ("FI") accounts on behalf of TIG's insurance subsidiaries. These FI agency subsidiaries had total assets of approximately $25.6 million at the date of sale. TIG recognized no gain or loss on the transaction.
In connection with the sale, effective April 1, 1995, TIG reinsured 90% of the gross premium produced by the FI agency subsidiaries with reinsurers unaffiliated with either TIG or the purchaser. FI gross premium written for the years ended December 31, 1996, 1995 and 1994 totaled $77 million, $88 million and $92 million, respectively. Net earned premium for the same periods was $8 million, $31 million and $90 million, respectively. TIG also reinsured 90% of the FI unearned premium reserves at April 1, 1995 which resulted in a net transfer of cash to the reinsurers of $34.3 million, but had no impact on net income.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------------- NOTE C. RESTRUCTURING CHARGES ================================================================================
RESTRUCTURING CHARGES. In February 1996, TIG announced the reorganization of its commercial operations and plans to exit certain lines of business that failed to meet profitability standards. As a result of this reorganization, TIG took the following actions: 1) combined its Specialty Commercial and Workers' Compensation divisions to form a new division called Commercial Specialty, 2) identified field offices for consolidation and closure, 3) identified lines of business for non-renewal or cancellation for which 1995 net premium written was approximately $190 million or 12% of consolidated 1995 net premium written, 4) formed a run-off division (called "Other Lines") to administer contractually required policy renewals for run-off lines of business, and 5) notified approximately 600 employees that their positions would be eliminated. At December 31, 1996, the consolidation/closure of field offices was complete although various lease obligations remain; net written premium for Other Lines had declined by 50% for the year ended December 31, 1996 as compared to 1995; and approximately 600 employees' responsibilities had been outsourced to third party service providers or their employment had been otherwise terminated. At December 31, 1996, TIG had approximately 1,300 employees as compared to approximately 2,000 employees at December 31, 1995.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------------- NOTE D. INVESTMENTS ================================================================================
In the normal course of business, TIG may choose to hedge some of its interest rate risk with derivative financial instruments. Such arrangements are intended to help TIG to more closely match the cash flow received from its assets to the payments on its liabilities. TIG's interest rate swap arrangements generally provide that one party pays interest at a floating rate in relation to movement in an underlying index and the other party pays interest at a fixed rate. While TIG is exposed to credit risk in the event of non-performance by the other party, non-performance is not anticipated due to credit rating of the counterparties. At December 31, 1996, TIG had
TIG has less than $2 million of non-income producing investments and has no geographic or other concentrations of investment risk which has not been disclosed. Assets of TIG, carried at $712 million and $649 million at December 31, 1996 and 1995, respectively, were either on deposit with government agencies as required by law in various states in which TIG insurance subsidiaries conduct business or were held as collateral for various business transactions.
Market Amortized (In millions) Value Cost ============================================================== Due in one year or less $39 $38 Due after one year through five years 753 736 Due after five years through ten years 658 645 Due after ten years 1,397 1,338 Mortgage-backed securities 1,210 1,219 - - -------------------------------------------------------------- Total fixed maturity investments $4,057 $3,976 ==============================================================
Years Ended December 31, ------------------------ (In millions) 1996 1995 1994 - - ---------------------------------------------------------- Fixed maturity investments Gross gains $37 $18 $6 Gross losses (41) (29) (26) - - ---------------------------------------------------------- Net investment loss before tax (4) (11) (20) Less related taxes 1 4 7 - - ---------------------------------------------------------- Net investment loss, net of taxes $(3) $(7) $(13) ==========================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------------- NOTE E. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES ================================================================================
TIG experienced unfavorable loss and LAE reserve development in 1996 of $16 million due primarily to adverse development in Other Lines. In connection with the February 1996 restructuring, TIG completed a re-evaluation of loss and LAE reserves related to run-off lines using additional loss development data received during the first quarter of 1996. This data confirmed adverse loss development trends observed in the second half of 1995 and was a consideration in the decision to exit certain lines of business as discussed at Note C. - Restructuring Charges. As a result of this re-evaluation and management's belief that the restructuring decision will make the claims settlement process less consistent and more volatile, TIG increased loss and LAE reserves by $31 million in the first quarter of 1996 for run-off lines, principally for long haul trucking and large accounts. This reserve strengthening was partially offset by continuing favorable development of 1993 and prior workers' compensation reserves.
