TIG's business properties include 45 leased locations, which represent approximately 950,000 square feet. TIG occupies approximately 275,000 square feet of space in Irving, Texas for which the lease expires in 2009 and may be extended by TIG for two renewal periods of five years each. All of TIG's other existing leases expire by the end of 2007.
1 - Consolidated Results), TIG Insurance will retain contingent exposure for catastrophes impacting Independent Agents business.
No major catastrophe losses were incurred by TIG in 1997 or 1996. As with all property/casualty insurers, TIG expects to pay some losses related to catastrophes and prices its products accordingly. Total gross catastrophe losses aggregated $5 million, $15 million and $34 million in 1997, 1996 and 1995, respectively. Total net catastrophe costs, including reinsurance reinstatement premium, aggregated $5 million, $11 million and $24 million in 1997, 1996 and 1995, respectively.
Investment Mix. Management continues to emphasize a conservative investment strategy by maintaining a portfolio of primarily high-quality, fixed maturity investments. In accordance with SFAS 115, TIG's entire fixed maturity portfolio has been classified as available-for-sale. As a result, all fixed maturity investments are recorded in TIG's financial statements at fair value. Unrealized gains and losses on fixed maturity investments and related hedges are recorded net of tax directly in shareholders' equity. See Note D to the Consolidated Financial Statements at
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1997.......................................54
Consolidated Statements of Changes in Shareholders' Equity for each of the three years in the period ended December 31, 1997 ..............55
Retail. Retail's principal products are standard automobile, non-standard automobile, homeowners and small business owner's insurance. Automobile policies cover liability to third parties for bodily injury and property damage and physical damage to the insured's own vehicle resulting from collision or various other causes of loss. Homeowners and small commercial property policies protect against loss of dwellings/buildings and contents arising from a variety of perils, as well as liability arising from ownership or occupancy. Retail's products are distributed through approximately 700 independent agents and through strategic relationships with general agents ("GAs") and other key distribution partners. Net premium written for the Retail division comprised 23%, 23% and 21% of consolidated net premium written for the years ended December 31, 1997, 1996 and 1995, respectively. (See Note C. - Sale of Independent Agents Business Unit).
Basis of Presentation. The consolidated financial statements are prepared in accordance with generally accepted accounting principles ("GAAP") and include the accounts of TIG Holdings, Inc. and its subsidiaries. Financial statements prepared in accordance with GAAP require the use of management's estimates. Intercompany transactions are eliminated in consolidation. Certain reclassifications of prior years' amounts have been made to conform with the 1997 presentation.
(In millions) 1997 1996 1995 ============================================= ========= ========= ========= Numerator: Net Income $52 $79 $118 Less: Preferred stock dividends 2 2 2 - --------------------------------------------- --------- --------- --------- Income available to common stockholders $50 $77 $116 Denominator: Weighted average shares outstanding for basic EPS 51.8 56.4 60.8 Effect of dilutive options 1.7 1.9 0.6 - --------------------------------------------- --------- --------- --------- Adjusted weighted average shares for diluted EPS 53.5 58.3 61.4
Basic EPS $0.97 $1.36 $1.91 - --------------------------------------------- --------- --------- --------- Diluted EPS $0.94 $1.32 $1.90 ============================================= ========= ========= =========
Investments. Fixed maturities are classified as available for sale, as TIG has no positive intent to hold such securities until maturity, and are carried at market value. Equity securities are also carried at market value while short-term investments are carried at cost, which approximates market value. Market value is principally based upon quoted market prices. Quoted market prices are available for substantially all fixed maturities and equity securities. The difference between the aggregate market value and amortized cost of securities, after deferred income tax effect, is reported as unrealized gain or loss directly in shareholders' equity and, accordingly, has no effect on net income.
