GRC Realty Corporation, also a wholly owned subsidiary of the Corporation, has retained title to the Corporation's former home office site in Greenwich, Connecticut. This site consists of approximately four acres of land and an office building which has about 160,000 square feet of office space that is rented to nonaffiliates. The Greenwich site is subject to a mortgage expiring December 31, 1998, which had a remaining balance of $5 million at December 31, 1995.
Cologne Re's German operations are principally based in an office building of approximately 130,000 square feet in Cologne, Germany. The United States operations of Cologne Re are based in an office building in Stamford, Connecticut. Cologne Re owns both of these office buildings.
(1) Excludes cumulative effect of accounting changes. The balance sheet data in the table on pages 9 and 10 reflect the adoption of Statement of Financial Accounting Standards No. 115, Accounting For Certain Investments in Debt and Equity Securities in 1994 and the adoption of Statement of Financial Accounting Standards No. 113, Accounting and Reporting for Reinsurance of Short-Duration and Long-Duration Contracts in 1993, with reclassifications made for 1992. Adoption of Standard No. 113 did not affect results from operations or common stockholders' equity. In 1993, the Corporation 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, the Corporation adopted Statement of Financial Accounting Standards 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.
(8) The common share price information is based on the Corporation's daily closing price on the New York Stock Exchange.
Net income in 1995 was $825 million or $9.92 per share, an increase of 24.5 percent over the $7.97 per share earned in 1994. These results include after-tax realized gains of $.45 per share in 1995 and $.54 per share in 1994. The improved results in 1995 were primarily attributable to increased underwriting profitability in the United States property/casualty operations, growth in after-tax investment income, increased income from the Corporation's international property/casualty operations and inclusion of Kolnische Ruckversicherungs-Gesellschaft AG's ("Cologne Re") life/health operations. Due to the Corporation's reporting of its international operations on a quarter lag, the 1995 results include only three quarters of the year's results for Cologne Re and the related joint-venture company, General Re-CKAG Reinsurance and Investment S.a r.l. ("GR-CK"). These results were not included in the comparable 1994 amounts, since the formation of GR-CK did not occur until December 28, 1994.
Consolidated net premiums written in 1995 were $6,102 million, an increase of $3,101 million or 103.3 percent, from $3,001 million in 1994. United States property/casualty premium volume was $2,964 million in 1995, compared with $2,581 million in 1994, an increase of 14.9 percent. Net premiums written in the international property/casualty reinsurance operations were $2,429 million in 1995, compared to $420 million in 1994, with $1,651 million of the growth attributable to the inclusion of Cologne Re's premium during the year. In addition, the underwriting results of the Corporation's wholly owned European operations, which were predominantly reported on a full underwriting-year lag in prior years, are now reported on a one-quarter lag beginning in 1995. The wholly owned European subsidiaries' net premiums written increased by $263 million during 1995 due to this change in reporting, although net income was not materially affected by the change. Net premiums written for the life/health segment, which consist of Cologne Re's United States and international life/health operations, were $709 million for 1995.
Net income in 1994 was $665 million or $7.97 per share, a decrease of 3.7 percent from $8.28 per share earned in 1993. These results include after-tax realized gains of $.54 per share in 1994 and $1.10 per share in 1993. Net income in 1993 also included a cumulative benefit of $.17 per share resulting from the adoption of the accounting prescribed by the Emerging Issues Task Force for multiple-year, retrospectively rated reinsurance contracts. Excluding after-tax realized gains and cumulative-effect adjustments, after-tax income for the year ended December 31, 1994 was $7.43 per share, an increase of 6.0 percent over $7.01 per share in 1993.
Consolidated net premiums written in 1994 were $3,001 million, an increase of $477 million or 18.9 percent from $2,524 million in 1993. United States property/casualty premium volume was $2,581 million in 1994, compared with $2,275 million in 1993, an increase of 13.4 percent. Net premiums written in the international
property/casualty operations were $420 million in 1994, an increase of 69.0 percent over 1993 premium volume.