TIG's reserves include an estimate of TIG's ultimate liability for asbestos-related matters, environmental pollution, toxic tort and other non-sudden and accidental claims for which ultimate values cannot be estimated using traditional reserving techniques. TIG's environmental claims activity is predominately from hazardous waste and pollution-related claims arising from commercial insurance policies. Most of TIG's pollution claims are from small regional operations or local business involved with disposing wastes at dump sites or having pollution on their own property due to hazardous material use or leaking underground storage tanks. In connection with the initial public offering of TIG Holding's common stock ("IPO"), an affiliate of Transamerica agreed to pay 75% of up to $119 million of reserve development and newly incurred claims, up to a maximum reimbursement of $89 million, on policies written prior to January 1, 1993 with respect to certain environmental claims involving paid losses and certain LAE in excess of TIG's environmental loss and LAE reserves at December 31, 1992. At December 31, 1996, the Transamerica affiliate had incurred no liability under this agreement.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------------- NOTE F. REINSURANCE ================================================================================
Reinsurance contracts do not relieve TIG from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to TIG; accordingly, allowances are established for amounts estimated to be ultimately uncollectible. TIG evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 1996, TIG held collateral related to reinsurance amounts that remain unpaid for more than 120 days in the form of letters of credit totaling $370 million, trust funds totaling $252 million, and funds held totaling $136 million.
The components of the income tax asset balance are as follows:
(In millions) 1996 1995 ======================================================= Current payable $ (9) $ (6) Net deferred tax asset 111 66 - - ------------------------------------------------------- Total $102 $60 =======================================================
purposes and the amounts used for income tax purposes. Significant components of TIG's deferred tax assets and liabilities as of December 31, 1996 and 1995 are shown in the following table:
DEFERRED TAX LIABILITIES: Deferred policy acquisition costs 52 51 Section 338 - marketable securities 128 124 Unrealized gain - marketable securities 28 59 Section 338 - other 5 29 - - ----------------------------------------------------------- Total deferred tax liabilities 213 263 - - ----------------------------------------------------------- Net deferred tax asset $ 111 $ 66 ===========================================================
Significant components of the income tax benefit (expense) are as follows:
Years Ended December 31, ------------------------ (In millions) 1996 1995 1994 ========================================================================== Federal income tax benefit (expense) at statutory rates $(26) $ (54) $ (15) Tax-exempt investment income 9 17 23 Tax liability adjustment 20 -- -- Other 1 -- (1) - - -------------------------------------------------------------------------- Total income tax benefit (expense) $ 4 $ (37) $ 7 ==========================================================================
In March 1996, TIG entered into settlement agreements with the IRS on several outstanding audit assessments, which resulted in a redetermination of certain tax liabilities related to prior tax years. A $20 million deferred tax benefit was recognized in first quarter of 1996 as a result of the redetermination.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------------- NOTE H. FINANCING ARRANGEMENTS ================================================================================
In April 1993, in connection with its IPO, TIG Holdings issued 250,000 shares of non-voting mandatory redeemable preferred stock with a cumulative annual cash dividend rate of $7.75 per share and an aggregate liquidation preference/redemption value of $25 million plus accrued and unpaid dividends. The preferred stock must be redeemed on April 27, 2000. With each regular quarterly dividend declared on the preferred shares, each holder also receives one non-transferable right (a "Right"). Each Right will constitute the right to receive an additional amount to the extent that the regular cash dividend to which the related Right was, in whole or in part, not made out of TIG Holdings' current or accumulated earnings and profits, as calculated for federal income tax purposes. In such event, the holder of a Right will be entitled to receive an amount which, when taken together with the regular cash dividend to which the Right was related, would cause the net after-tax return to such holder to equal what the net after-tax return on the mandatory redeemable preferred stock would have been had the regular cash dividend been paid entirely out of the current or accumulated earnings and profits of TIG Holdings. No additional payments were required during 1996. During 1995, TIG paid an additional $0.7 million in respect to these Rights in connection with dividends declared on the mandatory redeemable preferred stock during 1994. Transamerica agreed to indemnify TIG Holdings for any amounts paid with regard to any rights issued by TIG Holdings in connection with dividends declared on the mandatory redeemable preferred stock during 1993. Accordingly, $0.4 million was paid by Transamerica under this indemnification in 1994 with respect to dividends declared in 1993.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------------- NOTE J. SHAREHOLDERS' EQUITY ================================================================================