Loss and loss adjustment expense reserves. The liability for loss and loss adjustment expenses ("LAE") is based on an evaluation of reported losses and on estimates of incurred but unreported losses ("IBNR"). The reserve liabilities are determined using estimates of losses for individual claims (case basis reserves) and statistical projections of reserves for IBNR. Management considers many factors when setting reserves, including: (i) current legal interpretations of coverage and liability; (ii) economic conditions; and, (iii) internal methodologies which analyze TIG's experience with similar cases, information from ceding companies and historical trends, such as reserving patterns, loss payments, pending levels of unpaid claims and product mix. Based on these considerations, management believes that adequate provision has been made for TIG's loss and LAE reserves. Actual losses and LAE paid may deviate, perhaps substantially, from such reserves. Adjustments to the reserves resulting from subsequent developments or revisions to the estimate are reflected in results of operations in the period in which such adjustments become known. The liability is reported net of estimated salvage and subrogation recoverables of $31 million and $29 million at December 31, 1997 and 1996, respectively. Certain liabilities for unpaid losses related to long term workers' compensation coverage are discounted to present value. The discount on these workers' compensation loss reserves was $31 million at December 31, 1997 and $39 million at December 31, 1996.
Deferred Policy Acquisition Costs. Acquisition costs that vary with and are primarily related to the production of new business, consist principally of commissions, premium taxes, and other expenses incurred at policy issuance and renewal. The costs are generally deferred and amortized ratably over the terms of the underlying policies. Anticipated losses, loss expenses, and remaining costs of servicing the policies are considered in determining the amount of costs to be deferred. Anticipated investment income is considered in determining whether a premium deficiency exists. Amortization of deferred policy acquisition costs totaled $391 million, $347 million and $335 million for the years ended December 31, 1997, 1996 and 1995, respectively.
Participating Insurance Business. Dividends to policyholders, which relate primarily to workers' compensation policies, are accrued during the period in which the related premium is earned. Approximately 7%, 4% and 5% in 1997, 1996 and 1995, respectively, of TIG's total premium was subject to participation in such dividends.
In the normal course of business, TIG may choose to hedge some of its interest rate risk with futures contracts and/or interest rate swaps. Alternatively, derivative financial instruments may also be utilized to enhance prospective returns. TIG's interest rate swap arrangements generally provide that one party pays interest at a floating rate in relation to movements in an underlying index, and the other party pays interest at a fixed rate. While TIG is exposed to credit risk in the event of nonperformance by the other party, nonperformance is not anticipated due to the credit rating of the counterparties. No futures contract positions were open at December 31, 1997, or December 31, 1996. There were $14 million notional face amount of interest rate swaps at December 31, 1997, unchanged from December 31, 1996. All TIG derivative financial instruments were with financial institutions rated A or better by one or more of the major credit rating agencies. Total derivative positions were approximately $94 million par value, $78 million fair value, and represents approximately 1.8% of the total consolidated investment asset holdings at December 31, 1997.
TIG has no material non-income producing investments and has no geographic or other concentrations of investment risk which has not been disclosed. Invested assets of TIG, carried at $620 million and $712 million at December 31, 1997 and 1996, respectively, were either on deposit with government agencies as required by law in various states in which TIG insurance subsidiaries conduct business or were held as collateral for various business transactions. Invested assets of TIG's participation in Lloyd's Syndicates totaling $8.2 million at December 31, 1997, including cash of $4.9 million, are held in trust in accordance with Lloyd's of London regulations (see Note M Commitments and Contingencies).
The estimated market value and amortized cost of the portfolio, by contractual maturity, at December 31, 1997 are presented below. Expected maturities will differ from contractual maturities as certain borrowers have the right to call or prepay obligations.
Years Ended December 31, ---------------------------- (In millions) 1997 1996 1995 =================================================== ========= ======== ========= Fixed maturity investments Gross gains $38 $37 $18 Gross losses (22) (41) (29) Other losses (15) - - - --------------------------------------------------- --------- --------- -------- Net investment and other gain (loss) before tax 1 (4) (11) Less related taxes - 1 4 - --------------------------------------------------- --------- --------- -------- Net investment and other gain (loss), net of taxes $1 ($3) ($7) =================================================== ========= ========= ========
- -------------------------------------------------------------------------------- NOTE E. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES - --------------------------------------------------------------------------------
(In millions) 1997 1996 1995 ========================================== ======== ========= ========= Balance January 1, net of reinsurance recoverables $2,634 $2,752 $2,721 Incurred related to: Current year 1,076 1,122 1,200 Prior year 75 16 (24) - ------------------------------------------ -------- --------- --------- Total losses and LAE incurred 1,151 1,138 1,176 - ------------------------------------------ -------- --------- --------- Loss and LAE payments related to: Current year 417 374 367 Prior year 837 882 778 - ------------------------------------------ -------- --------- --------- Total losses and LAE payments 1,254 1,256 1,145 - ------------------------------------------ -------- --------- --------- Balance December 31, net of reinsurance recoverable 2,531 2,634 2,752 Reinsurance recoverable 1,404 1,126 1,134 - ------------------------------------------ -------- --------- --------- Gross loss and LAE reserves $3,935 $3,760 $3,886 ========================================== ======== ========= =========
In 1997, TIG recognized unfavorable prior year loss and LAE reserve development of $75 million, of which unfavorable development of $106 million was attributable to TIG Re reserve strengthening and favorable development of $31 million was attributable to TIG Insurance. The reserve strengthening by TIG Re in December 1997 was based on actuarial evaluations of loss data through September 30, 1997, which incorporated enhancements to TIG Re's actuarial process and previously unavailable data. This intensive actuarial review indicated that reserving issues were concentrated in a limited number of large proportional excess of loss programs, the majority of which were restructured or non-renewed effective January 1, 1997. TIG Re also increased 1997 accident year reserves by $39 million as a result of the September 30, 1997 actuarial study. The total $145 million reserve increase recorded by TIG Re in December 1997 was net of corporate aggregate stop loss reinsurance coverage, including $40 million under a 1995 intercompany agreement with TIG Insurance. The favorable prior year loss reserve development of $31 million for primary lines written by TIG Insurance was principally attributable to continuing favorable workers' compensation development. The majority of this favorable development was reallocated to the 1997 accident year for workers' compensation and various other lines for statutory reporting purposes. The assumption by TIG Insurance in Other Lines of $40 million in losses under the aforementioned intercompany reinsurance agreement was principally offset by a $27 million cession to a corporate aggregate stop loss reinsurance treaty.
Years Ended December 31, ---------------------------- (In millions) 1997 1996 ========================================================================== Deferred tax assets: Discounting of reserves for losses and loss adjustment expenses $158 $167 Net operating loss carryforward 70 35 Discounting of unearned premium reserves 38 42 Expense reserves 20 3 Restructuring charges 5 20 Postretirement benefits other than pensions 8 8 Capital loss carryforward 7 17 Business in force 7 14 Policyholder dividends 7 6 Other, net 8 12 - --------------------------------------------- ---------------------------- Total deferred tax assets 328 324 - --------------------------------------------- ----------------------------
Deferred tax liabilities: Section 338 - marketable securities 130 128 Deferred policy acquisition costs 53 52 Unrealized gain - marketable securities 52 28 Section 338 - other 10 5 - -------------------------------------------------------------------------- Total deferred tax liabilities 245 213 - -------------------------------------------------------------------------- Net deferred tax asset $83 $111 ==========================================================================
In accordance with the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes", TIG's management has reviewed its deferred tax asset balance and concluded that it is more likely than not the entire deferred tax asset will be realized. Management's conclusion is based on its expectation that sufficient taxable income will be generated in future periods within the carryforward period. TIG has reported profits in 1997, 1996, 1995 and 1994, and is expected to be profitable in the future. If TIG does not achieve its anticipated earnings level in future periods but maintains the earnings level sustained over the past four years and converts all of its tax-exempt securities into taxable securities, it anticipates that all of its net operating loss and capital loss carryforward and 90% of its existing deferred tax asset will be utilized by the year 2002.