United States property/casualty pretax income in 1995, excluding realized gains and the cumulative effect of accounting changes, increased 19.4 percent from 1994's income. This growth in pretax income was primarily due to improvement in the underwriting result of $59 million, an increase in investment income of $25 million and increased net other income (loss) of $32 million. The 1994 underwriting result was adversely affected by the earthquake in Northridge, California on January 17th. The increase in investment income of 3.7 percent in 1995 was due to growth in the segment's investment portfolio since the beginning of 1994 and an increase in market interest rates during 1994. Excluding the effect of an estimated $38 million reduction in investment income due to the Corporation's investment in the Cologne Re joint venture, which is now included in the international segment, investment income of the United States property/casualty segment grew by 9.3 percent in 1995. The improvement in net other income (loss) in 1995 was due to increased fee income on financial reinsurance transactions accounted for as deposits, and an increase in income from the Corporation's affiliates carried under the equity method.
The combined underwriting ratio is computed based on the relationship of losses and underwriting expenses to premiums. This ratio is the Corporation's principal indicator of underwriting performance, with 100 percent or lower generally indicating an underwriting profit. In 1995, the statutory combined ratio for the United States property/casualty segment was 99.0 percent, compared to 101.3 percent in 1994 and 101.5 percent in 1993. The 1995 underwriting result was consistent with the Corporation's operating objective of achieving an underwriting profit.
While the United States primary insurance market grew at approximately 3.9 percent in 1995, according to A.M. Best, General Reinsurance Corporation's ("GRC") treaty and facultative premiums grew by 15.5 percent. The Corporation believes that the growth in premiums written was due to marketing efforts, increased purchases of property reinsurance due to greater sensitivity to catastrophe exposures, the increase in insurance premiums written by medium- and smaller-sized primary companies that generally purchase relatively more reinsurance, the migration back to the United States of some insurance and reinsurance premiums that were being written in the London market, increased reinsurance cessions by primary companies as they seek to deleverage their capital in response to rating agency concerns and increased demand for reinsurance from better capitalized and more creditworthy reinsurers. In 1996, GRC's net premiums written will be adversely affected by the nonrenewal of a treaty which accounted for approximately $244 million of net premiums written. The lost after-tax investment income from nonrenewal of this contract is estimated to be less than $5 million for 1996.
For the General Star operations, which principally write excess specialty insurance, net premiums written grew 10.2 percent in 1995 due to increased marketing activities and improved rates for property business in the Southeast. General Star has produced a statutory underwriting profit for eleven consecutive years.
The Genesis operations provide direct excess insurance and reinsurance to companies with self-insurance programs. Net premiums written for Genesis increased during the year by 9.0 percent over 1994 levels principally due to growth in casualty premiums.
Net premiums written for the United States property/casualty insurance segment were $2,581 million in 1994, an increase of 13.4 percent over $2,275 million in 1993. As discussed in Note 3 to the consolidated financial statements, North Star Reinsurance Corporation, a wholly owned subsidiary, was sold to Signet Star Holdings, Inc. in 1993. The disposal affects premium comparisons relative to prior years. During the first quarter of 1993, North Star had net premiums written of $41 million. North Star's first-quarter premiums for 1993 are included with GRC in the preceding table.
Income before taxes for the international property/casualty operations of $53 million in 1994 increased 120.8 percent over 1993 levels. Included in these results were realized gains of $8 million in 1994. Growth in the income for the international property/casualty operations resulted principally from an underwriting profit of $6 million in 1994, compared to an underwriting loss of $13 million in 1993. Underwriting results improved over 1993 due to stronger pricing and demand in higher margin businesses, particularly in the Corporation's European operations. International net premiums written of $420 million in 1994 increased $171 million, or 69.0 percent, over 1993 premiums of $249 million. The premium growth reflects the continued expansion of existing client relationships, an increase in reinsurance rates, and the acquisition of new reinsurance relationships, particularly in European operations. Premium growth in 1994 also resulted from expanded operations in Madrid and the opening of new offices in Cologne, Milan, Paris and Singapore during the prior two years.
the option to purchase the Class B shares of GR-CK from the Corporation 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 United States 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 in Cologne Re through GR-CK, the Corporation purchased for its own account an additional 6.9 percent of the ordinary and preference shares of Cologne Re during 1995 for aggregate consideration of $68 million, which increased the Corporation's consolidated economic interest in Cologne Re to 73.2 percent.
Due to the Corporation's reporting of its international operations, including all of Cologne Re's business, on a quarter lag, the 1995 results include only three quarters of life/health operations. This segment includes the U.S. and international life/health operations of Cologne Re. During 1995 the life/health operations' income before taxes and minority interest was $51 million. This consists of pretax income of $15 million, $17 million, and $19 million in the second, third and fourth quarters, respectively. Pretax income during 1995 resulted from underwriting income of $10 million, investment income of $40 million and realized gains of $1 million. Life/health premiums written were $709 million during 1995. Approximately one-half of this segment's premium was written in continental Europe, another 40 percent was written in the United States and the remaining 10 percent was written throughout the rest of the world.
The financial services operations include the Corporation's derivative products, insurance brokerage and management, investment management, reinsurance brokerage and real estate management operations. Pretax income for the financial services operations was $103 million in 1995, an increase of 26.4 percent from $82 million earned in 1994. The increase in 1995 income was principally due to increased profitability of the Corporation's derivative products subsidiary, General Re Financial Products Corporation ("GRFP"), and revenues from General Re Underwriting Services Limited ("GRUS"). GRUS provides underwriting services for Tempest Reinsurance Company Limited ("Tempest"), an affiliated Bermuda-based company specializing in excess property catastrophe reinsurance.
management services. In August 1995, the Corporation acquired all of the outstanding stock of New England Asset Management in exchange for stock of the Corporation and combined it with the Corporation's own investment management subsidiary. The resulting company, General Re-New England Asset Management, Inc. ("GR-NEAM"), provides investment management services primarily for other insurance companies that seek the Corporation's expertise in managing insurance company investment portfolios. GR-NEAM has approximately 45 insurance company clients and approximately $10 billion of client assets under management at December 31, 1995.
Pretax income for the financial services operations was $82 million in 1994, an increase of 40.4 percent from $58 million earned in 1993. The increase in 1994 income was principally due to increased profitability of GRFP and new revenues from GRUS.
At December 31, 1995, total assets were $35,946 million, compared with $29,597 million at December 31, 1994. The $6,349 million of growth in assets was attributable to an increase of $3,110 million in the total assets of the United States property/casualty operations, $2,713 million in the international reinsurance operations, and $526 million in the financial services segment. The growth in the assets of the United States property/casualty operations was primarily due to the favorable bond and stock markets in 1995 and the investment of operating cash flows. The increase in the assets of the international operations was due to the investment of operating cash flows and the strengthening of the German mark compared to the United States dollar which increased assets by approximately $800 million.
The Corporation's invested assets increased from $18,898 million at December 31, 1994 to $23,494 million at December 31, 1995. The $4,596 million increase in invested assets was the result of an increase of $2,304 million in the United States property/casualty segment, an increase of $1,475 million in the international reinsurance operations and an increase of $817 million in the financial services operations. The unrealized appreciation after deferred income taxes on the Corporation's investment portfolio was $1,468 million and $421 million at December 31, 1995 and December 31, 1994, respectively. The increase was due to the favorable effect on bond prices of declining interest rates and appreciation in the equity markets in the United States. At December 31, 1995, all fixed maturity securities of the Corporation have been categorized as either available-for-sale or trading. Most of the securities transferred to the available-for-sale category were tax-exempt securities grandfathered under the Tax Reform Act of 1986 that the Corporation anticipates being called within the near future. The recategorization of the held-to-maturity securities increased investments by $82 million, and common stockholders' equity by $53 million.
To minimize its exposure to shifts in interest rates, the Corporation balances 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. The table below shows the average maturity and effective duration of the United States taxable and tax-exempt portfolios:
- --------------- (1) Bonds purchased after August 7, 1986 that do not remain fully tax-exempt under the Tax Reform Act of 1986.
At December 31, 1995, the effective average maturity of the fixed-maturity portfolio was 10.6 years, compared to an estimated average life of 9.1 years for the Corporation's property/casualty claim liabilities. The duration of the fixed maturity portfolio was 6.2 years, compared with 4.7 years for the property/casualty claim liabilities. This compares with 1994 durations of 5.0 years and 4.6 years, respectively. The increase in the duration of the Corporation's liabilities at December 31, 1995 was principally due to the sharp decline in interest rates in 1995 and, to a lesser extent, due to the mix of premiums written. Of the increase in the duration of the portfolio assets, approximately two thirds was due to the decline in interest rates, with the rest accounted for by specific shifts in the portfolio during the year.
Included in fixed-maturity investments were mortgage-backed securities ("MBS") of $622 million (2.7 percent of consolidated invested assets) and other asset-backed securities ("ABS") of $113 million (0.5 percent of consolidated invested assets) at December 31, 1995. These securities have interest and principal repayment patterns that differ from typical fixed maturities. MBS issued by quasi-federal agencies, federally supported institutions and corporations can either be direct pass-throughs of cash flows from the underlying mortgages or can be a grouping of underlying mortgages into various principal repayment tranches, known as collateralized mortgage obligations ("CMOs"). The MBS portfolio comprises pass-through securities (45 percent) and CMOs (55 percent) based on December 31, 1995 market values. The CMO portfolio is composed of almost entirely planned amortization class ("PACs") securities which have experienced less volatility in repayment of principal than other types of CMO securities. ABS are usually debt instruments which are collateralized by credit card or auto loan receivables whose interest and principal payments will vary with the underlying receivable. Almost all of the MBS and ABS portfolios are publicly traded and market values were obtained from an external pricing service.
At December 31, 1995, equity investments in the United States portfolio totaled $3,107 million, representing 19.5 percent of the United States property/casualty investment portfolio. The United States equity portfolio is well diversified and primarily consists of holdings in companies with large capitalizations that, collectively, have a calculated volatility approximating the Standard & Poor's 500 index.
A small portion of the United States investment portfolio was dedicated to nontraditional, private investments. These alternative investments, included in the balance sheet caption, "Other invested assets," were $344 million (1.5 percent of consolidated invested assets) and $325 million (1.7 percent of consolidated invested assets) at December 31, 1995 and 1994, respectively. Most of these investments are interests in limited partnerships run by professional managers. Over time, these investments are expected to provide a higher return than the overall portfolio. This segment, however, also may entail a greater amount of risk both in terms of limited liquidity and greater uncertainty of returns compared to the rest of the Corporation's portfolio. The Corporation evaluates the fair value of these alternative investments on a quarterly basis by reviewing available financial information of the investee and performing other financial analyses in consultation with external advisors. Any changes in the fair value of limited partnerships are included in unrealized appreciation or depreciation in common stockholders' equity, unless a decline in fair value is considered other than temporary, resulting in a charge to income.
Pretax total return for the United States portfolio was 19.2 percent in 1995, compared with a negative return of 2.6 percent in 1994. With lower interest rates and sharply higher stock prices, all investment sectors recorded higher returns in 1995 than in 1994.
The Corporation's international property/casualty and life/health reinsurance operations had invested assets of $7,535 million at December 31, 1995, an increase of $1,475 million from December 31, 1994. These portfolios include $6,026 million of Cologne Re's investments, $1,050 million in wholly owned international operations' investments and $459 million of GR-CK investments. GR-CK's investment portfolio consisted of high credit quality, German mark denominated securities with an average maturity of approximately 6 years.
At December 31, 1995, Cologne Re's invested assets were $6,026 million, an increase of $1,309 million, or 27.8 percent from year-end 1994. The fixed maturity portfolio consisted of high credit quality securities. Almost all bonds were investment grade; the average rating of the portfolio was above AA. The common equity portfolio of Cologne Re was well diversified with holdings principally from the major European stock markets, United States, and Japan. The real estate portfolio was internationally diversified with principal holdings in Germany. The relatively high share of short-term investments in Cologne Re's portfolio is due to the need to hedge investment crediting provisions in certain financial reinsurance contracts, a specific "barbell" bond strategy in 1995 and an unusually high volume of cash at the end of the reporting period.
As part of its foreign exchange risk management program, Cologne Re's investment portfolio is globally diversified, with most fixed maturities having a term less than five years. The currency structure of the investment portfolio is determined by Cologne Re's reinsurance business. Cologne Re hedges its currency risk by seeking to match its assets and liabilities by currency. Due to the high volatility and the significant movements in the currency markets during 1995, Cologne Re remained relatively neutral in its currency exposures.
The overall pretax yield on Cologne Re's portfolio was 5.1 percent during 1995. Cologne Re writes a significant portion of its business in property lines of business and, accordingly, invests in shorter duration securities as part of its program to match its asset and liability durations. In addition, Cologne Re's reported investment yield is decreased by the sharing of investment income under certain reinsurance agreements.
The gross liability for claims and claim expenses, which provides for future obligations arising from current and prior property/casualty reinsurance transactions, amounted to $14,252 million and $12,158 million at December 31, 1995 and 1994, respectively. Growth in the liability of $2,094 million during 1995 was due to $778 million in the United States property/casualty segment and $1,316 million in the international property/casualty segment. In addition to the gross liability for property/casualty claim and claim expenses, the Corporation, through its interest in Cologne Re, had a gross liability for policy benefits for life/health contracts of $2,263 million and $1,960 million at December 31, 1995 and 1994, respectively. The asset for reinsurance recoverable on paid and unpaid losses was $2,794 million at December 31, 1995, compared to $2,067 million at December 31, 1994. Growth of $727 million in the asset for reinsurance recoverable was due to $422 million associated with the United States property/casualty segment, $253 million for the international property/casualty operations and $52 million related to the life/health operations.
The ongoing financial integrity of the Corporation is dependent on reserve adequacy. The gross liability and reinsurance recoverable for claims and claim expenses were based on the Corporation's analysis of reports and individual case estimates received from ceding companies. The liability and related recoverables, which include an amount estimated by the Corporation for claims and claim expenses incurred but not reported ("IBNR"), are evaluated continuously by management, annually by the Corporation's independent account-
The Corporation has established a liability for litigation costs associated with coverage disputes arising out of direct excess insurance policies (rather than from reinsurance assumed). Certain subsidiaries were parties in 108 active direct excess coverage cases involving environmental and latent injury claims at December 31, 1995. Such coverage litigation expenses are estimated using an actuarial estimate of actionable items and their projected costs. The Corporation paid $8 million in such costs during 1995, and as of December 31, 1995, the liability for future litigation costs related to coverage disputes for environmental and latent injury claims was $165 million (included in the table above). As coverage disputes are tried and verdicts rendered, the Corporation 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, the Corporation does not expect the future costs associated with reinsurance disputes to be material.
GRFP controls its market risk exposures through the use of cash instruments and derivative transactions. GRFP's components of market risk include foreign exchange, interest rate, swap spread, volatility, correlation
See Note 2 on page 41 for a discussion of new accounting standards.
Schedules other than those listed above have been omitted since they are either not required, not applicable or repeat information disclosed in the notes to financial statements.
The consolidated financial statements include estimated liabilities for unpaid claims and claim expenses of the Corporation's United States and international property/casualty reinsurance subsidiaries. The provision for reported but unpaid claims and claim expenses is based on client reports and individual case estimates, including anticipated salvage and subrogation recoverable. A provision is included for incurred but not reported ("IBNR") claims and claim expenses on the basis of past experience. Historic premium, claim and claim expense data are organized in actuarial formats, analyzed for credibility, and processed through actuarial formulae. Using actuarial judgment, forecasts of IBNR claims and claim expenses are determined and tested for validity. The Corporation strives for accuracy in its reserving structure and monitors its predictions against actual claims and claim expense emergence. The methods of making such estimates and for establishing the resulting liabilities are continually reviewed and updated. All adjustments to the reserve structure (which encompasses claims from up to 50 years ago) are included in current operating results.
The table below provides a reconciliation of the beginning and ending claim and claim expense liability, net of reinsurance, for 1995, 1994 and 1993.
Table 4 presents the development of net balance sheet liabilities for the Corporation's United States property/casualty operations from 1985 through 1995. Table 5 presents the development of the gross balance sheet liability for the Corporation's United States property/casualty operations from 1992 through 1995. Reference is made to Exhibit 28, "Combined United States Property/Casualty Insurance Company Schedule P" for a more detailed review of SAP liabilities on an accident year basis.
ANALYSIS OF UNITED STATES NET CLAIMS AND CLAIM EXPENSE DEVELOPMENT (IN MILLIONS)
- --------------- * The liability for workers' compensation tabular reserves for claims and claim expenses is discounted as discussed herein. Therefore, the liability reestimated for each year includes the effect of the discount and its amortization.
ANALYSIS OF UNITED STATES GROSS CLAIMS AND CLAIM EXPENSE DEVELOPMENT (IN MILLIONS)
High levels of social and economic inflation have had a leveraged effect on liabilities for claims and claim expenses. Implicit within the reserve structure is an increase in both the frequency and severity of claims between years. In recent years, some of the Corporation's clients have increased the amount of their retained risk which partially offsets the effect of social and economic inflation.
The Corporation purchases reinsurance, in both the United States and international markets, which provides protection from large property, liability or workers' compensation claims and allows the Corporation to offer greater capacity to clients for certain lines of business. The Corporation increased its capacity over time by retaining more risk and by purchasing additional reinsurance protection above its retentions. The Corporation has selected financially sound reinsurers and anticipates receiving the full amounts recoverable, net of allowances provided for uncollectible reinsurance recoverables.
The Corporation's international property/casualty operations produced revenues of $2,573 million, or 35.7 percent, of consolidated revenues in 1995. With the consolidation of the results of Kolnische Ruckversicherungs-Gesellschaft AG ("Cologne Re") in 1995, international property/casualty premium now accounts for a significantly greater portion of the Corporation's revenues. The Corporation's international business in 1995 was primarily conducted through operations based in Germany, the United Kingdom, Switzerland, Ireland, Australia, and Argentina.
The Corporation's life/health reinsurance operations produced revenues of $742 million, or 10.3 percent, of the consolidated total in 1995. These operations include the United States and international life/health reinsurance operations of Cologne Re.
Included in other invested assets are investments in reinsurance joint ventures, limited partnerships and real estate. Reinsurance ventures reported under the equity method are carried at initial cost with adjustment after acquisition for the Corporation's proportionate share of the venture's earnings. The amount of the adjustment is included in income. Limited partnership investments are carried at estimated fair value. Real estate is valued at cost and depreciated over its estimated useful life.
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 the Corporation'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.
DEPOSITS: Reinsurance contracts that do not indemnify the ceding company against loss or liability are recorded as deposits and included in "Other reinsurance balances." These deposits are treated as financing transactions and are credited or charged with interest income or expense according to contract terms.
ALLOWANCE FOR DOUBTFUL ACCOUNTS: Allowances are provided for uncollectible reinsurance recoverables and other doubtful receivables. The allowance is recorded as a valuation account and reduces the corresponding asset. The allowance was $135 million and $121 million at December 31, 1995 and 1994, 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 the balance sheet captions, 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.
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.
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. Companies electing to remain with the accounting in Opinion No. 25 must make pro forma disclosures of net income and earnings per share as if the fair-value based method of accounting defined in the Statement were applied. The Statement is effective in 1996. The Corporation intends to continue its current method of accounting for stock-based compensation plans. Therefore, the adoption of the Statement will have no effect on the Corporation'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. The Statement is effective in 1996. It is anticipated the adoption of the Statement will have no material impact on the results from operations, financial position or cash flows of the Corporation.
Effective January 1, 1994, the Corporation adopted Statement of Financial Accounting Standards No. 115, Accounting for Certain Investments in Debt and Equity Securities. The after-tax effect of Statement No. 115 decreased common stockholders' equity by $81 million at December 31, 1994. The Statement's adoption had
On December 28, 1994, the Corporation and Colonia Konzern AG ("Colonia") formed a new company that acquired 75 percent of the ordinary shares and approximately 30 percent of the preference shares of Cologne Re, which collectively represents a 66.3 percent economic interest in Cologne Re. In exchange for its Cologne Re shares, Colonia, for itself and as trustee for Nordstern Allgemeine Versicherungs AG (collectively, "CKAG"), received 100 percent of the Class A shares of the new company, General Re-CKAG Reinsurance and Investment S.a r.1. ("GR-CK"). The Corporation initially contributed $884 million (DM 1,377 million) to GR-CK in exchange for 100 percent of the Class B shares of GR-CK. On December 30, 1994, GR-CK paid $302 million (DM 475 million) to the Corporation in exchange for notes in the principal amount of DM 475 million. The notes pay interest of 8.0 percent annually to GR-CK and are due on December 30, 2004. The intercompany notes have been eliminated in consolidation. The funds invested in GR-CK are subject to certain restrictions according to the joint venture agreement.
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 United States 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 in Cologne Re through GR-CK, the Corporation purchased for its own account an additional 6.9 percent of the ordinary and preference shares of Cologne Re during 1995 for aggregate consideration of $68 million, which increased the Corporation's consolidated economic interest in Cologne Re to 73.2 percent. The purchase of Cologne Re shares during 1995 was accounted for as a step acquisition. Under the step acquisition method of accounting, the fair value of assets and liabilities are recorded at each acquisition date with the excess of cost over fair value recorded as incremental goodwill.
The following unaudited, pro forma information was prepared assuming the transaction with Cologne Re had occurred as of the beginning of the periods presented. These results were prepared for informational purposes and do not purport to be the actual results of the entities, had they been combined at that time. The pro forma information includes all significant adjustments to the historical results which were directly attributable to the transaction and were expected to have a continuing effect on the Corporation.
On December 30, 1994, General Reinsurance Corporation ("GRC") exchanged its 50.0 percent partnership interest in Engineering Insurance Group ("EIG"), a machinery breakdown insurer, for nonvoting preferred stock in EIG having a value of $20 million. The preferred stock pays dividends at a rate of 6.5 percent per annum.
maturing on July 1, 2003, bearing an interest rate of 6.5 percent for which the principal and interest are guaranteed by Berkley.
- --------------- 1 Cost is amortized cost for short-term investments and fixed maturities and original cost for equity securities and other invested assets.
The liability for claims and claim expenses for 1994 and prior accident years for the Corporation's property/casualty operations, net of related reinsurance recoveries, increased by $13 million in 1995. The increase was principally the result of the net effect of reserve strengthening for environmental and latent injury claims, partly offset by favorable loss development on casualty lines of business. The liability for United States operations for prior accident years was decreased by $36 million in 1994, and increased by $140 million during 1993. The adverse effect on income in 1993 was the result of reserve strengthening principally for environmental and latent injury claims. The liability for claims and claim expenses for 1994 and prior accident years for the international operations, net of related reinsurance recoveries and foreign exchange, increased by $1 million in 1995.
The gross liability for environmental and latent injury claims and claim expenses and the related reinsurance recoverable were $1,756 million and $498 million, respectively, at December 31, 1995. 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. The Corporation 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 the Corporation has recorded its current best estimate of its liabilities for unpaid claims and claim expenses, it is reasonably possible that these estimated liabilities, net of estimated reinsurance recoveries, may increase in the future and that the increase may be material to the Corporation's results 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.
The Corporation's effective income tax rate is less than the United States statutory rate due to permanent differences between financial statement income and taxable income. An analysis of the Corporation's effective tax rate as a percentage of pretax income follows:
Income taxes paid were $216 million, $138 million and $142 million in 1995, 1994 and 1993, respectively.
The carrying amounts of the Corporation's loans payable were as follows:
The 9.0 percent debenture due in 2009 has a covenant requiring the Corporation not to encumber its common stock holding in GRC, the largest subsidiary of the Corporation. The mortgage payable is collateralized by the Corporation's prior home office.
The Corporation issues commercial paper for financial flexibility and liquidity purposes. Information on the commercial paper program is as follows:
In August 1995, the Corporation modified its $1.0 billion of available lines of credit with nineteen participating banks. The credit lines consist of a 364-day facility of $500 million and a five-year credit facility of the remaining $500 million. The credit agreements with the banks require the Corporation to maintain a minimum consolidated tangible net worth, as defined, of $2.5 billion. All $1.0 billion of available lines of credit were unused at December 31, 1995 and 1994. Interest expense and interest paid for all loans payable and commercial paper were as follows:
The Corporation has noncontributory pension plans covering substantially all employees. Plans for United States 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. The Corporation'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 United States employees was determined using an assumed discount rate of 7.0 percent in 1995, 8.25 percent in 1994 and 7.25 percent for 1993, and an assumed long-term compensation increase of 5.75 percent in 1995, 6.0 percent for 1994 and 5.5 percent for 1993. An assumed long-term rate of return on plan assets of 8.5 percent was used in determining pension expense in 1995, 1994 and 1993. The projected benefit obligation for Cologne Re employees was determined using an assumed discount rate of 7.0 percent in 1995 and 1994 and an assumed long-term compensation increase of 3.5 percent in 1995 and 1994.
Through unfunded plans, the Corporation provides pension benefits for certain employees above amounts allowed under tax qualified plans. The Corporation also provides postretirement retainers through unfunded plans for members of the Board of Directors.
The Corporation has a leveraged Employee Savings and Stock Ownership Plan ("ESSOP") in which substantially all United States employees may participate. The ESSOP borrowed $150 million from the Corporation 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 the Corporation. 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 the Corporation. The Corporation makes contributions to the ESSOP which, together with the dividend on shares of the preferred stock, are sufficient to make loan interest and principal repayments back to the Corporation. As interest and principal are repaid, a portion of the preferred stock is allocated to participating employees. The Corporation recognizes compensation expense for the ESSOP based on the shares-allocated method.
The Plan also permits the granting of restricted stock awards as compensation to key executives and managerial employees. Shares of restricted stock become outstanding upon grant, receive dividends and have voting rights identical to other outstanding shares of common stock. Restrictions lapse upon termination of the restriction period or upon death, disability or normal retirement. During 1995, 1994 and 1993, the Corporation made aggregate compensatory restricted stock awards of 31,900, 17,250, and 38,250 shares, respectively. The cost of restricted stock awards is based on the market value of the common stock at the date of grant and is recognized as expense over the restriction period.
The Plan also provides for bonus awards to be made in cash, common stock, share units or restricted stock options ("RSOs"). RSOs restrictions lapse five years after the grant date and RSOs expire ten years after the grant date. RSOs are included in the table above. Share units are paid in shares of common stock at a designated future date in advance of the bonus award period. The expense of the Plan was $4 million in 1995, $2 million in 1994 and $1 million in 1993.
The Corporation utilizes reinsurance to reduce its exposure to large claims. These agreements provide for recovery of a portion of certain claims and claim expenses from reinsurers. If the reinsurers are unable to meet their obligations under the agreements, the Corporation would be liable for such defaulted amounts. The Corporation holds partial collateral under these agreements and has never suffered a significant loss because of defaults. The Corporation utilizes various United States and international reinsurers as part of its retrocessional program. Prior to being included in the Corporation's retrocessional program, reinsurers are reviewed for their anticipated long-term creditworthiness by the Corporation's Retrocessional Market Committee. At December 31, 1995, the largest reinsurance recoverable on unpaid claims and claim expenses from any single reinsurer was $399 million. The reinsurer is rated A++ by A.M. Best and has a Standard & Poor's claims paying rating of AAA.
General Re Financial Products Corporation ("GRFP") is a dealer in derivative financial instruments. GRFP's products include cross-currency and interest rate swaps, interest rate caps and floors, foreign exchange contracts, options and options on swaps. These instruments are carried at their current estimates of fair value, which is a function of underlying interest rates, currency rates, security values, volatilities and the creditworthiness of counterparties. Future changes in interest rates, currency rates, security values, and interest rate volatilities or a combination thereof may affect the fair value of these instruments with any resulting adjustment, including amounts in excess of those previously recognized in the financial statements, being included currently in the income statement. In the course of conducting its business, GRFP also engages in a variety of other related transactions to manage its exposure to market and credit risks.
Interest rate, equity and currency options grant the purchaser the right but not the obligation to either purchase from or sell to the writer a specified financial instrument under agreed terms. Interest rate caps and floors require the writer to pay the purchaser at specified future dates the amount, if any, by which the option's underlying market interest rate exceeds the fixed cap or falls below the fixed floor rate, applied to a notional amount.
A summary of contract and notional amounts of interest rate contracts at December 31, 1995 and 1994 is included in the table below. For swap and option transactions, the contract and notional amounts represent the amount of 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 74 percent of the notional volume outstanding for swap and option contracts at December 31, 1995 have a term of five years or less and substantially all of the instruments have a term of less than ten years.
GRFP enters into futures contracts for delayed delivery of foreign currencies or securities in which the seller/purchaser agrees to make/take delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise from the inability of the exchange to meet the terms of the contracts and from a futures broker's inability to remit additional margin.
GRFP regularly consults with internal and external legal counsel (in relevant jurisdictions) to determine legality and enforceability of various transactions with different types of counterparties. When there is perceived risk that a proposed counterparty may lack legal capacity to enter into a transaction, the relevant statutes, regulations, and consents are examined.
The Corporation uses various methods and assumptions in estimating the fair value of financial instruments. The following valuation methods and assumptions were utilized by the Corporation in estimating the fair value of financial instruments.
Investments -- Fair values for fixed maturities and equity securities were generally based on quoted market prices or dealer quotes. The fair value of investments in limited partnerships, which were included in other invested assets on the balance sheet, was determined by reviewing available financial information of the investee and by performing other financial analyses in consultation with external advisors. Fair values for investments in real estate were determined using discounted cash flow analyses for each property. Fair values for reinsurance ventures were based on the Corporation's proportionate share in the entity's stockholders' equity, since the cost of determining fair value exceeds the benefits derived. The carrying amounts for short-term investments approximate their fair values.
Mortgage and loans receivable/payable -- The fair value of the Corporation's mortgage and notes receivable/payable was estimated using discounted cash flow analyses, based on the Corporation's current incremental borrowing rates for similar types of arrangements. The fair value of the Corporation's 9.0 percent debenture due in 2009 was based on a market price quotation.
The following table is a summary of the Corporation's business by geographic area. Allocations to geographic area have been made on the basis of subsidiary location.