THE 1996 LONG-TERM INCENTIVE PLAN. The 1996 Long-Term Incentive Plan (the "1996 Plan") provides for awards of stock options, stock appreciation rights, restricted stock grants, restricted stock units and/or performance units. The maximum number of shares of Common Stock in respect for which awards may be granted or paid out under the 1996 Plan is 5 million shares plus, effective January 1, 2000, the Limitation Amount. The "Limitation Amount" is 1.5% of the total number of issued and outstanding shares of Common Stock as of January 1, 2000, plus, effective each January 1 thereafter through and including January 1, 2006, 1.5% of the total number of issued and outstanding shares of Common Stock as of such January 1. In addition to the shares available for grant as previously mentioned, 2 million shares of Common Stock will be available solely for the grant of awards to employees in connection with acquisitions of other entities or businesses by the Company and its Related Companies. As of December 31, 1996, there were no stock appreciation rights, restricted stock units or performance units outstanding. The 1996 Plan will terminate on the date of the Company's annual meeting of stockholders in 2006. Thereafter, no awards may be granted. Stock options under the 1996 Plan have a term of ten years from the date of the grant and vest in equal annual installments over four years. Restricted stock grants vest in equal annual installments over three years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------------- risk-free interest rate of 7 percent; and expected life of 7 years. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The following tables summarize information about stock options outstanding and exercisable at December 31, 1996:
Options Excercisable ------------------------------------------- Range of Number Weighted-Avg Exercise Excercisable @ Exercise Prices 12/31/96 Price ===================================================================== $13.00 to $18.00 259,522 $16.34 $18.01 to $24.00 8,688,232 $22.53 $24.01 to $28.00 128,350 $25.66 $28.01 to $32.00 - - - - --------------------------------------------------------------------- $13.00 to $32.00 9,076,104 $22.39 =====================================================================
TIG Holdings' employee benefit plans (the "Plans") include the Diversified Savings Plan, the Employee Stock Ownership Plan, and the Profit Sharing Plan. Effective January 1, 1994, TIG Holdings adopted the ESOP and Profit Sharing Restoration Plans. TIG Holdings may amend, terminate, or suspend contributions to the Plans at any time as it may deem advisable. TIG Holdings is the administrator of the Plans. Any subsidiary of TIG Holdings participating in the Plans may withdraw at any time with the consent of the Holdings' Board of Directors. The Board of Directors has fiduciary responsibilities relating to the interpretation and operation of the Plans. As of January 1, 1997, the Diversified Savings Plan and Profit Sharing Plan were combined into the TIG Holdings, Inc. Diversified Savings and Profit Sharing Plan.
PROFIT SHARING PLAN. The TIG Holdings, Inc. Employees' Profit Sharing Plan (the "Profit Sharing Plan"), benefits eligible employees of TIG Holdings. Eligible employees are those who either were employed by TIG Holdings on December 31, each year or were employed during the plan year but who died prior to the plan year end. Generally, each
PROFIT SHARING RESTORATION PLAN. The TIG Holdings, Inc. Profit Sharing Restoration Plan is an unfunded plan for the purpose of providing deferred compensation for a select group of management or highly compensated employees whose allocations under the qualified Profit Sharing plan are limited by the annual restrictions as determined by the Internal Revenue Code. Highly compensated employees will be eligible for participation immediately upon the date of hire if annual earnings, including bonus in the year paid, exceed a specified threshold. The threshold for each year will be the amount of the cap on compensation that may be taken into account under the qualified plan for that year, or such greater amount as may be determined by the Committee in its discretion. Effective January 1, 1995, a Participant vests 25% after one year of service, 50% after two years of service and 100% after three years of service. Participants' accounts are credited for the difference between the dollar amount credited to the participants' account under the qualified Profit Sharing Plan and the amount that would have been credited in the absence of the restrictions noted above. Participants' accounts are adjusted for gains, losses and earnings as if invested in the same manner as such associate's account under the qualified Profit Sharing Plan. Liabilities due to the participants were approximately $916 thousand, $447 thousand and $111 thousand as of December 31, 1996, 1995 and 1994.
Increasing the trend rate by one percentage point in each year would increase the actuarial present value obligation for postretirement medical benefits as of December 31, 1996, 1995 and 1994 by $1.9 million, $2.0 million and $1.9 million, respectively, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by $0.1 million for 1996, 1995 and 1994. The weighted average discount rate used in determining the postretirement benefit obligation was 7.0% at December 31, 1996 and 1995.
Leases. Future minimum rental commitments as of December 31, 1996 for all noncancelable operating leases are as follows:
PERMITTED STATUTORY ACCOUNTING PRACTICES. TIG prepares its statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the domiciliary state insurance department. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the NAIC. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. Furthermore, the NAIC has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "prescribed" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1997 and implemented in 1998 will likely change the definitions of what comprises prescribed versus permitted statutory accounting practices, and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements.
Statutory amounts for TIG's business segments are as follows (see Note O - Business Segments):
Years Ended December 31, ------------------------ (In millions) 1996 1995 1994 ====================================================== STATUTORY NET INCOME (LOSS): Primary operations $ 88 $ 67 $(29) Reinsurance operations 96 69 42 - - ------------------------------------------------------ Total $184 $136 $13 ======================================================
In June 1993, the California Department of Insurance permitted TIG Insurance Company ("TIC"), TIG's lead insurer, to record a quasi-reorganization of its statutory capital accounts. The effect of the quasi-reorganization was to increase the earned surplus of TIC to zero from a negative $285 million and to decrease contributed surplus by the same amount. This transaction significantly increased TIC's future dividend paying capability as insurance companies may only pay dividends from earned surplus.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - - -------------------------------------------------------------------------------- NOTE O. BUSINESS SEGMENTS ================================================================================
The 1994 first and third quarters were impacted by pre-tax catastrophe costs of $32 and $13 million, respectively, arising from the January 1994 Northridge earthquake. In the second quarter of 1995, a reserve of $6.3 million was established for exit costs resulting from management's decision to reduce small individually underwritten commercial policies, while a normal re-evaluation of the Company's allowance for reinsurance recoverables in the fourth quarter of 1995 resulted in an increase to pretax income of approximately $11 million for the quarter. In the first quarter of 1996, an after-tax restructuring change of $65 million was taken for costs related to management's decision to restructure operations (see Note C. - Restructuring Charges).
In January of 1997, TIG Capital Trust I ("TIG Capital" or the "Trust"), a statutory business trust created under Delaware law and a trust subsidiary of TIG Holdings, completed a private offering for $125 million of 8.597% capital securities. TIG Holdings is the inital holder of 100% of the common securities of TIG Capital. Holders of the capital securities of the Trust will have a preference under certain circumstances over the holders of common securities of the Trust with respect to cash distributions and amounts payable on liquidation, redemption, or otherwise.
TIG Holdings issued $128.75 million in 8.597% Junior Subordinated Debentures to TIG Capital Trust I (including approximately $3.75 million with respect to the capital contributed to the Trust by TIG Holdings). TIG Holdings guaranteed the payment of distributions and payments on liquidation or redemption of the capital securities but only in each case to the extent of funds held by the Trust. The guarantee does not cover payment of distributions when the Trust does not have sufficient funds to pay such distributions. All of the net proceeds received by TIG Holdings from the issuance of the debentures will be used for general corporate purposes which may include repurchases of the Company's common stock.