Years Ended December 31, ----------------------------- (In millions) 1997 1996 1995 ================================================================= Current expense ($9) ($9) ($2) Deferred benefit (expense) (1) 13 (35) ----------------------------------- --------- ---------- -------- Total income tax benefit (expense) ($10) $4 ($37) =================================================================
Years Ended December 31, -------------------------- (In millions) 1997 1996 1995 ====================================================================== Discounting of reserves for losses and loss adjustment expenses ($9) ($5) ($7) Discounting of unearned premium reserves (4) 1 - Net operating loss carryforward 35 (11) 2 Expense reserves 17 - - Restructuring charges (15) 16 (3) Capital loss carryforward (10) 3 3 Business in force (7) (6) (7) Policyholder dividends 1 (4) (5) Tax liability adjustment 5 20 - Deferred investment income (2) (4) (15) Deferred policy acquisition costs (1) (1) (3) Other (11) 4 - - -------------------------------------------- -------- -------- -------- Total deferred income tax benefit (expense) ($1) $13 ($35) =======================================================================
Years Ended December 31, -------------------------- (In millions) 1997 1996 1995 ========================================================================== Federal income tax expense at statutory rates ($22) ($26) ($54) Tax-exempt investment income 9 9 17 Tax liability adjustment 5 20 - Other (2) 1 - - ----------------------------------------------- -------- -------- -------- Total income tax benefit (expense) ($10) $4 ($37) ==========================================================================
Line of Credit. In December 1995 (as amended and restated in 1997), TIG established an unsecured revolving line of credit with maximum borrowings of $250 million. Included in the restrictive covenants are limitations on the disposition of significant subsidiaries of TIG, limitations on liens and limitations on the merger of the Company. The full amount of the five year credit facility was available for general corporate purposes as of December 31, 1997.
In April 1993, in connection with it's IPO, TIG Holdings issued 250,000 shares of non-voting mandatory redeemable preferred stock with a cumulative annual cash dividend rate of $7.75 per share and an aggregate liquidation preference/redemption value of $25 million plus accrued and unpaid dividends. The preferred stock must be redeemed on April 27, 2000. With each regular quarterly dividend declared on the preferred shares, each holder also receives one non-transferable right (a "Right"). Each Right will constitute the right to receive an additional amount to the extent that the regular cash dividend to which the related Right was, in whole or in part, not made out of TIG Holdings' current or accumulated earnings and profits, as calculated for federal income tax purposes. In such event, the holder of a Right will be entitled to receive an amount which, when taken together with the regular cash dividend to which the Right was related, would cause the net after-tax return to such holder to equal what the net after-tax return on the mandatory redeemable preferred stock would have been had the regular cash dividend been paid entirely out of the current or accumulated earnings and profits of TIG Holdings. No additional payments were required during 1997 and 1996. During 1995, TIG paid an additional $0.7 million in respect to these Rights in connection with dividends declared on the mandatory redeemable preferred stock during 1994.
Authorized Capital Stock. TIG Holdings' authorized capital stock consists of one million shares of $0.01 par value Class A convertible common stock, 180 million shares of $0.01 par value common stock, and 15 million shares of $0.01 par value preferred stock.
The 1996 Long-Term Incentive Plan. The 1996 Long-Term Incentive Plan (the "1996 Plan") provides for awards of stock options, stock appreciation rights, restricted stock grants, restricted stock units and/or performance units. The maximum number of shares of Common Stock for which awards may be granted or paid out under the 1996 Plan is 5 million shares plus, effective January 1, 2000, the Limitation Amount. The "Limitation Amount" is 1.5% of the total number of issued and outstanding shares of Common Stock as of January 1, 2000, plus, effective each January 1 thereafter through and including January 1, 2006, 1.5% of the total number of issued and outstanding shares of Common Stock as of such January 1. In addition to the shares available for grant as previously mentioned, 2 million shares of Common Stock will be available solely for the grant of awards to employees in connection with acquisitions of other entities or businesses by the Company. As of December 31, 1997, there were no stock appreciation rights, restricted stock units or performance units outstanding. The 1996 Plan will terminate on the date of the Company's annual meeting of stockholders in 2006. Thereafter, no awards may be granted. Stock options under the 1996 Plan typically have a term of ten years from the date of the grant and vest in equal annual installments over four years. Restricted stock grants typically vest in equal annual installments over three years.
Restricted Class A Shares Shares Options =============================================================================== Outstanding at January 1, 1995 56,014 76,259 9,996,197 Granted 4,600 - 1,391,100 Exercised/Earned (30,911) (39,800) (100,133) Forfeited or canceled (843) (666) (275,982) - ----------------------------------- ------------- ------------- ------------- Outstanding at December 31, 1995 28,860 35,793 11,011,182 - ----------------------------------- ------------- ------------- ------------- Granted 110,170 - 1,476,736 Exercised/Earned (25,436) (35,793) (383,594) Forfeited or canceled (14,380) - (472,089) - ----------------------------------- ------------- ------------- ------------- Outstanding at December 31, 1996 99,214 - 11,632,235 - ----------------------------------- ------------- ------------- ------------- Granted 71,319 - 2,090,117 Exercised/Earned (33,972) - (2,994,788) Forfeited or canceled (11,268) - (262,820) - ----------------------------------- ------------- ------------- ------------- Outstanding at December 31, 1997 125,293 - 10,464,744 ===============================================================================
The weighted average fair value of options granted during 1997 was $10.45 while the weighted average fair value of restricted stock granted during the year was $33.80. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in 1997, 1996 and 1995 respectively: dividend yield of 1.70 percent, 1.75 percent and 1.75 percent; expected volatility of .220, .201 and .201; risk free interest rate of 6 percent, 7 percent and 7 percent and expected life of 7 years for all years. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
If the fair value of the stock compensation granted had been accounted for under SFAS 123, the proforma net income for 1997 would have been $41.1 million or $0.76 per basic share or $0.74 per diluted share. Net income for 1996 would have been $74.5 million or $1.29 per basic share or $1.26 per diluted share. Net income for 1995 would have been $115.7 million or $1.87 per basic share or $1.86 per diluted share. For purposes of proforma disclosures, the estimated fair value of the stock compensation is amortized to expense over the stock compensation's vesting period. The effect on net income of the stock compensation amortization for the years presented above is not likely to be representative of the effects on reported net income for future years.
Diversified Savings and Profit Sharing Plan. As of January 1, 1997, the Diversified Savings Plan and Profit Sharing Plan were combined into the TIG Holdings, Inc. Diversified Savings and Profit Sharing Plan (the "DS&PSP"). The DS&PSP is qualified under Section 401 (a) of the Internal Revenue Code ("IRC") and the trust established to hold the assets of the DS&PSP is tax-exempt under Section 501 (a) of the IRC. Effective January 1, 1995, an employee vests 25% after one year of service, 50% after two years of service and 100% after three years of service. While the assets are maintained in a single trust, the recordkeeping, contributions and participant qualifications remain as if under two separate plans, the Diversified Savings Plan (the "DSP") and the Profit Sharing Plan (the "PSP").
The PSP benefits eligible employees of TIG Holdings. Eligible employees are those who either were employed by TIG Holdings on December 31, each year or were employed during the plan year but died prior to the plan year end. Generally, each salaried employee is eligible to participate in the PSP. No employee contributions are permitted to be made to the PSP. The amount of any contribution for any calendar year made by TIG Holdings will be determined at the sole discretion of the TIG Holdings' Board of Directors. For 1997, 1996 and 1995 plan years, TIG contributed on behalf of each participant an amount equal to the sum of (i) two percent of the participant's Employee Compensation, as defined, for the Plan Year and (ii) four percent of the participant's annual Employee Compensation in excess of a determined wage base. Contributions were $2 million, $1 million and $2 million for 1997, 1996 and 1995, respectively.
Diversified Savings and Profit Sharing Restoration Plan. Effective January 1, 1997, TIG Holdings adopted the TIG Holdings, Inc. Diversified Savings Restoration Plan and combined it with the existing Profit Sharing Restoration Plan. The TIG Holdings, Inc. Diversified Savings and Profit Sharing Restoration Plan (the "DS&PS Restoration Plan") is an unfunded plan for the purpose of providing deferred compensation for a select group of management or highly compensated employees whose allocations under the qualified DS&PSP are limited by the annual restrictions as determined by the Internal Revenue Code. Highly compensated employees will be eligible for participation immediately upon the date of hire if annual earnings, including bonus in the year paid, exceed a specified threshold. The threshold for each year will be the amount of the cap on compensation that may be taken into account under the qualified plan for that year, or such greater amount as may be determined by the Committee in its discretion. A Participant vests 25% after one year of service, 50% after two years of service and 100% after three years of service. Participants' accounts are credited for the difference between the dollar amount credited to the participants' account under the qualified DS&PSP and the amount that would have been credited in the absence of the restrictions noted above. Participants' accounts are adjusted for gains, losses and earnings as if invested in the same manner as such associate's account under the qualified DS&PSP. Liabilities due to the participants were approximately $2 million and $1 million as of December 31, 1997, and 1996, respectively.
Years Ended December 31, ------------------------- (In millions) 1997 1996 1995 ============================================================================ Service cost - benefits earned during the period $ - $0.3 $0.3 Interest cost on projected benefit obligation 1.7 1.4 1.4 Amortization of prior service cost (0.1) (0.1) (0.1) Amortization of loss 0.2 - - - -------------------------------------------------- -------- -------- ------- Net periodic other postretirement benefit cost $1.8 $1.6 $1.6 ============================================================================
The weighted average annual assumed rate of increase in the health care cost trend rate is 10.0 percent for 1997 and 9.0 percent for 1998 and will decrease to 8.0 percent in 1999 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported.
Increasing the trend rate by one percentage point in each year would increase the actuarial present value obligation for postretirement medical benefits as of December 31, 1997, 1996, and 1995 by $2 million, and the aggregate of the service and interest cost components of net periodic postretirement benefit cost by $0.1 million for 1997, 1996, and 1995. The weighted average discount rate used in determining the postretirement benefit obligation was 7.0% at December 31, 1997 and 1996.
(In millions) ========================================= 1998 $19 1999 17 2000 15 2001 12 2002 9 Thereafter 50 ========================================= Sublease rental income 23 - ----------------------------------------- Net commitments $99 =========================================
On February 12, 1998, a purported class action complaint, naming TIG and two of its executive officers as defendants, was filed in the United States District Court for the Southern District of New York on behalf of persons who purchased TIG common stock during the period from October 21, 1997 to January 30, 1998, when TIG announced its fourth quarter 1997 results. The complaint alleges that TIG violated the federal securities laws by misrepresenting the adequacy of its underwriting and monitoring standards and loss reserves, and that three of its officers and directors sold shares at prices that were artificially inflated as a result of the alleged misrepresentations. Plaintiffs seek unspecified monetary damages, including punitive damages. Management believes that the lawsuit is without merit and it will be vigorously defended.
Ratio of Total Adjusted Capital to Authorized Control Level Risk-Based Regulatory Event Capital (Less Than or Equal to) ========================================================================= Company action level 2.0 (or 2.5 with negative trends) Regulatory action level 1.5 Authorized control level 1.0 Mandatory control level 0.7 -------------------------------------------------------------------------
Permitted Statutory Accounting Practices. TIG prepares its statutory financial statements in accordance with accounting principles and practices prescribed or permitted by the domiciliary state insurance department. Prescribed statutory accounting practices include state laws, regulations, and general administrative rules, as well as a variety of publications of the NAIC. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state, and may change in the future. Furthermore, the NAIC has a project to codify statutory accounting practices, the result of which is expected to constitute the only source of "Prescribed" statutory accounting practices. Accordingly, that project, which is expected to be completed in 1998 and implemented in 1999 will likely change the definitions of what comprises prescribed versus permitted statutory accounting practices, and may result in changes to the accounting policies that insurance enterprises use to prepare their statutory financial statements. TIG does not expect such changes will have a material impact on its reported statutory results.
In June 1993, the California Department of Insurance permitted TIG Insurance Company ("TIC"), TIG's lead insurer to record a quasi-reorganization of its statutory capital accounts. The effect of the quasi-reorganization was to increase the earned surplus of TIC to zero from a negative $285 million and to decrease contributed surplus by the same amount. This transaction significantly increased TIC's future dividend paying capability as insurance companies may only pay dividends from earned surplus. The Company's surplus and capital exceeds the NAIC's "risk-based capital" requirements at the end of 1997.
The following table is a summary of TIG's Primary insurance operations by major division: