The principal operations of Cologne Re, the largest subsidiary in the international property/casualty segment, are based in an office building of approximately 130,000 square feet in Cologne, Germany. The North American life/health operations of Cologne Re are based in an office building in Stamford, Connecticut. Cologne Re owns both of these office buildings.
In addition, General Re's North American property/casualty, financial services, and international life/health operations have branch and affiliate operations conducted from leased premises in various cities in the United States and foreign countries. At this time, General Re believes its facilities are suitable for its purpose and provide adequate capacity for General Re's present and anticipated needs.
(2) Excludes cumulative effect of accounting changes. The balance sheet data in the table on pages 8 and 9 reflect the adoption of Statement of Financial Accounting Standards ("SFAS") No. 115, Accounting For Certain Investments in Debt and Equity Securities in 1994 and the adoption of SFAS No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts in 1993, with reclassifications made for 1992. Adoption of SFAS No. 113 did not affect results from operations or common stockholders' equity. In 1993, General Re adopted the accounting prescribed by the Emerging Issues Task Force for multiple-year, retrospectively rated reinsurance contracts. The cumulative effect from prior years recorded in 1993 increased net income by $14 million or $.17 per share. In 1992, General Re adopted SFAS No. 109, Accounting for Income Taxes. The cumulative effect from prior years recorded in 1992 increased net income by $61 million or $.71 per share.
Net income of General Re Corporation and its subsidiaries ("General Re") was $894 million or $11.00 per share in 1996, an increase of 10.9 percent over the $9.92 per share earned in 1995. These results include after-tax realized gains of $.21 per share in 1996 and $.45 per share in 1995. The increase in 1996 earnings was primarily attributable to improved property/casualty underwriting results and growth in investment income in the North American and international property/casualty operations. Due to General Re's reporting of its international operations on a quarter lag, the 1996 results also benefited from a full year of results for Kolnische Ruckversicherungs-Gesellschaft AG ("Cologne Re") and the related joint-venture company, General Re-CKAG Reinsurance and Investment S.a r.l. ("GR-CK"), compared to only three quarters in 1995. In addition, North American property/casualty operations include the operating results of National Re Corporation and its subsidiaries ("National Re") since its acquisition by General Re Corporation on October 3, 1996.
Consolidated net premiums written in 1996 were $6,661 million, an increase of $559 million or 9.2 percent, from $6,102 million in 1995. North American property/casualty premium volume was $3,081 million in 1996, compared with $2,964 million in 1995, an increase of 3.9 percent. North American property/casualty net premiums written in 1996 include approximately $89 million from National Re. Net premiums written in the international property/casualty reinsurance operations were $2,505 million in 1996, compared to $2,429 million in 1995. Net premiums written for the life/health segment, which consist of Cologne Re's North American and international life/health operations, were $1,075 million for 1996, as compared to $709 million in 1995.
Consolidated investment income was $1,205 million in 1996, compared with $1,017 million in 1995. The consolidation of a full year of Cologne Re in 1996 accounts for approximately $90 million of the $188 million increase in consolidated investment income in 1996. Investment income for the North American property/casualty operations was $727 million in 1996, an increase of 2.3 percent over $711 million earned in 1995. The growth of pretax investment income in the North American operations was adversely affected by (1) the shift in assets from taxable to tax-advantaged securities over the last few years in response to General Re's tax planning strategies; (2) the maturity and calls of higher yielding fixed income securities; and (3) the use of North American cash flow from operations for common dividends and share repurchases. Investment income for the international property/casualty operations increased 59.5 percent to $394 million in 1996, compared with $247 million in 1995. The life/health operations earned investment income of $59 million in 1996, compared to $40 million in 1995. The financial services operations earned investment income of $25 million in 1996, compared with $19 million in 1995.
Consolidated net investment income was $1,017 million in 1995, compared with $749 million in 1994. The consolidation of Cologne Re accounts for approximately $193 million of the $268 million increase in consolidated investment income in 1995. Investment income for the North American property/casualty operations was $711 million in 1995, an increase of 3.7 percent over $686 million earned in 1994. The growth of pretax investment income in the North American operations was adversely affected by the shift in assets from taxable to tax-advantaged securities over the past few years in response to General Re's tax planning strategies, the maturity or call of higher yielding fixed income securities and the use of North American cash flow from operations for common dividends and stock repurchases. Investment income for the international property/casualty operations increased 375.4 percent to $247 million in 1995, compared with $52 million in 1994. Excluding the effect of Cologne Re, the international property/casualty operations investment income grew 24.2 percent in 1995. The life/health operations earned investment income of $40 million in 1995. The financial services operations earned investment income of $19 million in 1995, compared with $11 million in 1994.
North American property/casualty pretax income in 1996, excluding realized gains, increased 3.5 percent over 1995. This growth in pretax income was primarily due to an improvement in the underwriting result of $14 million and an increase in investment income of $16 million, partly offset by an increase in net other loss of $5 million. The 1994 underwriting result was adversely affected by the earthquake in Northridge, California on January 17th. The growth in investment income of 2.3 percent in 1996 was due to an increase in the portfolio as a result of operating cash flows in 1995 and 1996. The increase in net other loss in 1996 was due to higher general corporate expenses which are charged to this segment and non-recurring fee income in 1995.
The combined underwriting ratio is computed based on the relationship of losses and underwriting expenses to premiums earned. This ratio is General Re's principal indicator of underwriting performance, with less than 100.0 percent indicating an underwriting profit. In 1996, the combined ratio for the North American property/casualty segment was 99.1 percent, compared to 99.6 percent in 1995 and 101.9 percent in 1994. The 1996 and 1995 underwriting results were consistent with General Re's operating objective of achieving an underwriting profit.
General Reinsurance Corporation's ("GRC") treaty and facultative reinsurance premiums grew by 2.0 percent in 1996. Included in this figure is $89 million of net premiums written from National Re. GRC's premium growth was adversely affected by the nonrenewal of a large quota share treaty contract. Excluding the premiums associated with the nonrenewed contract and National Re, GRC's property/casualty premiums written increased 8.7 percent over the 1995 amounts. The underlying growth in GRC's premiums has slowed from growth in the prior few years due to the increasingly competitive primary insurance and reinsurance environments, increased retentions by certain large primary insurers, and the consolidation of companies in the primary insurance industry. In 1996, GRC's premium growth was primarily in the regional and specialty accounts, while individual risk facultative business was essentially flat.
For the General Star operations, which primarily write excess, surplus and specialty insurance, net premiums written grew 22.1 percent in 1996 due to increases in direct writings and retention levels. The facilities department within General Star grew by $12 million principally in the casualty errors and omissions line of business. The property department increased premium by $15 million primarily in fire and allied lines. The primary casualty department increased its net premiums by $9 million, while the net premiums of the excess casualty department increased by $11 million. General Star has produced a statutory underwriting profit for twelve consecutive years.
Income before taxes and realized gains for the international property/casualty operations was $320 million in 1996, an increase of 59.2 percent from 1995. The segment's results are affected by the inclusion of a full year of Cologne Re's operating results in 1996 as compared to only three quarters in 1995 (see below for a description of the Cologne Re transaction). Excluding the additional quarter, the international property/casualty segments income before taxes would have grown 41.1 percent.
[PIE CHART] International net premiums written were $2,505 million in 1996, compared with Germany 29.1% $2,429 million in 1995. The composition of international property/casualty US$ Foreign 17.2% premiums by currency presented in the chart to the left displays the Australia 5.4% geographic diversification of General Re's international business. The United Kingdom 10.5% category labelled "other" represents more than 100 currencies. France 6.1%
The reported growth in premiums was affected by a number of factors, including: a) the inclusion of a full year of Cologne Re's property/casualty premiums in 1996 compared to only three quarters in 1995; b) the effect of including current underwriting year estimates of the wholly owned European operations beginning in 1995;
c) the effect of a stronger U.S. dollar which lowered international premiums when translated into U.S. dollars; and d) the placing of Cologne Re's U.S. property/casualty subsidiary into runoff. Adjusting for these factors, international property/casualty net premiums written decreased 2.9 percent in 1996. As in North America, international property/casualty insurance became more competitive in 1996, and as a result, General Re has been cautious about business expansion in this environment.
General Re has an option to purchase from January 1, 2002 to January 1, 2004 the Class A shares of GR-CK owned by CKAG at a formula price. The option has a minimum exercise price of DM 1,306 million and a maximum of DM 1,509 million, subject to certain warranty and other adjustments that may affect the exercise price. If General Re does not exercise its option to purchase the Class A shares of GR-CK from CKAG, CKAG has an option to purchase the Class B shares of GR-CK from General Re under a similar exercise price formula.
During the second quarter of 1995, Cologne Re completed a rights offering that raised DM 437 million ($317 million at the June 30, 1995 exchange rate), which increased its capital under U.S. generally accepted accounting principles by 62.9 percent over the amount at December 31, 1994. In connection with Cologne Re's rights offering, GR-CK subscribed for its pro rata share, approximately DM 297 million ($215 million at the June 30, 1995 exchange rate), of the offering. In addition to its ownership of Cologne Re through GR-CK, General Re purchased for its own account an additional 8.4 percent of the ordinary and preference shares of Cologne Re through December 31, 1996 for aggregate consideration of $85 million, which increased General Re's consolidated economic interest in Cologne Re to 74.7 percent at December 31, 1996.
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, equity, swap spread, volatility, correlation, 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 U.S. and foreign government securities or entering into offsetting derivative transactions.
Pretax income for the financial services operations was $100 million in 1995, an increase of 18.1 percent from $85 million earned in 1994. The increase in 1995 income was principally due to increased profitability of GRFP.
At December 31, 1996, total assets were $40,161 million, compared with $34,263 million at December 31, 1995. The $5,898 million growth in assets was attributable to an increase of $2,249 million in the total assets of the North American property/casualty operations, $1,022 million in the international reinsurance operations, and $2,627 million in the financial services segment. The growth in the assets of the North American property/casualty operations was primarily due to the inclusion of National Re's assets of $2,237 million. The increase in the assets of the international operations was due to the investment of operating cash flows offset by the decline of the German mark compared to the U.S. dollar which decreased assets by approximately $734 million.
General Re's invested assets increased from $23,494 million at December 31, 1995 to $26,562 million at December 31, 1996. The $3,068 million increase in invested assets was the result of an increase of $1,398 million in the North American property/casualty segment, an increase of $755 million in the international reinsurance operations and an increase of $915 million in the financial services operations. Unrealized appreciation after deferred income taxes on General Re's investment portfolio was $1,625 million and $1,468 million at December 31, 1996 and December 31, 1995, respectively. The increase was principally due to the appreciation of equities held in the North American and the international operations and appreciation of bonds held in the London and Australian operations, partially offset by a decline in the value of bonds held in the United States.
The composition of the North American property/casualty invested assets as a percent of the total portfolio at December 31, 1996 is shown in the pie chart below.
[PIE CHART] During 1996, there was a minimal amount of net new cash flow Preferred equities 5.6% allocated to the North American property/casualty portfolio, as Other 2.8% almost all available cash flow was used to purchase National Re, pay U.S. Government bonds 5.0% dividends to stockholders and repurchase General Re's common Foreign bonds 2.5% stock. Within the portfolio, General Re continued to shift assets from Mortgage-backed bonds 6.5% taxable to tax-advantaged securities as part of its tax planning Corporate bonds 6.3% strategies. In addition, this shift reflects management's belief that Municipal bonds 51.7% for much of the year, municipal securities were attractively priced Common equities 19.6% relative to their taxable equivalents. General Re anticipates that the investment of future cash flows will be weighted towards municipal securities.
To minimize its exposure to shifts in interest rates, General Re balances within a range the duration (a present-value weighted measure of average life) of its property/casualty claim liabilities with the duration of fixed maturity investments in the investment portfolio.
Included in fixed-maturity investments were mortgage-backed securities of $966 million (3.6 percent of consolidated invested assets) and other asset-backed securities of $53 million (0.2 percent of consolidated invested assets) at December 31, 1996. These securities have interest and principal repayment patterns that differ from typical fixed maturities. Mortgage-backed securities are generally issued by quasi-federal agencies or federally supported institutions and, to a lesser extent, by corporations. They can either be direct pass-throughs of cash flows from the underlying mortgages or can be a grouping of underlying mortgages into various principal repayment tranches, known as collateralized mortgage obligations ("CMOs"). The mortgage-backed securities portfolio comprises pass-through securities (49.9 percent) and CMOs (50.1 percent) based on December 31, 1996 market values. The CMO portfolio is composed of a range of security types but is primarily invested in sequential and planned amortization class securities. Other asset-backed securities are usually debt instruments which are collateralized by credit card or auto loan receivables whose interest and principal payments will vary with the underlying receivables. Most of the mortgage-backed and other asset-backed securities are publicly traded and market values were obtained from an external pricing service.
Tax-exempt Taxable Credit considerations are an important part of General Re's Nonrated .05 1.3 fixed-maturity investment strategy. The overall fixed- Below BBB .01 2.1 maturity portfolio continued to have an average credit rating BBB 2.1 3.8 of AA at December 31, 1996. The distribution of General Re's North A 22.1 17.0 American property/casualty fixed- maturity portfolio by credit AA 32.6 12.1 quality is presented in the chart on the left. AAA 42.6 63.7
Based on its current investment portfolio and the current yield curve, General Re presently anticipates additional calls and maturities through the end of 1997 of approximately $100 million of grandfathered tax-exempt bonds and $200 million of preferred equities, both with an average yield of approximately 7.6 percent. Reinvestment of these funds may adversely affect average portfolio yields and investment income.
General Re's international [PIE CHART] property/casualty and life/health reinsurance operations held invested Real estate/other 3.1% assets of $8,290 million at December 31, 1996, an increase of $755 million from Common equities 9.0% December 31, 1995. These portfolios include $6,545 million of Cologne Re's Short-term 9.4% investments, $1,255 million in wholly owned international operations' Government bonds 45.4% investments and $490 million of GR-CK investments. Most of the international Corporate & other bonds 33.1% invested assets are managed internally.
The composition of the international investment portfolio by major asset class at December 31, 1996 is presented in the chart to the right. During 1996, the composition of the international investment portfolio did not change significantly, although there was a reduction in the level of short-term securities in favor of bonds.
The fixed income portfolio of the [GRAPH] international operations consists of high credit quality securities. Substantially Nonrated 0.3% all bonds were investment grade; the average rating of the portfolio was above Below BBB 0.8% AA. The table to the left presents the credit ratings of fixed maturity BBB 1.3% securities held in the international investment portfolios. The common equity A 6.0% portfolio was well diversified with holdings principally from the major stock AA 34.2% markets in Europe, the United States and Japan. The real estate portfolio of $176 AAA 57.4% million was internationally diversified with principal holdings in Germany. The relatively high share of short-term investments in the portfolio is due to the need to hedge investment crediting provisions in certain deposit contracts.
The currency structure of the international investment portfolio is globally diversified according to the currency structure of the underlying reinsurance business. General Re hedges its currency risk by seeking to match its assets and liabilities by currency. The composition of the international operation's invested assets by currency is presented in the chart below.
The gross liability for claims and claim expenses, which provides for estimated future payments arising from current and prior property/casualty reinsurance transactions, amounted to $15,977 million and $14,252 million at December 31, 1996 and 1995, respectively. Growth in the liability of $1,725 million during 1996 was due to $1,410 million in the North American property/casualty segment and $315 million in the international property/casualty segment. Growth in the North American property/casualty gross liability for claims and claim expenses is in part due to $1,037 million of liabilities assumed with the acquisition of National Re. In addition to the gross liability for property/casualty claim and claim expenses, General Re had a gross liability for policy benefits for life/health contracts of $751 million and $580 million at December 31, 1996 and 1995, respectively. The asset for reinsurance recoverable on paid and unpaid losses was $2,935 million at December 31, 1996, compared to $2,794 million at December 31, 1995. Growth of $141 million in the asset for reinsurance recoverable was due to $112 million associated with the North American property/casualty segment, $3 million for the international property/casualty operations and $26 million related to the life/health operations. Approximately $89 million of the increase in reinsurance recoverables was due to the acquisition of National Re.
Consolidated net claims and claim expenses for 1995 and prior accident years experienced favorable development of $39 million in 1996. Net claims and claim expenses for 1995 and prior accident years for the North American operations experienced favorable development of $48 million in 1996. The net favorable loss development was due to favorable development on casualty lines of business, partially offset by losses related to environmental, asbestos and other mass tort claims. Net claims and claim expenses for 1995 and prior accident years for the international operations, after the effect of foreign exchange, had adverse development of $9 million in 1996. The net adverse loss development for the international operations was primarily related to strengthening of reserves for environmental, asbestos and other mass tort claims in runoff operations.
Included in General Re's liability for claims and claim expenses are liabilities for environmental and latent injury damage claims. These claims are principally related to claims arising from remediation costs associated with
hazardous waste sites and bodily injury claims relating to asbestos products and environmental hazards. These amounts include provisions for both reported and IBNR claims. The table below presents the three-year development of the balance sheet liability for environmental and latent injury claims:
General Re continually estimates its liabilities and related reinsurance recoverable for environmental and latent injury claims and claim expenses. While most of its liabilities for such claims arise from exposures in North America, General Re has also provided for international environmental and latent injury exposures. Environmental and latent injury 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. General Re's estimate for IBNR 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.
General Re has established a liability for litigation costs associated with coverage disputes arising out of direct excess insurance policies (rather than from reinsurance assumed). Certain subsidiaries were parties in 121 active direct excess coverage cases involving environmental and latent injury claims at December 31, 1996. Such coverage litigation expenses are estimated using an actuarial estimate of actionable items and their projected costs. General Re paid $7 million in such costs during 1996, and as of December 31, 1996, the liability for future litigation costs related to coverage disputes for environmental and latent injury claims was $132 million (included in the table above). As coverage disputes are tried and verdicts rendered, General Re expects that the settled case law will result in a downward trend in future direct excess litigation expenses. Because reinsurance contracts generally contain arbitration clauses which control disputes between the ceding company and the reinsurer, General Re does not expect the future costs associated with reinsurance disputes to be material.
The liability for environmental and latent injury claims and claim expenses is management's best estimate of future claim and claim expense payments and recoveries which are expected to develop over the next several decades. General Re continues to monitor evolving case law and its effect on environmental and latent injury claims. Changing government regulations, newly identified toxins, newly reported claims, new theories of liability, new contract interpretations and other factors could significantly affect future claim development. While General Re 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 General Re's results from 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.
GRFP sets market risk limits for each type of risk based on a 95 percent probability that movements in market rates will not affect the results from operations in excess of the limit over a one-week period. Since inception, GRFP's largest consolidated weekly position change has been $5 million. 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.
A summary of General Re's cash flow by business segment was as follows:
General Re's cash flow from operations was $1,678 million in 1996, compared with $1,774 million in 1995, and $1,086 million in 1994. North American property/casualty financing cash flows include General Re's stock repurchases and dividends to stockholders. During 1996, General Re utilized $313 million in cash for the acquisition of National Re. As discussed earlier, General Re made a net cash investment in 1994 of $582 million in GR-CK, the holding company which owns approximately 66.3 percent of Cologne Re. The funds invested in GR-CK are subject to certain restrictions according to the joint- venture agreement.
Dividends paid to General Re common and preferred stockholders were $174 million, $172 million and $168 million in 1996, 1995 and 1994, respectively. General Re used $735 million, $35 million and $207 million to repurchase 4,989,000 shares, 235,200 shares and 1,912,500 shares of its common stock in the years ended December 31, 1996, 1995 and 1994, respectively. Through December 31, 1996, General Re has purchased $2,333 million (27,133,500 shares) of its common stock since the inception of the repurchase program in 1987. On June 12, 1996, General Re's Board of Directors authorized $500 million of stock repurchases, in addition to the standing authority to repurchase shares in anticipation of shares to be issued under various compensation plans. The 1996 repurchase authorization had $226 million of remaining capacity as of December 31, 1996. On February 12, 1997, the Board of Directors declared a regular quarterly dividend of $.55 per share on the common stock of General Re. This represents an increase of 7.8 percent over the $.51 per share dividend paid in prior quarters during 1996 and the 21st consecutive year in which General Re has increased its dividend.
At December 31, 1996, General Re Corporation had $275 million of senior debt outstanding of which $150 million was issued by General Re Corporation and is rated AAA by Standard & Poor's and Aa1 by Moody's, and $125 million was issued by National Re and is rated AA by Standard and Poor's and Aa2 by Moody's. General Re Corporation issues commercial paper to provide additional financial flexibility for its operations. Commercial paper offered by General Re Corporation has been rated A1+ by Standard & Poor's and Prime 1 by Moody's. At December 31, 1996, $140 million of commercial paper was outstanding. General Re Corporation
GRC and the General Star and Genesis insurers have a claims-paying ability rating of AAA by Standard & Poor's and are also rated A++ by A.M. Best Company, a leading insurance industry rating agency. GRC has a financial strength rating of Aaa by Moody's. Each of these ratings represents the highest category for the respective rating agency. Cologne Re has a claims- paying ability rating of AAA by Standard & Poor's and an A rating from A.M. Best Company.
Forward-looking statements are inherently subject to risks and uncertainties. General Re cautions that factors which may cause General Re's results to differ materially from such forward-looking statements include, but are not limited to, the following:
3) The ability of General Re to execute its growth strategies in its property/casualty, life/health and financial services operations;
4) The ability of General Re to retain a significant portion of National Re's book of business and realize certain synergies in connection with its acquisition of National Re;
5) Catastrophe losses in General Re's North American or international property/casualty businesses;
6) Adverse development on property/casualty claim and claim expense liabilities related to business written in prior years, including, but not limited to, evolving case law and its effect on environmental and other latent injury claims, changing government regulations, newly identified toxins, newly reported claims, new theories of liability, or new insurance and reinsurance contract interpretations;
7) Changes in inflation that affect the profitability of General Re's current property/casualty and life/health businesses or the adequacy of its property/casualty claim and claim expense liabilities and life/health policy benefit liabilities related to prior years' business;
10) Increases in interest rates, which cause a reduction in the market value of General Re's interest rate sensitive investments, including, but not limited to, its fixed income investment portfolio, and its common stockholders' equity;
11) Decreases in interest rates causing a reduction of income earned on new cash flow from operations and the reinvestment of the proceeds from sales, calls or maturities of existing investments;
12) Declines in the value of General Re's common equity investments;
14) Changes in the demand for financial services operations' products, including derivatives offered by GRFP;
15) Credit losses on General Re's investment portfolio; credit and market losses on GRFP's portfolio of derivatives and other transactions;
17) Gains or losses related to foreign currency exchange rate fluctuations.
Table 1 presents the development of net balance sheet liabilities for General Re's North American property/casualty operations from 1986 through 1996. Table 2 presents the development of the gross balance sheet liability for General Re's North American property/casualty operations from 1992 through 1996.
for these exposures. In recent years, reserve strengthening on environmental and mass tort claims has been offset by favorable development on reinsurance of liability business.
In evaluating the information included in Tables 1-4, it should be noted that conditions and trends affecting the development of liabilities in the past may not occur in the future. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on these tables. Current actuarial studies indicate that liabilities for claims and claim expense as of December 31, 1996, net and gross of reinsurance, are adequate.
ANALYSIS OF INTERNATIONAL NET CLAIMS AND CLAIM EXPENSE DEVELOPMENT (IN MILLIONS)
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of General Re Corporation and subsidiaries as of 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. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995 (IN MILLIONS, EXCEPT SHARE DATA)
General Re Corporation and subsidiaries ("General Re") have global reinsurance and financial services operations in 62 cities in 30 countries on 6 continents and provide reinsurance coverage in approximately 150 countries. General Re operates four principal businesses: North American property/casualty reinsurance, international property/casualty reinsurance, life/health reinsurance and financial services. General Re's principal reinsurance operations are based in North America and Germany, with other major operations in Asia, Australia, Europe and South America. General Re's financial services operations are located in New York, London, Tokyo, Hong Kong, and Toronto. GRC is the largest North American professional property/casualty reinsurer, and General Re is among the three largest reinsurers in the world based on net premiums written and capital.
General Re's international property/casualty operations produced revenues of $3,004 million, or 36 percent, of consolidated revenues in 1996. With the consolidation of the results of Kolnische Ruckversicherungs-Gesellschaft AG ("Cologne Re") in 1995, international property/casualty premiums now account for a significantly greater portion of General Re's revenues.
General Re's financial services operations include derivative products, insurance brokerage and management, investment management, reinsurance brokerage and real estate management operations. Through General Re Financial Products Corporation and affiliates ("GRFP"), General Re offers a full line of interest rate, currency and equity swaps and options, as well as structured finance products. The financial services operations produced $271 million, or 3 percent, of General Re's 1996 revenues.
than temporary. Realized gains or losses include gains and losses arising from the translation into U.S. dollars of investments held by the North American operations and denominated in foreign currencies. General Re periodically uses derivatives to reduce the price risk associated with its investment portfolio. Derivatives used to manage these risks must be designated as a hedge at their inception and must remain a hedge throughout the hedge period. To the extent these derivatives are considered hedges, related gains or losses are treated as basis adjustments of the hedged securities. Investment income is recognized as earned and includes the accretion of bond discount and amortization of bond premium.
POLICY BENEFITS FOR LIFE/HEALTH CONTRACTS: The liability for policy benefits for life contracts has been computed based upon assumed investment yields and mortality and withdrawal rates anticipated at the later of either the acquisition of Cologne Re or at the date of contract issuance. These assumptions include a margin for adverse deviation and vary with the characteristics of the reinsurance contract's date of issuance, policy duration and country of risk. The interest rate assumptions used vary by country ranging principally from 3.0 percent to 7.0 percent. Appropriate provisions for profit-sharing commissions to ceding companies have been recorded.
PRESENT VALUE OF FUTURE PROFITS: The present value of future profits ("PVP") is the actuarially determined present value of the projected profits from the continuation of in-force reinsurance on existing insurance policies on the date Cologne Re was acquired. The calculation of the estimated profits includes anticipated future premiums, death and benefit payments, reserve changes, profit sharing amounts, expenses and related investment income. PVP was determined using risk-adjusted discount rates ranging primarily from 10.0 percent through 16.0 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. PVP, which is included in "Other assets" on the balance sheet, was $112 million and $125 million at December 31, 1996 and 1995, respectively, and is being amortized over the duration of the related life business, approximately 20 years, based upon the assumed underlying profits of the business acquired using a 7.0 percent interest rate.
GOODWILL: General Re amortizes on a straight-line basis goodwill recorded in connection with its business combinations. Included in 1996 goodwill is approximately $595 million related to the acquisition of National Re. The 1995 goodwill amount is principally related to the Cologne Re joint venture. General Re's goodwill is amortized predominantly over 40 years. The amount of goodwill reported for the Cologne Re transaction fluctuates based on changes in the value of the German mark relative to the U.S. dollar during the period.
DEFERRED INCOME TAXES: Deferred income taxes have been provided for all temporary differences between the bases of assets and liabilities used in the financial statements and General Re's United States and foreign tax returns. Deferred income taxes are also provided for unrealized appreciation (depreciation) of equity securities and certain fixed maturities, and for foreign currency translation gains or losses by a charge or credit directly to the applicable component of common stockholders' equity.
FOREIGN CURRENCY TRANSLATION: Revenues and expenses denominated in foreign currencies are translated at the average rate of exchange during the period. 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. General Re's international operations have exposures to the major currencies in Europe, principally the German mark and British pound. A deterioration in the value of these currencies could have an adverse effect on General Re's financial position and operating results. 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.
ALLOWANCE FOR DOUBTFUL ACCOUNTS: Allowances are provided for uncollectible reinsurance recoverables and other doubtful receivables. Write-offs of receivables reduce the allowance. At December 31, 1996 and 1995, the allowance was $126 million and $135 million, respectively.
FINANCIAL SERVICES: GRFP's derivative contracts are carried at estimated fair value which is determined using financial models which incorporate current interest rates, currency rates, and security values. Securities owned, securities sold but not yet purchased and futures contracts are carried at fair value. Realized and unrealized gains or losses from selling or valuing securities and contractual commitments at fair value are included in "Other revenues." Included in trading account assets and liabilities are the unrealized gains and losses on interest rate and currency swaps, forward currency commitments and option products. These estimated unrealized gains and losses, which have been included in income, represent the fair value of estimated future cash flows for these transactions. 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 are recorded at their contractual resale or repurchase amounts, plus accrued interest.
ACCOUNTING ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. General Re's principal estimates include property/casualty claims and claim expenses, policy benefits for life/health contracts, estimated premium when General Re has not received ceding company reports and valuation of nonexchange traded financial instruments. General Re utilizes historical information, actuarial analyses, financial modeling and other analytical techniques to prepare these estimates. Actual results for all these items could differ from the estimates included in General Re's income statement, balance sheet and statement of cash flows.
EARNINGS PER SHARE: Earnings per common share were based on earnings less preferred dividends, divided by the weighted average common shares outstanding during each year. Fully diluted earnings per share, assuming the conversion of all outstanding convertible preferred stock and the maximum dilutive effect of common stock equivalents, have not been presented because the effects are not material.
In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation. The Statement establishes financial accounting and reporting standards for stock-based employee compensation plans. The Statement defines a fair-value based method of accounting for stock option plans whereby compensation cost is measured at the grant date based on the value of the award and is recognized over the service period. Under the new Statement, companies may continue to measure compensation cost of stock-based plans using the current accounting prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. General Re elected to continue its current method of accounting for stock-based compensation and disclosed in Note 11 pro forma net income and earnings per share as if the Statement's fair-value based method of accounting were applied. Adoption of the Statement had no effect on General Re's results from operations, financial position or cash flows.
In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to be Disposed of. The Statement established accounting standards for the determination of impairment of long- lived assets, certain identifiable intangibles and goodwill. The Statement requires that long-lived assets and intangibles be reviewed for impairment using an estimate of future undiscounted cash flows compared to the carrying amount of the assets. Adoption of the Statement had no material effect on the results from operations, financial position or cash flows of General Re.
General Re has an option to purchase from January 1, 2002 to January 1, 2004 the Class A shares of GR-CK owned by the CKAG at a formula price. The option has a minimum exercise price of DM 1,306 million and a maximum of DM 1,509 million, subject to certain warranty and other adjustments that may affect the exercise price. If General Re does not exercise its option to purchase the Class A shares of GR-CK from CKAG, CKAG has an option to purchase the Class B shares of GR-CK from General Re under a similar exercise price formula.
- -------- /1/Cost is amortized cost for short-term investments and fixed maturities and original cost for equity securities and other invested assets.
Securities with a market value of approximately $924 million at December 31, 1996 were on deposit with various state or governmental departments to comply with insurance laws.
The table below provides a reconciliation of the beginning and ending claim and claim expense liability, net of reinsurance, for the years presented.
General Re continually estimates its liabilities and related reinsurance recoverable for environmental and latent injury claims and claim expenses. While most of its liabilities for such claims arise from exposures in North America, General Re has also provided for international environmental and latent injury exposures. Environmental and latent injury 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, incurred but not reported ("IBNR") and direct excess coverage litigation expenses. General Re's estimate for IBNR 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. General Re 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.
Income taxes were established on a consolidated basis for all United States and international operations of General Re. No provisions have been made for U.S. income taxes relating to $146 million of cumulative undistributed income of wholly owned international subsidiaries as of December 31, 1996, which is considered permanently reinvested. Applicable U.S. income taxes have been recorded for Cologne Re's income since it distributes dividends to its shareholders on an annual basis. Income taxes paid were $219 million, $216 million and $138 million in 1996, 1995 and 1994, respectively.
General Re's effective income tax rate is less than the U.S. statutory rate due to permanent differences between financial statement income and taxable income. An analysis of General Re's effective tax rate as a percentage of pretax income follows:
The carrying amounts of General Re's notes payable and commercial paper were as follows:
General Re Corporation issues commercial paper for short-term funding needs. Information on the commercial paper program is as follows:
General Re Corporation has $1.2 billion of available lines of credit which provide financial flexibility and support General Re Corporation's commercial paper program. The credit lines consist of a 364-day facility of $400 million and a five-year credit facility of the remaining $800 million. The credit agreements with the banks require General Re to maintain a minimum consolidated tangible net worth, as defined, of $2.7 billion. All $1.2 billion of available lines of credit were unused at December 31, 1996 and 1995. Interest expense and interest paid for all loans payable and commercial paper were as follows:
General Re has noncontributory pension plans covering substantially all employees. Plans for U.S. employees provide pension benefits that are generally computed on the basis of the average earnings during the three consecutive years of highest earnings during the employee's service. General Re's funding policy is to contribute sufficient amounts to meet the minimum annual funding required by applicable regulations, plus such additional amounts as it may determine to be appropriate from time to time. Pension plan assets are principally invested in investment-grade fixed maturities and equities. Cologne Re provides unfunded pension benefits to its employees based on years of service and age at retirement.
The projected benefit obligation for U.S. employees was determined using an assumed discount rate of 7.50 percent in 1996, 7.00 percent in 1995 and 8.25 percent for 1994, and an assumed long-term compensation increase of 6.00 percent in 1996, 5.75 percent for 1995 and 6.00 percent for 1994. An assumed long-term rate of return on plan assets of 8.50 percent was used in determining pension expense in 1996, 1995 and 1994. The projected benefit obligation for most Cologne Re employees was determined using an assumed discount rate of
7.00 percent in 1996 and 1995 and an assumed long-term compensation increase of 3.50 percent in 1996 and 1995.
Through unfunded plans, General Re provides pension benefits for certain employees above amounts allowed under tax qualified plans. General Re also provides postretirement retainers through unfunded plans for members of the Board of Directors.
General Re has a leveraged Employee Savings and Stock Ownership Plan ("ESSOP") in which substantially all U.S. employees may participate. This is a defined contribution plan which allows employees to make regular contributions that the ESSOP matches up to a maximum of 6 percent of the employee's salary. In 1989, the ESSOP borrowed $150 million from General Re at 9.25 percent, payable annually through 2014. The proceeds of this borrowing were used by the ESSOP to purchase 1,754,386 shares of 7.25 percent ($6.20 dividend per share) cumulative convertible preferred stock of General Re. All preferred stock outstanding is held by the ESSOP and is convertible into common stock, under certain conditions, on a one-to-one basis. The preferred stock is held by the ESSOP trustee as collateral for the loan from General Re. General Re 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 General Re. As interest and principal are repaid, a portion of the preferred stock is released for allocation to participating employees. General Re recognizes compensation expense for the ESSOP based on the shares-allocated method.
General Re has a Long-Term Compensation Plan (the "Plan") which provides for the granting of incentive and nonqualified stock options to members of the Board of Directors and officers. The Plan provides that the exercise price of the options granted may not be less than the fair market value of General Re's common stock on the date the options are granted. The options are exercisable cumulatively, 20 percent each year commencing one year from the date of grant and expire ten years from the grant date. In certain circumstances, replacement options may be granted upon exercise of an original option, with the exercise price equal to the current market price and with a term extending to the expiration date of the original option.
In celebration of its 75th Anniversary during 1996, General Re issued 75 option shares or stock appreciation rights ("SARs") to most of its employees. These options are exercisable cumulatively 33 percent each year commencing one year from March 21, 1996. As part of the acquisition of National Re, holders of National Re stock options had the opportunity to roll over their options into options to purchase General Re's common stock. These rollover options are fully vested and have exercise prices that maintain the holder's intrinsic value in the options held.
General Re has elected to continue accounting for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25 for all of its compensatory plans. Accordingly, no compensation expense has been recognized for its nonqualified stock option plan. Had compensation expense for General Re's nonqualified stock option plan been recognized in accordance with FASB Statement No. 123, General Re's net income and earnings per share would have been $882 million, or $10.86 per share, in 1996 and $823 million, or $9.90 per share in 1995.
During the fourth quarter of 1996, GRC paid a $940 million dividend to General Re Corporation in connection with the acquisition of National Re. Subsequently, General Re Corporation made a cash contribution to GRC of $210 million and contributed the common stock of National Re. As a result of the extraordinary dividend, any additional dividend payments by GRC to General Re Corporation prior to October 1, 1997 will be extraordinary and will require regulatory approval. The statutory standard for such approval requires that GRC's statutory surplus must be reasonable in relation to its outstanding liabilities and adequate relative to its financial needs following payment of the dividend.
GRFP is engaged as a dealer in various types of derivative instruments, which are described below:
Interest rate, currency and equity 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 re-exchange the currencies at a future date and agreed exchange rate.
A summary of notional amounts of derivative contracts at December 31, 1996 and 1995 is included in the table below. For these transactions, the notional amount represents 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 69 percent of the notional volume outstanding for derivative contracts at December 31, 1996 has a term of five years or less and approximately 94 percent of the contracts has a term of less than ten years.
Market risk is the potential change in value of the portfolio caused by movements in foreign exchange, interest rate and equity markets. The level of market risk is influenced by factors such as volatility and market liquidity in which the financial instruments are traded. GRFP controls market risk exposures by taking offsetting positions in either cash instruments or other derivatives to reduce its overall exposure due to movements in these variables. For securities sold, but not yet purchased, GRFP may incur a loss if the market value of the security increases prior to the purchase of the instruments. GRFP manages its exposures on a portfolio basis. Under this approach, GRFP monitors its market risk on a daily basis across all swap and option products by calculating the effect on operating results of potential changes in market variables 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 affect the results from operations in excess of the limit over a one week holding period. GRFP also monitors its consolidated market risk across all trading books on a weekly basis and has established limits assuming simultaneous losses of two market risk components, each at the 95
percent confidence level. When a risk limit is exceeded, appropriate action is taken, dependent upon the amount and duration of the excess, to monitor, control, and reduce the excess within approved levels. The weekly market risk limit across all trading books was $10 million.
Since inception, GRFP has not experienced a weekly position change in excess of the aggregate weekly market risk limit. In addition to these daily and weekly assessments of risk, GRFP prepares periodic stress tests to assess its exposure to movements in various market risk factors such as volatilities, shifts in yield curves, and foreign currency exchange rates.
Counterparties to the financial instruments are, in decreasing order of magnitude, foreign and domestic commercial banks, U.S. government-chartered organizations, sovereigns and corporations. GRFP evaluates the creditworthiness of its counterparties by performing formal internal credit analyses and by referring to ratings of widely-accepted credit rating services. Counterparty credit limits are determined based on this analysis and counterparty credit exposures are monitored in accordance with these limits. GRFP receives cash and/or investment grade securities from certain counterparties as collateral and, where appropriate, may purchase credit insurance or enter into other transactions to mitigate its credit exposure. GRFP also incorporates into contracts with certain counterparties provisions which allow the unwinding of these transactions in the event of a downgrade in credit rating or other indications of decline in creditworthiness of either the counterparty or GRFP.
GRFP assesses credit risk by counterparty across all transactions with each respective counterparty. Assuming non-performance by all counterparties on all contracts potentially subject to a loss, the maximum potential loss, based on the cost of replacement, net of collateral held, at market rates prevailing at December 31, 1996, approximated $2,852 million. This value represents unrealized gains on financial instrument contracts in gain positions, net of any unrealized losses with these counterparties from offsetting positions. The maximum potential loss will increase or decrease during the life of the transaction as a function of contract terms and market conditions such as interest and currency rates. In the judgment of GRFP's management, the likelihood that all counterparties would default, resulting in a maximum potential loss, is remote. GRFP has not had any credit losses as a result of counterparty defaults.
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. All of these transactions are collateralized by U.S. and foreign government securities. In addition to interest amounts shown in Note 8, GRFP had $96 million, $90 million and $83 million of interest expense in 1996, 1995 and 1994, respectively, on related collateralized borrowings. GRFP's exposure to credit risks associated with the nonperformance of counterparties in fulfilling these contractual obligations can be directly affected by market fluctuations, which may affect 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.
Legal risk arises from the uncertainty of the enforceability, through legal or judicial processes, of the obligations of GRFP's counterparties, including contractual provisions intended to reduce credit exposure by providing for the offsetting or netting of mutual obligations. GRFP seeks to reduce legal risk by consulting with internal and external legal counsel (in relevant jurisdictions) to determine legality and enforceability of various transactions with different types of counterparties.
The following are the estimated fair values of General Re's financial instruments:
General Re uses various methods and assumptions in estimating the fair value of financial instruments. The following valuation methods and assumptions were utilized by General Re in estimating the fair value of financial instruments.
Contract deposit assets/liabilities--The fair value of contract deposit assets and liabilities approximates their carrying value.
General Re has been named as defendant in litigation in the ordinary course of conducting its 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. General Re'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 General Re'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, or any other litigation, would be material to the financial position, results of operations or cash flow of General Re.
On July 1, 1996, U.S. Aviation Underwriters, Inc. ("USAU"), a subsidiary of General Re, and John V. Brennan, the former Chairman and Chief Executive Officer of USAU, after a trial in the U.S. District Court for the Eastern District of New York, were found guilty of mail fraud in connection with the allocation of insurance claims between two companies, arising out of the December 7, 1987 crash of a domestic United States flight. General Re does not expect the amount of any liability to USAU to be material to the financial position, results of operations or cash flows of General Re.
General Re has the authority to issue 250 million shares of $.50 par value common stock, of which 102 million have been issued. Common stock purchased in the open market is carried at cost and shown as a reduction to common stockholders' equity. When treasury shares are reissued, the treasury stock account is reduced for the cost of the common stock reissued on a first-in, first-out basis. No treasury stock of General Re is held by any subsidiary. The number of shares included in treasury stock were as follows:
General Re also has the authority to issue 20 million shares of preferred stock, of which 1,711,907 are issued and outstanding and held by the ESSOP, and 1 million (Series A Junior Participating Preferred) are reserved for the Stockholders' Rights Plan. Under the Stockholders' Rights Plan, one Right attaches to each outstanding share of common stock. In the event a person or group acquires or commences a tender or exchange offer for 20 percent or more of General Re's common stock, each Right entitles common stockholders to purchase Series A Junior Participating Stock, which is convertible to common stock having a value equal to two times the rights exercise price.
General Re conducts its operations principally through the following business segments: the property/casualty reinsurance operations, which include both North American and international subsidiaries, life/health operations and financial services.
The following is a summary of industry segment activity for 1996, 1995 and 1994: