The Company owns its corporate headquarters buildings located at 385 Washington Street and 130 West Sixth Street, St. Paul, Minnesota. These buildings are adjacent to one another and consist of approximately 1.1 million square feet of gross floor space. The Company also owns properties in Woodbury, Minnesota, where an administrative services building and off-site computer processing operations are located. The Woodbury properties are currently being marketed for sale.
The Company also owns six buildings in Hartford, Connecticut. The Company currently occupies approximately 1.7 million square feet of office space in these buildings. The Company also owns other real property, which includes office buildings in Fall River, Massachusetts, and in Irving, Texas, and a data center located in Norcross, Georgia. In addition, the Company leases 222 field and claim offices totaling approximately 4.9 million square feet throughout the United States under leases or subleases with third parties.
(1) On April 1, 2004, Travelers Property Casualty Corp. (TPC) merged with a subsidiary of The St. Paul Companies, Inc. (SPC), as a result of which TPC became a wholly-owned subsidiary of SPC and SPC changed its name to The St. Paul Travelers Companies, Inc. On October 1, 2001, TPC purchased The
(3) Total liabilities include minority interest liabilities of $117 million, $105 million and $87 million at December 31, 2004, 2003 and 2002, respectively.
The following is a discussion and analysis of the financial condition and results of operations of The St. Paul Travelers Companies, Inc. (together with its subsidiaries, the Company). On April 1, 2004, Travelers Property Casualty Corp. (TPC) merged with a subsidiary of The St. Paul Companies, Inc. (SPC), as a result of which TPC became a wholly-owned subsidiary of SPC, and SPC changed its name to The St. Paul Travelers Companies, Inc. In connection with the merger, each issued and outstanding share of TPC class A (including the associated preferred stock purchase rights) and class B par value $0.01 common stock was exchanged for 0.4334 of a share of the Company’s common stock without designated par value. Share and per share amounts for all periods presented have been restated to reflect the second quarter exchange of TPC common stock for the Company’s common stock in the merger. For accounting purposes, this transaction was accounted for as a reverse acquisition with TPC treated as the accounting acquirer. Accordingly, this transaction was accounted for as a purchase business combination, using TPC historical financial information and applying fair value estimates to the acquired assets, liabilities, and commitments of SPC as of April 1, 2004. Beginning on April 1, 2004, the results of operations and financial condition of SPC were consolidated with TPC’s. Accordingly, all financial information presented herein for the twelve months ended December 31, 2004 reflects the accounts of TPC for the three months ended March 31, 2004 and the consolidated accounts of SPC and TPC for the nine months ended December 31, 2004. The financial information presented herein for the prior year periods reflects the accounts of TPC.
Net income of $955 million, or $1.56 per share basic and $1.53 diluted
Net unfavorable prior year reserve development of $2.39 billion ($1.59 billion after-tax), including $928 million related to asbestos, $290 million related to environmental, $500 million of construction and $300 million of surety related to the merger, $252 million related to a specific construction contractor and $113 million from the commutation of certain reinsurance agreements.
Shareholders’ equity of $21.20 billion, equivalent to book value per common share of $31.35
Net income in 2004 totaled $955 million, or $1.53 per share diluted, compared with net income of $1.70 billion, or $3.80 per share diluted, in 2003. The $741 million decline in net income in 2004 compared with 2003 was driven by $1.59 billion of after-tax net unfavorable prior-year reserve development ($2.39 billion pretax). That pretax net unfavorable prior year reserve development was primarily comprised of $928 million to strengthen asbestos reserves primarily as a result of the completion of the Company’s annual asbestos liability review in the fourth quarter, $290 million to strengthen environmental reserves, reserve adjustments related to the merger of $500 million for construction and $300 million for surety, $252 million related to a specific construction contractor, $113 million related to the commutation of agreements with a major reinsurer and other net reserving actions, the major components of which are described in more detail in the following segment discussions. Net unfavorable reserve development in the Commercial and Specialty segments more than offset additional income resulting from the merger and strong operating income generated by the Company’s Personal segment. In addition, after-tax catastrophe losses in 2004 of $511 million were $282 million higher than in 2003. The catastrophe losses in 2004 were primarily driven by four hurricanes that struck the southeastern United States in the third quarter.
The rate environment continued to moderate in 2004 due to more aggressive pricing in the marketplace. Customer retention levels remained stable throughout the Company’s insurance underwriting operations; however, new business volume in 2004 declined when compared with the combined new business volume of SPC and TPC in 2003. Net income in 2004 included net realized investment losses of $28 million, compared with net realized investment gains of $21 million in 2003.
Index to Financial Statements The $6.49 billion growth in earned premiums over 2003 was primarily due to the merger, and also reflected the earned premium effect of rate increases on renewal business over the last 12 months and strong customer retention levels throughout a majority of the markets served by the Company’s insurance segments.
Net investment income in 2004 increased $794 million over 2003, due largely to the increase in invested assets resulting from the merger. In addition, strong operational cash flows in 2004 contributed to the growth in invested assets. The average pretax investment yield in 2004 of 4.8% declined from 5.3% in 2003, due to a higher proportion of tax-exempt investments and lower yields on fixed income securities and alternative investments. In addition, SPC’s investment portfolio acquired in the merger was recorded at its fair value as of the merger date in accordance with purchase accounting, which reduced the Company’s reported average investment yield in 2004. Net investment income in 2004 included $111 million of income resulting from the initial public trading of an investment in its private equity portfolio.
Fee income in 2004 grew 26% over 2003, primarily driven by new business in the National Accounts sector of the Company’s Commercial segment, as described in more detail in the segment narrative that follows.
Asset management revenues of $390 million were generated by Nuveen Investments, which was acquired in the merger. Nuveen Investments’ gross sales of investment products in 2004 from the date of the merger totaled $19.86 billion.
The Company’s net pretax realized investment losses of $39 million in 2004 included impairment charges totaling $80 million, whereas net pretax realized gains of $38 million in 2003 included $90 million of impairment charges. Net realized investment gains (losses) in 2004 and 2003 also included losses of $44 million and $27 million, respectively, related to U.S. Treasury futures contracts which are settled daily. Further information regarding the nature of impairment charges in each year is included in the “Critical Accounting Estimates” section later in this discussion. Other revenues in all periods presented primarily consist of premium installment charges.
Earned premiums in 2003 increased $1.39 billion, or 12%, over 2002 due to rate increases on renewal business, growth in targeted new business and strong customer retention.
Net investment income decreased $12 million, or less than 1%, in 2003, despite higher average invested assets resulting from strong cash flows from operations. The decline resulted from a reduction in pretax investment yields from 6.0% in 2002 to 5.3% in 2003. That decrease reflected the lower interest rate environment, the shortening of the average effective duration of the fixed maturity portfolio, a higher proportion of tax-exempt investment holdings and reduced returns in the Company’s private equity investments. These factors were partially offset by higher returns in arbitrage fund investments.
Net realized investment gains were $38 million in 2003, compared with $147 million in 2002. Net realized investment gains included $90 million of impairment charges in 2003, compared with $284 million in 2002.
Effective with the merger, the Company’s business operations consist of the following four segments: Commercial, Specialty, Personal (collectively comprising the Company’s insurance segments) and Asset Management. The Asset Management segment was acquired in the merger. Prior period results for the three insurance segments have been restated, to the extent practicable, to conform with the 2004 presentation.
Claims and claim adjustment expenses of $15.44 billion in 2004 were $6.32 billion higher than the comparable 2003 total, primarily reflecting growth in business volume resulting from the merger. The 2004 total also included $2.39 billion of net unfavorable prior year reserve development, of which $928 million represented a provision to strengthen asbestos reserves primarily as a result of the completion of the Company’s annual asbestos liability review in the fourth quarter and $290 million represented a provision to strengthen environmental reserves. Additional components of 2004 unfavorable prior year reserve development are described below. Net unfavorable prior year reserve development in 2003 totaled $476 million and was primarily the result of reserve strengthening at the Company’s Gulf subsidiary. The 2004 total also included $772 million of catastrophe losses (net of reinsurance), compared with catastrophe losses of $352 million in 2003.
In June of 2004, the Company decided to commute certain reinsurance agreements with a major reinsurer resulting in a $113 million prior year reserve charge (in addition to a current year loss of $40 million). Commutations are a complete and final settlement with a reinsurer that results in a discharge of all obligations of the parties to the terminated reinsurance agreement. The Company also recorded a charge of $252 million related to a specific construction contractor as described in the Specialty segment discussion.
Other items increasing the 2004 claims and expenses compared to 2003 include $296 million of charges to increase the allowances for estimated amounts due from reinsurance recoverables, policyholders receivables, and co-surety participations on a specific construction contractor claim. The increase in the allowance for uncollectible reinsurance recoverables recognized a change in estimated disputes with reinsurers and is based upon the Company’s reinsurance strategy of reduced reinsurance utilization, including the cessation of ongoing business relationships with certain of SPC’s reinsurers, and aggressive collection of reinsurance recoverables. A provision was also made to increase the estimated uncollectible amounts due from policyholders for loss sensitive business (primarily high deductible business). This increase recognized a change in estimated uncollectible amounts due and resulted from applying the Company’s credit based methodology for determining uncollectible amounts to the recoverables acquired in the merger. Because reinsurance recoverables and amounts due from policyholders for loss sensitive business are insurance contract-related assets, these assets are subject to the same types of estimation variables as loss reserves. Also during the second quarter of 2004, a participating co-surety on a contract surety exposure announced that insurance regulators had approved its submitted run-off plan. Based upon industry knowledge of the co-surety’s run-off plan and an analysis of the co-surety’s financial condition, the Company concluded that it was unlikely to collect the full amount projected to be owed by the co-surety and established an appropriate level of reserves.
(1) Excludes losses recovered under the Citigroup indemnification agreement in 2002.
The GAAP combined ratio in 2004 included a 12.6 point impact from net unfavorable prior year reserve development and a 4.0 point impact from catastrophes. The respective impacts of these factors on the 2003 combined ratio were 3.8 points and 2.8 points. Excluding these impacts from both years, the adjusted ratio of 91.1 in 2004 was 1.4 points higher than the adjusted 2003 combined ratio of 89.7. The increase in the adjusted ratio primarily reflected the impact of the higher underwriting expense ratio of the business acquired in the merger, as well as expenses associated with the merger.
The 20.3 point improvement in the 2003 GAAP combined ratio resulted from lower unfavorable prior year reserve development, primarily due to having no asbestos charges in 2003, compared to asbestos charges in 2002 that added 19.2 points. The benefit from premium rate increases that exceeded loss cost trends were largely offset by higher catastrophe losses.
On August 1, 2002, Commercial Insurance Resources, Inc. (CIRI), a subsidiary of the Company and the holding company for the Gulf Insurance Group (Gulf), completed a transaction with a group of outside investors and senior employees of Gulf. Capital investments made by the investors and employees included 9.7 million shares of mandatorily convertible preferred stock for a purchase price of $8.83 per share, $50 million of convertible notes and 0.4 million common shares for a purchase price of $8.83 per share, representing a 24% ownership interest of CIRI, on a fully diluted basis. The dividend rate on the preferred stock was 6.0%. The interest rate on the notes was 6.0% payable on an interest-only basis. The notes would have matured on December 31, 2032. Trident II, L.P., Marsh & McLennan Capital Professionals Fund, L.P., Marsh & McLennan Employees’ Securities Company, L.P. and Trident Gulf Holding, LLC (collectively Trident) invested $125 million, and a group of approximately 75 senior employees of Gulf invested $14 million. Fifty percent of the Gulf senior employees’ investment was financed by CIRI. This financing was collateralized by the CIRI securities purchased and was forgivable if Trident achieved certain investment returns. The applicable agreements provided for registration rights and transfer rights and restrictions and other matters customarily addressed in agreements with minority investors.
Total revenues of $11.11 billion in 2004 reflected growth of $2.12 billion in earned premiums, which was primarily due to the merger and also reflected the earned premium effect of moderating renewal price increases over the last twelve months in the Company’s core Commercial operations. In addition, incremental premiums resulting from the renewal rights transaction with Royal & SunAlliance in the third quarter of 2003 contributed to premium growth in 2004.
National Accounts is the primary source of fee income due to its service businesses, which include claim and loss prevention services to large companies that choose to self-insure a portion of their insurance risks, and claims and policy management services to workers’ compensation residual market pools, automobile assigned risk plans and to self-insurance pools. The strong increase in 2004 fee income reflected higher new business levels, resulting, in part, from the third quarter 2003 renewal rights transaction with Royal & SunAlliance, renewal price increases and more workers’ compensation business being written by state residual market pools.
Index to Financial Statements The loss and loss adjustment expense ratio in 2004 included a 13.6 point impact from prior-year reserve development and a 4.1 point impact from catastrophe losses. In 2003, the impacts of these factors on the loss and loss expense ratio were 10.3 points and 1.6 points, respectively. Excluding those factors in both years, the adjusted loss and loss expense ratio in 2004 of 62.3 was 1.2 points improved over the adjusted 2003 ratio of 63.5. The 3.3 point increase in the underwriting expense ratio in 2004 compared to 2003 primarily reflected the impact of the higher underwriting expense ratio of the business acquired in the merger and operating expenses associated with Commercial other (where premium volume declined significantly).
Operating income of $1.06 billion in 2003 was a significant improvement over the operating loss of $310 million in 2002. Operating results in 2003 reflected a favorable, but moderating, rate environment characterized by rate increases in excess of loss cost trends, and increased business volumes. After-tax catastrophe losses totaled $67 million in 2003, whereas in 2002 the Commercial segment incurred no catastrophes. The 2002 operating loss was driven by significant asbestos-related unfavorable prior-year reserve development.
Earned premiums in 2003 grew $721 million, or 12%, over 2002, primarily due to premium rate increases, growth in targeted new business and strong customer retention. The strong growth in 2003 earned premiums was partially offset by a $214 million decline in earned premiums at the Northland subsidiaries that resulted from the withdrawal in 2002 of business at American Equity Insurance Company and Commercial Guaranty Casualty Insurance Company. Net investment income in 2003 increased $17 million over 2002 due to higher average invested assets resulting from strong cash flows from operations, partially offset by the reduction in average pretax investment yields to 5.3% in 2003 from 6.0% in 2002. The decrease in yields reflected the lower interest rate environment, the shortening of the average effective duration of the fixed maturity portfolio, a higher proportion of tax-exempt investments and reduced returns in the Company’s private equity investments; partially offset by higher returns in arbitrage fund investments. The $99 million, or 22%, increase in fee income in 2003 over 2002 reflected higher new business levels, price increases and more workers’ compensation business being written by state residual market pools.
Commercial Accounts’ premium volume of $4.21 billion in 2004 grew $960 million, or 30%, over 2003 volume of $3.25 billion, primarily due to the merger. Retention rates remained strong and renewal price change increases were essentially flat by the end of the year. New business levels moderated during the second half of 2004 as the benefit from the Atlantic Mutual and Royal & SunAlliance renewal rights transactions completed in the third quarter of 2003 diminished in the second half of the year.
The 13% increase in National Accounts’ premium volume in 2004 reflected new business from the third-quarter 2003 Royal & SunAlliance renewal rights transaction and higher business volumes in residual market pools, the impacts of which were partially offset by a shift to deductible and fee-based products by some of the Company’s clients.
In the Commercial Other business, the $226 million, or 31%, decline in 2004 premium volume compared with 2003 primarily reflected the placement of Gulf operations in runoff in the second quarter of 2004. Subsequently, certain business previously written by Gulf is now being written in the Commercial or Specialty segments. The runoff healthcare, reinsurance and international business acquired in the merger produced minimal written premium volume in 2004.
Commercial Accounts net written premiums increased $100 million, or 3%, in 2003. Net written premiums associated with the Northland subsidiaries declined to $547 million in 2003 from $825 million in 2002 due to the factors described above. Excluding the Northland subsidiaries’ net written premiums in both 2003 and 2002, Commercial Accounts premium volume in 2003 grew 16% over 2002. The increase was primarily due to renewal price increases, new business growth in targeted markets and strong retention across all major product lines.
The Commercial Other sector of the Commercial segment in 2003 and 2002 consisted primarily of results from the Company’s Gulf subsidiary, which marketed products to national, mid-sized and small customers and distributed them through both wholesale brokers and retail agents and brokers throughout the United States with particular emphasis on management and professional liability coverages and excess and surplus lines of insurance. Gulf net written premiums increased $83 million, or 14%, in 2003 as a result of significant rate increases across all classes of management liability products.
The Specialty segment’s results for the twelve months ended December 31, 2004 reflect the results of TPC’s Bond and Construction operations for the three months ended March 31, 2004 and the post-merger combined results of SPC’s specialty operations and TPC’s Bond and Construction operations for the nine months ended December 31, 2004. Results for 2003 and 2002 represent TPC’s Bond and Construction operations only.
The operating loss of $724 million in 2004 was driven by after-tax unfavorable prior year reserve development of $1.03 billion ($1.59 billion, pretax) including $500 million and $300 million (pretax) of net unfavorable prior year loss development related to the construction and surety reserves, respectively, acquired in
the merger as well as other net reserving actions that are described in the narrative that follows. In June 2004, the Company decided to commute certain reinsurance agreements with a major reinsurer, resulting in a prior year reserve charge of $75 million. Operating results in 2004 also included $155 million of after-tax catastrophe losses resulting from the four hurricanes described previously, whereas 2003 results included no catastrophe losses.
Domestic Specialty earned premiums totaled $3.86 billion in 2004, compared with $1.17 billion in 2003. International Specialty earned premiums in 2004 were $930 million, whereas 2003 results included minimal international premiums. The increases over 2003 were primarily driven by incremental premiums resulting from the merger, and also reflected the impact of price increases. Net investment income increased $324 million over 2003 due to the increase in invested assets as a result of the merger. In addition, strong operational cash flows contributed to the growth in invested assets over the same period of 2003. Also impacting in net investment income is the effect of a decline in pretax investment yields due to a higher proportion of tax-exempt investments and lower yields on fixed income securities and alternative investments.
Beginning on April 1, 2004, upon the completion of the merger of TPC and SPC, personnel from the predecessor companies were able to share detailed policyholder information, claim files and actuarial data related to the acquired construction reserves. This enabled an analysis to be performed in the second quarter of the acquired construction reserves using TPC’s long-established practices that includes evaluating exposures by type of claim (e.g. construction defect, construction wrap up, other), by type of coverage, (e.g. guaranteed cost, loss responsive, other) and by detailed line of business (general liability, commercial auto, etc.), among others. For general liability exposures, which include construction defect and construction wrap-up, interpretation of underlying trends (both present and future) and the related reserve estimation process is highly judgmental due to the low frequency/high severity and complex nature of these exposures. In particular, for construction defect, there is a high degree of uncertainty relating to whether coverage exists, when losses occur, the size of each loss, expectations for future interpretive rulings concerning contract provisions and the extent to which the assertion of these claims will expand geographically. As a result, material variations can and do occur among actuarial reserve estimates for these types of exposures. In a merger, these differences are likely to be even more pronounced. Prior to a merger, each legacy company consistently applies its assumptions, judgments and actuarial methods to estimate reserves. Differences between these assumptions, judgments and actuarial methods need to be understood and reconciled, and a uniform approach needs to be adopted for the merged entity. In this situation, material adjustments can and do occur for reserves related to exposures having a high degree of uncertainty.
Beginning on April 1, 2004, upon completion of the merger of TPC and SPC, personnel from the predecessor companies were able to share the detailed SPC policyholder information, including underwriting, claim and actuarial files related to surety reserves. Access to this detailed information enabled the Company to perform a claim-by-claim review of reserves and claims handling strategies during the second quarter of 2004 using the combined expertise of claims adjusters from the legacy companies. This type of review involves considerable judgment, especially with respect to the economic outlook within which claims will be settled,
estimates for dates of loss occurrence and evaluations of IBNR exposures for each insured. For example, as a result of the detailed information obtained concerning contractors with reported claims, the Company considered whether or not losses were incurred but not yet reported on one or more additional projects for each contractor examined.
Also on April 1, 2004, the Company could begin to use this detailed information to compare SPC’s assumptions, judgments and actuarial methods that were underlying the acquired reserves with its own assumptions, judgments and actuarial methods. Similarities and differences were found to exist. Similarities included, but were not limited to, recognizing claim reserves when it was determined that contractors and commercial surety insureds were in default and thereby unable to meet their obligations, estimating initial IBNR provisions, and periodically re-evaluating, at least quarterly, the adequacy of the reserves established based on actual claims recorded and revised estimates of IBNR. Differences included judgments and methods related to determining IBNR development factors and expected salvage, among others.
That these differences exist is not unusual for surety reserve estimates. Surety is a line of business for which there are low frequency, high severity, very complex claims for certain exposures, particularly those related to large construction contractors and commercial surety insureds. Determining the date of loss in these circumstances requires a high degree of judgment. In addition, the claim reserve estimates even for reported claims are also highly judgmental. These two factors, among others, combine to make IBNR reserve estimations for surety extremely difficult. Due to this high degree of uncertainty, the informed judgments of different actuaries could and do vary materially. As discussed above, in a merger, these differences are likely to be even more pronounced.
Prior to the merger and beginning in the third quarter of 2003, SPC disclosed that a large construction contractor for which it had written several surety bonds was experiencing financial difficulty. Based upon an analysis of the financial condition of the construction contractor that was performed in the third quarter of 2003, a restructuring plan was adopted by the construction contractor, its banks, and SPC, among others, as a means to minimize estimated losses. SPC monitored the progress of the construction contractor toward meeting the requirements of the restructuring plan throughout subsequent quarters. SPC also estimated and disclosed its estimated ultimate net losses related to this exposure, beginning in the third quarter of 2003 and updated each quarter thereafter, including the effects of advances made or expected to be made to the construction contractor, applicable collateral, co-surety participations and reinsurance. The size and complexity of these particular construction contracts, coupled with the deteriorating credit quality of the construction contractor and the inherent uncertainty as to whether it would meet the obligations of the restructuring plan, resulted in a high degree of judgment in estimating potential losses.
A comprehensive analysis that began in the first quarter of 2004 was completed during the last half of the second quarter. Based upon this analysis, the Company concluded that the contractor would not be able to meet the targets set forth in its business and restructuring plans. Therefore, the Company moved from supporting the contractor’s restructuring plan to adopting a workout plan as a means to minimize estimated losses. Under the workout plan, the Company would no longer provide additional surety bonds for new projects of the construction contractor. Also as part of the workout plan, the Company was able to implement additional accounting and engineering procedures for each open project, which included using specialists to implement additional forecasting, cash management, and reporting procedures, on both a project-by-project and consolidated level. Based upon this second quarter change to a workout plan and the detailed financial analysis that was able to be performed, the Company increased its estimate of the ultimate net loss by $252 million, including $9 million of reinsurance. This estimate took into consideration paid amounts, net receivables, liquidated damages, overhead
costs, additional completion costs, including costs associated with replacing the contractor, receivable discounts, current and future claims from owners and subcontractors against the contractor, and the value of collateral, among others.
Claim and claim adjustment expenses in 2004 included $225 million of catastrophe losses, compared with no such losses in 2003. Results in 2004 also reflected increased current year loss provisions on portions of the Bond and Construction books of business, and $150 million of unfavorable prior year reserve development recorded in TPC’s Construction operation prior to the merger. Excluding the impact of catastrophes, the majority of the remaining markets comprising this segment recorded strong underwriting results, driven by favorable current year loss experience.
The combined ratio in 2004 included a 33.1 point impact of unfavorable prior year reserve development and a 4.8 impact of catastrophe losses. The impact of both items in 2003 was negligible.
The 5.3 point improvement in the combined ratio in 2003 reflected the impact of price increases, higher new business volumes and controlled expense growth.
levels also declined substantially. In Bond, the repositioning of the book of business was primarily centered in the SPC business acquired in the merger.
Operating income of $939 million in 2004 increased $447 million over 2003. The significant improvement in 2004 was driven by historically low loss frequency levels, particularly in the property line, after-tax favorable prior year reserve development of $246 million, an increase in investment income, and strong premium growth reflecting the impact of unit growth and price increases.
quarter of the year. Also impacting net investment income in 2004 was the effect of a decline in pretax investment yields resulting from a higher proportion of tax-exempt investments, and generally lower yields on fixed-income securities purchased during the year.
The amortization of deferred acquisition costs totaled $941 million in 2004, an 18% increase over the 2003 total of $800 million. The increase was due to higher commission and premium taxes associated with the increases in earned premium previously described, as well as a change in product mix. General and administrative expenses of $536 million in 2004 were 28% higher than comparable expenses of $420 million in 2003, primarily due to business growth, higher commission expense related to improved underwriting results and investments in personnel, technology and infrastructure to support business growth and product development.
The loss and loss adjustment expense ratio in 2004 reflected a 6.8 point favorable impact from prior-year reserve development, compared with a favorable prior-year impact of 4.4 points on the 2003 ratio. Catastrophe losses accounted for 3.4 points and 5.2 points of the 2004 and 2003 ratios, respectively. In addition to these factors, the significant improvement in the 2004 loss and loss adjustment expense ratio reflected the earned impact of price increases that continued to exceed loss cost trends. The 1.2 point increase in the underwriting expense ratio reflected the investments described previously, as well as the impact of higher commission expenses related to improved underwriting results.
Operating income in 2003 increased $145 million, or 42%, over 2002. Operating income in 2003 benefited from a favorable, but moderating, premium rate environment in both automobile and property, increased business volumes and a continued moderation in the increase in loss costs.
Index to Financial Statements The amortization of deferred acquisition costs, which totaled $800 million in 2003, increased $63 million, or 9%, over 2002 due to higher commission and premium taxes associated with the increases in earned premium previously described. General and administrative expenses in 2003 also increased 9% over 2002, driven by business growth and higher commissions that resulted from improved underwriting results.
The 4.5 point improvement in the loss and loss adjustment expense ratio over 2002 was due to renewal price increases that exceeded loss cost trends, continued reduced levels of non-catastrophe property claim frequency and higher favorable prior year reserve development, partially offset by higher catastrophes.
Net written premiums in 2004 increased 17% over 2003. Both Automobile and Homeowners and other net written premiums increased in 2004 due to higher organic new business volumes, the impact of new business associated with the Royal & SunAlliance renewal rights transaction completed in the third quarter of 2003, continued strong retention, and renewal price increases. The Personal segment had approximately 6.1 million, 5.4 million and 5.2 million policies in force at December 31, 2004, 2003 and 2002, respectively.
Automobile net written premiums in 2003 increased $211 million, or 7%, over 2002 due to higher business volumes and renewal price increases. Policies in force at December 31, 2003 increased 4% over 2002.
Homeowners and Other net written premiums increased $295 million, or 17%, in 2003 due to higher business volumes and renewal price increases. Policies in force increased 6% in 2003.
Net after-tax expense for Interest Expense and Other for the year ended December 31, 2004 increased $70 million compared with 2003, primarily reflecting the impact of the merger. Included in the increase was $46 million of incremental interest expense on debt assumed in the merger. That amount was net of the favorable impact of $36 million of the amortization of the fair value adjustment related to debt recorded at the acquisition date. The 2004 total also included $9 million of charges related to the merger that were recorded in the second quarter.
Interest Expense and Other in 2003 increased $9 million, after tax, primarily due to higher interest costs. After-tax interest expense was $105 million in 2003 compared to $100 million in 2002. The increase in interest expense in 2003 was primarily due to certain one time costs associated with the first and second quarter refinancing activities that lowered average interest costs, but resulted in higher levels of temporary debt. Temporary financing included $550 million first obtained in December 2002 in connection with the fourth quarter 2002 asbestos reserve strengthening and $1.40 billion of senior notes issued on March 11, 2003. The proceeds from the issuance of these senior notes were used to prepay and refinance a $500 million note to Citigroup on March 11, 2003, and to redeem $900 million of trust preferred securities on April 9, 2003. For additional information see “Liquidity and Capital Resources.”
The Company believes that the property and casualty insurance industry has suffered from court decisions and other trends that have attempted to expand insurance coverage for asbestos claims far beyond the intent of insurers and policyholders. As a result, the Company continues to experience a significant number of asbestos claims being tendered to the Company by the Company’s policyholders (which includes others seeking coverage under a policy) including claims against the Company’s policyholders by individuals who do not appear to be impaired by asbestos exposure. Factors underlying these increases include more intensive advertising by lawyers seeking asbestos claimants, the increasing focus by plaintiffs on new and previously peripheral defendants and entities seeking bankruptcy protection as a result of asbestos-related liabilities. In addition to contributing to the increase in claims, bankruptcy proceedings may increase the volatility of asbestos-related losses by initially delaying the reporting of claims and later by significantly accelerating and increasing loss payments by insurers, including the Company. Bankruptcy proceedings are also causing increased settlement demands against those policyholders who are not in bankruptcy but that remain in the tort system. Recently, in many jurisdictions, those who allege very serious injury and who can present credible medical evidence of their injuries are receiving priority trial settings in the courts, while those who have not shown any credible disease manifestation have their hearing dates delayed or placed on an inactive docket. This trend, along with the focus on new and previously peripheral defendants, contributes to the increase in loss and loss expense payments experienced by the Company. In addition, the Company sees, as an emerging trend, an increase in the Company’s asbestos-related
Because each policyholder presents different liability and coverage issues, the Company generally evaluates the exposure presented by each policyholder on a policyholder-by-policyholder basis. In the course of this evaluation, the Company considers: available insurance coverage, including the role of any umbrella or excess insurance the Company has issued to the policyholder; limits and deductibles; an analysis of each policyholder’s potential liability; the jurisdictions involved; past and anticipated future claim activity and loss development on pending claims; past settlement values of similar claims; allocated claim adjustment expense; potential role of other insurance; the role, if any, of non-asbestos claims or potential non-asbestos claims in any resolution process; and applicable coverage defenses or determinations, if any, including the determination as to whether or not an asbestos claim is a products/completed operation claim subject to an aggregate limit and the available coverage, if any, for that claim. When the gross ultimate exposure for indemnity and related claim adjustment expense is determined for a policyholder, the Company calculates, by each policy year, a ceded reinsurance projection based on any applicable facultative and treaty reinsurance, past ceded experience and reinsurance collections. Conventional actuarial methods are not utilized to establish asbestos reserves. The Company’s evaluations have not resulted in any data from which a meaningful average asbestos defense or indemnity payment may be determined.
At December 31, 2004, net asbestos reserves totaled $3.93 billion, compared with $2.98 billion at December 31, 2003. The Company acquired $311 million of net asbestos reserves in the merger with SPC. Net incurred asbestos losses and loss adjustment expenses totaled $928 million in 2004, driven by a $922 million provision to strengthen reserves in the fourth quarter following completion of the Company’s annual ground-up review of asbestos exposures. That review included an analysis of exposure and claim payment patterns by policyholder category, as well as recent settlements, policyholder bankruptcies, state judicial rulings and legislative actions. The $922 million provision primarily resulted from an increase in litigation costs and activity surrounding peripheral defendants.
Assumed reinsurance exposure primarily consists of reinsurance of excess coverage, including various pool participations. The Company’s international operations are exposed to U.S. asbestos liabilities through participations in excess insurance policies, quota share and excess of loss reinsurance policies, and retrocession policies, underwritten in the London insurance market. Details of exposures under the reinsurance and retrocession policies are identified only when the Company is advised by the retrocedant.
In addition to incurred but not reported (IBNR), amounts contained in the reserves for specific policyholders or groups of policyholders described above, the Company has established an unallocated IBNR reserve for further adverse development related to existing policyholders, new claims from policyholders reporting claims for the first time and policyholders for which there is, or may be, litigation and direct actions against the Company. During 2004, reclassification of reserves to “Policyholders with settlement agreements” resulted in a reduction in the unallocated IBNR reserve of $595 million. The Direct Action Settlement accounted for $502 million of this reclassification.
The Company has been, and continues to be, involved in litigation involving insurance coverage issues pertaining to environmental claims. The Company believes that some court decisions have interpreted the insurance coverage to be broader than the original intent of the insurers and policyholders. These decisions often pertain to insurance policies that were issued by the Company prior to the mid-1970s. These decisions continue
to be inconsistent and vary from jurisdiction to jurisdiction. Environmental claims when submitted rarely indicate the monetary amount being sought by the claimant from the policyholder, and the Company does not keep track of the monetary amount being sought in those few claims which indicate a monetary amount.
At December 31, 2004, approximately 71% of the net environmental reserve (approximately $456 million) is carried in a bulk reserve and includes unresolved and incurred but not reported environmental claims for which the Company has not received any specific claims as well as for the anticipated cost of coverage litigation disputes relating to these claims. The balance, approximately 29% of the net environmental reserve (approximately $185 million), consists of case reserves. The bulk reserve the Company carries is established and adjusted based upon the aggregate volume of in-process environmental claims and the Company’s experience in resolving those claims.
The resolution of environmental exposures by the Company generally occurs by settlement on a policyholder-by-policyholder basis as opposed to a claim-by-claim basis. Generally, the Company strives to extinguish any obligations it may have under any policy issued to the policyholder for past, present and future environmental liabilities and extinguish any pending coverage litigation dispute with the policyholder. This form of settlement is commonly referred to as a “buy-back” of policies for future environmental liability. In addition, many of the agreements have also extinguished any insurance obligation which the Company may have for other claims, including but not limited to asbestos and other cumulative injury claims. The Company and its policyholders may also agree to settlements which extinguish any future liability arising from known specified sites or claims. Provisions of these agreements also include appropriate indemnities and hold harmless provisions to protect the Company. The Company’s general purpose in executing these agreements is to reduce the Company’s potential environmental exposure and eliminate the risks presented by coverage litigation with the policyholder and related costs.
In establishing environmental reserves, the Company evaluates the exposure presented by each policyholder and the anticipated cost of resolution, if any. In the course of this analysis, the Company considers the probable liability, available coverage, relevant judicial interpretations and historical value of similar exposures. In addition, the Company considers the many variables presented, such as the nature of the alleged activities of the policyholder at each site; the allegations of environmental harm at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of environmental harm and the corresponding remedy at each site; the nature of government enforcement activities at each site; the ownership and general use of each site; the overall nature of the insurance relationship between the Company and the policyholder, including the role of any umbrella or excess insurance the Company has issued to the policyholder; the involvement of other insurers; the potential for other available coverage, including the number of years of coverage; the role, if any, of non-environmental claims or potential non-environmental claims, in any resolution process; and the applicable law in each jurisdiction. Conventional actuarial techniques are not used to estimate these reserves.
There have been judicial interpretations that, in some cases, have been unfavorable to the industry and the Company. Additionally, payments for loss and allocated loss adjustment expenses have increased over past years. In its review of environmental reserves, the Company considered: the adequacy of reserves for past settlements; changing judicial and legislative trends; the potential for policyholders with smaller exposures to be named in new clean-up action for both on- and off-site waste disposal activities; the potential for adverse development and additional new claims beyond previous expectations; and the potential higher costs for new settlements. Based on these trends, developments and management judgment, the Company increased its IBNR reserves accordingly. In 2004, the Company recorded a pretax charge of $290 million, net of reinsurance, to increase environmental reserves due to revised estimates of costs related to recent settlement initiatives.
The Company’s review of policyholders tendering claims for the first time has indicated that they are lower in severity. These policyholders generally present smaller exposures, have fewer sites and are lower tier defendants. Further, regulatory agencies are utilizing risk-based analysis and more efficient clean-up technologies. However, the Company has experienced an increase in the anticipated settlement amounts of certain matters as well as an increase in loss adjustment expenses.
the Company’s previous assessment of these claims, the number and outcome of direct actions against the Company and future developments pertaining to the Company’s ability to recover reinsurance for asbestos and environmental claims. In addition, the Company sees, as an emerging trend, an increase in the Company’s asbestos-related loss and loss expense experience as a result of the exhaustion or unavailability due to insolvency of other insurance potentially available to policyholders along with the insolvency or bankruptcy of other defendants. It is also not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims. This development will be affected by future court decisions and interpretations, as well as changes in applicable legislation. It is also difficult to predict the ultimate outcome of large coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. As part of its continuing analysis of asbestos reserves, which includes an annual ground-up review of asbestos policyholders, the Company continues to study the implications of these and other developments. The Company completed the annual ground-up review, which included the asbestos liabilities acquired in the merger, during the fourth quarter of 2004. Also see “Item 3 - Legal Proceedings.”
The Company’s invested assets at December 31, 2004 totaled $64.71 billion, including $477 million of securities in process of settlement, of which 92% was invested in fixed maturity and short-term investments, 1% in common stocks and other equity securities, 1% in mortgage loans and real estate and 6% in other investments. Excluding the impact on invested assets of securities lending, unrealized investment gains and losses, receivables for investment sales and payables on investment purchases, the pretax average yield was 4.8%, 5.3% and 6.0% and the after tax average yield was 3.7%, 4.0% and 4.4% for the years ended December 31, 2004, 2003 and 2002, respectively.
$25 million in the fixed income portfolio related to various issuers with credit risk associated with the issuer’s deteriorated financial position.
For publicly traded securities, the amounts of the impairments were recognized by writing down the investments to quoted market prices. For non-publicly traded securities, impairments are recognized by writing down the investment to its estimated fair value, as determined during the Company’s quarterly internal review process.
The specific circumstances that led to the impairments described above did not materially impact other individual investments held during 2004 or 2003.
The following table summarizes for all fixed maturities and equity securities available for sale and for equity securities reported at fair value for which fair value is less than 80% of amortized cost at December 31, 2004, the gross unrealized investment loss by length of time those securities have continuously been in an unrealized loss position:
At December 31, 2004, non-investment grade securities comprised 3% of the Company’s fixed income investment portfolio. Included in those categories at December 31, 2004 were securities in an unrealized loss position that, in the aggregate, had an amortized cost of $321 million and a fair value of $314 million, resulting in a net pretax unrealized loss of $7 million. These securities in an unrealized loss position represented less than 1% of the total amortized cost and less than 1% of the fair value of the fixed income portfolio at December 31, 2004, and accounted for 3% of the total pretax unrealized loss in the fixed income portfolio.
The Company’s strategic objective is to enhance its position as a consistently profitable market leader and a cost-effective provider of property and casualty insurance in the United States. A variety of factors continue to affect the property and casualty insurance market and the Company’s core business outlook for 2005, including the moderating level of price increases in the commercial marketplace, the increasing competitive environment across all of the Company’s businesses, loss cost trends (including medical inflation and auto loss costs), asbestos-related developments and rising reinsurance and litigation costs.
The industry has experienced unprecedented low levels of claim frequency over the last several years, a trend that is not expected to change materially in 2005. Severity trend, the other component of loss trend, is expected to continue to remain stable. Nevertheless, with continued pressure on pricing, it is likely that margins will contract in certain parts of the Company’s business in 2005, albeit from very strong levels.
Changes in the general interest rate environment affect the returns available on new investments. While a rising interest rate environment enhances the returns available on new fixed income investments, it reduces the market value of existing fixed maturity investments and the availability of gains on disposition. A decline in interest rates reduces the returns available on new investments but increases the market value of existing investments and the availability of realized investment gains on disposition. In 2004, interest rates began to increase after reaching their lowest levels since the 1950’s in 2003. Consequently, yields available on new investments began to grow, but remained below the existing portfolio’s average book yield. The continuation of an upward trend in interest rates in 2005 would favorably impact the average book yield of the Company’s fixed income holdings.
The Company expects to realize its targeted merger-related cumulative expense savings of $350 million by the end of 2005 and $450 million by the end of 2006. A portion of these savings are expected be redeployed to support growth in the Company’s business segments and investments in technology.
On November 26, 2002, the Terrorism Risk Insurance Act of 2002 (the Terrorism Act) was enacted into Federal law and established the Terrorism Insurance Program (the Program), a temporary Federal program in the Department of the Treasury, that provides for a system of shared public and private compensation for insured losses resulting from acts of terrorism or war committed by or on behalf of a foreign interest. In order for a loss to be covered under the Program (subject losses), the loss must be the result of an event that is certified as an act of terrorism by the U.S. Secretary of Treasury. In the case of a war declared by Congress, only workers’ compensation losses are covered by the Terrorism Act. The Terrorism Act generally requires that all commercial property casualty insurers licensed in the United States participate in the Program. The Program terminates on December 31, 2005. Under the Program, a participating insurer is entitled to be reimbursed by the Federal Government for 90% of subject losses, after an insurer deductible, subject to an annual cap. In each case, the deductible percentage is applied to the insurer’s direct earned premiums from the calendar year immediately preceding the applicable year. The deductible under the Program was 7% for 2003, 10% for 2004 and is 15% for 2005. The Program also contains an annual cap that limits the amount of aggregate subject losses for all participating insurers to $100 billion. Once subject losses have reached the $100 billion aggregate during a program year, there is no additional reimbursement from the U.S. Treasury and an insurer that has met its deductible for the program year is not liable for any losses (or portion thereof) that exceed the $100 billion cap. The Company’s estimated deductible under this federal program is $2.51 billion for 2005. The Company had no terrorism-related losses in 2004 or 2003. If the Program is not renewed for periods after January 1, 2006, the benefits of the Program will not be available to the Company, and the Company will be subject to losses from acts of terrorism subject only to the terms and provisions of applicable policies.
There are currently various state and federal legislative and judicial proposals to require asbestos claimants to demonstrate an asbestos illness. At this time it is not possible to predict the likelihood or timing of such proposals being enacted or the effect if they are enacted. The Company’s ongoing analysis of its asbestos reserves did not assume the adoption of any asbestos reforms. For information about the outlook with respect to asbestos-related claims and liabilities see “-Asbestos Claims and Litigation” and “-Uncertainty Regarding Adequacy of Asbestos and Environmental Reserves.”
See notes 3 and 18 of notes to the Company’s consolidated financial statements for a description of intercompany arrangements and transactions between TPC and Citigroup.
Net cash flows provided by operating activities in 2003 benefited from premium rate increases and the receipt of $361 million from Citigroup related to recoveries under the asbestos indemnification agreement in the first quarter of 2003 and $531 million of federal income taxes refunded from the Company’s net operating loss carryback.
The majority of funds available for investment are deployed in a widely diversified portfolio of high quality intermediate-term taxable U.S. government, corporate and mortgage backed bonds and tax-exempt U.S. municipal bonds. The Company closely monitors the duration of its fixed maturity investments, and investment purchases and sales are executed with the objective of having adequate funds available to satisfy the Company’s insurance and debt obligations. The Company’s management of the duration of the fixed income investment portfolio generally produces a duration that exceeds the duration of the Company’s net insurance liabilities. As the Company’s investment strategy focuses on asset and liability durations, and not specific cash flows, asset sales may be required to satisfy obligations and/or rebalance asset portfolios. The average duration of fixed maturities and short-term securities was 4.1 years as of December 31, 2004, unchanged from December 31, 2003.
At December 31, 2004, total cash and short-term invested assets of $159 million were held at the holding company level. These liquid assets were primarily funded by dividends received from the Company’s operating subsidiaries. These liquid assets, combined with other sources of funds available, primarily additional dividends from the Company’s operating subsidiaries, are considered sufficient to meet the liquidity requirements of the Company. These liquidity requirements include primarily, shareholder dividends and debt service.
In 2004 and 2003, the Company acquired 0.4 million and 0.8 million shares (as adjusted for the merger), respectively, of common stock from employees as treasury stock primarily to cover payroll withholding taxes in connection with the vesting of restricted stock awards and exercises of stock options. In 2003, TPC repurchased approximately 1.1 million shares (as adjusted for the merger) of common stock at a total cost of $40 million, representing the acquisition of shares under a repurchase program that had been approved by TPC’s board of directors. TPC’s repurchase program was terminated upon completion of the merger.
Index to Financial Statements The declaration and payment of future dividends to holders of the Company’s common stock will be at the discretion of the Company’s Board of Directors and will depend upon many factors, including the Company’s financial condition, earnings, capital requirements of the Company’s operating subsidiaries, legal requirements, regulatory constraints and other factors as the Board of Directors deems relevant. Dividends would be paid by the Company only if declared by its Board of Directors out of funds legally available, subject to any other restrictions that may be applicable to the Company.
Upon completion of the merger on April 1, 2004, the Company acquired all obligations related to SPC’s outstanding debt, which had a carrying value of $3.68 billion at the time of the merger. In accordance with purchase accounting, the carrying value of the SPC debt acquired was adjusted to market value as of April 1, 2004 using the effective interest rate method, which resulted in a $301 million adjustment to increase the amount of the Company’s consolidated debt outstanding. That fair value adjustment is being amortized over the remaining life of the respective debt instruments acquired. That amortization, which totaled $56 million in 2004, reduced reported interest expense.
Index to Financial Statements The Company has the option to defer interest payments on its convertible junior subordinated notes for a period not exceeding 20 consecutive quarterly interest periods. If the Company elects to defer interest payments on the notes, it will not be permitted, with limited exceptions, to pay dividends on its common stock during a deferral period.
In March 2002, TPC issued $893 million aggregate principal amount of 4.5% convertible junior subordinated notes which will mature on April 15, 2032, unless earlier redeemed, repurchased or converted. Interest is payable quarterly in arrears. See note 10 of notes to the Company’s consolidated financial statements for a further discussion.
As a result of the expiration of the SPC 364-Day Line of Credit and the TPC 364-Day Line of Credit, the Company entered into a new $480 million 364-day revolving line of credit agreement (the STA 364-Day Line of Credit) with a syndicate of banks. As of December 31, 2004, the Company has access to the following bank credit lines: (i) the $250 million 45-Month Line of Credit, (ii) the $270 million 5-Year Line of Credit, and (iii) the $480 million STA 364-Day Line of Credit (collectively, the Company Line of Credit).
Borrowings under the Company Line of Credit may be made, at the Company’s option, at a variable interest rate equal to either the lender’s base rate plus an applicable margin or at LIBOR plus an applicable margin. The Company Line of Credit includes a commitment fee and, for any date on which advances exceed 50% of the total commitment for each line of credit, a utilization fee. The applicable margin and the rates on which the commitment fee and utilization fee are based vary based upon the Company’s long-term senior unsecured non-credit-enhanced debt ratings.
An event of default will occur if there is a change in control (as defined in the 45-Month Line of Credit and 5-Year Line of Credit agreements). The merger of TPC and SPC did constitute a change in control for both TPC and SPC; however, both entities obtained a waiver from their respective banks of that event of default. There were no amounts outstanding under the Company Line of Credit at December 31, 2004.
(5) Includes commitments to vendors entered into in the ordinary course of business for goods and services including office supplies, archival services, etc.
For business underwritten by non-U.S. operations, future cash flows related to reported and unreported claims incurred and related claim adjustment expenses were translated at the spot rate on December 31, 2004.
The amounts reported in the table are presented on a nominal basis and have not been adjusted to reflect the time value of money. Accordingly, the amounts above will differ from the Company’s balance sheet to the extent that the liability for claims and claim adjustment expenses has been discounted in the balance sheet. (See note 1 of the financial statements.)
The Company’s principal insurance subsidiaries are domiciled in the states of Connecticut and Minnesota. The insurance holding company laws of both states applicable to the Company’s subsidiaries requires notice to, and approval by, the state insurance commissioner for the declaration or payment of any dividend, that together
with other distributions made within the preceding twelve months, exceeds the greater of 10% of the insurer’s surplus as of the preceding December 31, or the insurer’s net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices. (In the case of Minnesota, net income excludes realized investment gains for purposes of the calculation of the 10% threshold). This declaration or payment is further limited by adjusted unassigned surplus, as determined in accordance with statutory accounting practices.
The NAIC adopted RBC requirements for property casualty companies to be used as minimum capital requirements by the NAIC and states to identify companies that merit further regulatory action. The formulas have not been designed to differentiate among adequately capitalized companies that operate with levels of capital higher than RBC requirements. Therefore, it is inappropriate and ineffective to use the formulas to rate or to rank these companies. At December 31, 2004, all of the Company’s insurance subsidiaries had adjusted capital in excess of amounts requiring any company or regulatory action.
Property-casualty claims and claim adjustment expense reserves at December 31, 2004 increased by $24.51 billion over year-end 2003, primarily as a result of the merger with SPC and reserve charges recorded subsequent to the merger. Of the increase in 2004, $19.50 billion resulted from the addition of the acquired reserves, and $2.39 billion, net of reinsurance, was due to net unfavorable prior year reserve development primarily comprised of $928 million to strengthen asbestos reserves primarily as a result of the completion of the Company’s annual asbestos liability review in the fourth quarter, $290 million to strengthen environmental reserves, $800 million of reserve adjustments related to the merger for surety and construction loss reserves, $252 million related to a specific construction contractor, $113 million related to the commutation of agreements with a major reinsurer and other net reserving actions. For discussion of the components of net unfavorable prior year reserve development, see note 9 to the consolidated financial statements.
Asbestos and environmental reserves are included in the General liability, Commercial multi-peril lines and International and other lines in the summary table. Asbestos and environmental reserves are discussed separately, see “Asbestos Claims and Litigation”, “Environmental Claims and Litigation” and “Uncertainty Regarding Adequacy of Asbestos and Environmental Reserves”.
Claim and claim adjustment expense reserves (loss reserves) represent management’s estimate of ultimate unpaid costs of losses and loss adjustment expenses for claims that have been reported and claims that have been incurred but not yet reported. The process for estimating these liabilities begins with the collection and analysis of claim data. Data on individual reported claims, both current and historical, including paid amounts and individual claim adjuster estimates, are grouped by common characteristics (“components”) and evaluated by actuaries in their analyses of ultimate claim liabilities by product line. Such data is occasionally supplemented with external data as available and when appropriate. The process of analyzing reserves for a component is undertaken on a regular basis, generally quarterly, in light of continually updated information.
Property casualty insurance policies are either written on a claims made or on an occurrence basis. Policies written on a claims made basis require that claims be reported during the policy period. Policies that are written on an occurrence basis require that the insured demonstrate that a loss occurred in the policy period, even if the insured reports the loss many years later.
A key assumption in most actuarial analyses is that past patterns demonstrated in the data will repeat themselves in the future, absent a material change in the associated risk factors discussed below. To the extent a material change affecting the ultimate claim liability is known, such change is quantified to the extent possible through an analysis of internal company and, if available and when appropriate, external data. Such a measurement is specific to the facts and circumstances of the particular claim portfolio and the known change being evaluated.
Informed management judgment is applied throughout the reserving process. This includes the application, on a consistent basis over time, of various individual experiences and expertise to multiple sets of data and analyses. In addition to actuaries, individuals involved with the reserving process also include underwriting and claims personnel as well as other company management. Therefore, it is quite possible and, generally, likely that management must consider varying individual viewpoints as part of its estimation of loss reserves. It is also likely that during periods of significant change, such as a merger, consistent application of informed judgment becomes even more complicated and difficult.
uncertain. In addition, the greater the reporting lag the greater the proportion of IBNR claims to the total claim liability for the product line. Writing new products with material reporting lags can result in adding several years worth of IBNR claim exposure before the reporting lag exposure becomes clearly observable, thereby increasing the risk associated with pricing and reserving such products. The most extreme example of claim liabilities with long reporting lags are asbestos claims. A more recent but less extreme example is automobile leasing residual value coverage.
Lastly, significant structural changes to the available data, product mix or organization can also materially impact the reserve estimation process. During the past year, the merger of TPC and SPC resulted in the exposure of each other’s actuaries and claim departments to different products, data histories, analysis methodologies, claim settlement experts, and more robust data when viewed on a combined basis. This has impacted the range of estimates produced by the Company’s actuaries, as they have reacted to new data, approaches, and sources of expertise to draw upon. It has also resulted in additional levels of uncertainty, as past trends (that were a function of past products, past claim handling procedures, past claim departments, and past legal and other experts) may not repeat themselves, as those items affecting the trends change or evolve due to the merger. This has also increased the potential for material variation in estimates, as experts can have differing views as to the impact of these frequently evolutionary changes. Events such as mergers increase the inherent uncertainty of reserve estimates for a period of time, until stable trends reestablish themselves within the new organization.
Index to Financial Statements The effect of a particular risk factor on estimates of claim liabilities cannot be isolated in most cases. For example, estimates of potential claim settlements may be impacted by the risk associated with potential court rulings, but the final settlement agreement typically does not delineate how much of the settled amount is due to this and other factors.
This line is typically the largest source of reserve estimate uncertainty in the United States (excluding assumed reinsurance contracts covering the same risk). Major contributors to this reserve estimate uncertainty include the reporting lag (i.e. the length of time between the event triggering coverage and the actual reporting of the claim), the number of parties involved in the underlying tort action, whether the “event” triggering coverage is confined to only one time period or is spread over multiple time periods, the potential dollars involved (in the individual claim actions), whether such claims were reasonably foreseeable and intended to be covered at the time the contracts were written (i.e., coverage dispute potential), and the potential for mass claim actions. Claims with longer reporting lags result in greater inherent risk. This is especially true for alleged claims with a latency feature, particularly where courts have ruled that coverage is spread over multiple policy years, hence involving multiple defendants (and their insurers and reinsurers) and multiple policies (thereby increasing the potential dollars involved and the underlying settlement complexity). Claims with long latencies also increase the potential recognition lag, i.e., the lag between writing a type of policy in a certain market and the recognition that such policies have potential mass tort and/or latent claim exposure.
The amount of reserve estimate uncertainty also varies significantly by component for the General Liability product line. The components in this product line with the longest latency, longest reporting lags, largest potential dollars involved, and greatest claim settlement complexity are Asbestos and Environmental. Components that include latency, reporting lag and/or complexity issues, but to a materially lesser extent than Asbestos and Environmental, include construction defect, medical malpractice, and other mass tort actions, such as those related to silicone implants. Many components of General Liability are not subject to material latency or claim complexity risks and hence have materially less uncertainty than the previously mentioned components. In general, policies providing coverage with shorter reporting lags, fewer parties involved in settlement negotiations, only one policy potentially triggered per claim, fewer potential settlement dollars, reasonably
foreseeable (and stable) potential hazards/claims and no mass tort potential result in much less reserve estimate uncertainty than policies without those characteristics.
Changes in the propensity to sue, in general with specificity to particular issues
Amount of time to return property to full usage (for business interruption claims)
Commercial automobile reserves are typically analyzed in four components; bodily injury liability, property damage liability, collision claims and comprehensive claims. These last two components have minimum reserve risk and fast payouts and, accordingly, separate risk factors are not presented.
Index to Financial Statements Commercial automobile book of business risk factors
Workers’ compensation is generally considered a long tail coverage, as it takes a relatively long period of time to finalize claims from a given accident year. While certain payments such as initial medical treatment or temporary wage replacement for the injured worker are made quickly, some other payments are made over the course of several years, such as awards for permanent partial injuries. In addition, some payments can run as long as the injured worker’s life, such as permanent disability benefits and on-going medical care. Despite the possibility of long payment tail, the reporting lags are generally short, settlements are generally not complex, and most of the liability can be considered high frequency, moderate severity. The largest reserve risk generally comes from the low frequency, high severity claims providing lifetime coverage for medical expense arising from a worker’s injury. Overall, the claim liabilities for this line create a somewhat greater than moderate estimation risk.
Workers’ compensation reserves are typically analyzed in three components: indemnity losses, medical losses and claim adjustment expenses.
Index to Financial Statements Workers’ compensation book of business risk factors
Fidelity is generally considered a short tail coverage. It takes a relatively short period of time to finalize and settle fidelity claims. The volatility of fidelity reserves is generally related to the type of business of the insured, the size and complexity of the insured’s business operations, amount of policy limit and attachment point of coverage. The uncertainty surrounding reserves for small, commercial insureds is typically less than the uncertainty for large commercial or financial institutions. The high frequency, low severity nature of small commercial fidelity losses provides for stability in loss estimates whereas, the low frequency, high severity nature of losses for large insureds results in a wider range of ultimate loss outcomes. Actuarial techniques that rely on a stable pattern of loss development are generally not applicable to low frequency, high severity policies.
Overall, the line is generally high frequency, low to moderate severity (except for catastrophes), with simple to moderate claim complexity.
International and other includes the international product line and other products not discussed above. The principle component of “other” is assumed reinsurance written on an excess-of-loss basis, which may include reinsurance of non-U.S. exposures, and is primarily run-off business.
Changes in policy provisions (e.g., deductibles, policy limits, endorsements, “claims made” language)
As of December 31, 2004, the Company had reinsurance recoverables from syndicates at Lloyd’s of $738 million. In 1996, Lloyd’s restructured its operations with respect to claims for years prior to 1993 and reinsured these into Equitas Limited, which is currently unrated. Approximately $90 million of the Company’s Lloyd’s reinsurance recoverable at December 31, 2004 relates to Equitas liabilities. The remaining recoverables of $648 million are from the continuing market of Lloyd’s, which is rated A (third highest of 16 ratings) by A.M. Best. During the first quarter of 2004, TPC entered into an agreement to settle all current and future reinsurance claims against certain underwriters at Lloyd’s reinsured by Equitas. Under terms of this settlement, the Company received $245 million, resolving approximately $255 million of TPC’s net claim balances from Equitas. Virtually all of the $90 million reinsurance recoverables relating to Equitas remaining at December 31, 2004 relate to SPC.
Factors the Company considers in determining whether a decline is other-than-temporary for debt securities include the following:
the investee loses a principal customer or supplier for which there is no short-term prospect for replacement or experiences other substantial changes in market conditions;
the investee has announced, or the Company has become aware of, adverse changes or events such as changes or planned changes in senior management, restructurings, or a sale of assets; and
the regulatory, economic, or technological environment has changed in a way that is expected to adversely affect the investee’s profitability.
a secondary equity offering at a price substantially lower than the holder’s cost;
the securities owned continue to generate reasonable earnings and dividends, despite a general stock market decline;
bond interest or preferred stock dividend rate (on cost) is lower than rates for similar securities issued currently but quality of investment is not adversely affected;
financial condition, market share, backlog and other key statistics indicate growth.
Other investments include venture capital investments, which are generally non-publicly traded instruments, consisting of early-stage companies and, historically, having a holding period of four to seven years. These investments have primarily been made in the health care, software and computer services, and networking and information technologies infrastructures industries. The Company typically is involved with venture capital companies early in their formation, as they are developing and determining the viability of, and market demand for, their product. Generally the Company does not expect these venture capital companies to record revenues in the early stages of their development, which can often take three to four years, and does not generally expect them to become profitable for an even longer period of time. With respect to the Company’s valuation of such non-publicly traded venture capital investments, on a quarterly basis, portfolio managers as well as an internal valuation committee review and consider a variety of factors in determining the potential for loss impairment. Factors considered include the following:
whether or not we have the ability and intent to hold the security for a period of time sufficient to allow for recovery, enabling us to receive value equal to or greater than our cost.
The Company’s investment portfolio includes non-publicly traded investments, such as venture capital investments, private equity limited partnerships, joint ventures, other limited partnerships, and certain fixed income securities. Venture capital investments owned directly are consolidated in the Company’s financial statements. The Company uses the equity method of accounting for joint ventures, limited partnerships and certain private equity securities. Certain other private equity investments, including venture capital investments, are not subject to the provisions of Statement of Financial Accounting Standards (FAS) No. 115, Accounting for Certain Investments in Debt and Equity Securities, but are reported at estimated fair value in accordance with FAS 60, Accounting and Reporting by Insurance Enterprises. The fair value of the venture capital investments is based on an estimate determined by an internal valuation committee for securities for which there is no public market. The internal valuation committee reviews such factors as recent filings, operating results, balance sheet stability, growth, and other business and market sector fundamental statistics in estimating fair values of specific investments.
The following is a summary of the approximate carrying value of the Company’s non-publicly traded securities at December 31, 2004:
Index to Financial Statements Reserves for losses and loss adjustment expenses on a statutory basis were $41.73 billion, $24.03 billion and $23.28 billion at December 31, 2004, 2003 and 2002, respectively. The $17.70 billion increase in 2004 primarily resulted from the merger with SPC and reserve charges recorded subsequent to the merger. Those reserve charges included $928 million to strengthen asbestos reserves primarily as a result of the completion of the Company’s annual asbestos liability review in the fourth quarter, $290 million to strengthen environmental reserves, reserve adjustments related to the merger of $500 million for construction and $300 million for surety, $252 million related to a specific construction contractor, $113 million related to the commutation of agreements with a major reinsurer, and other net reserving actions.
Prior to the IPO, TPC participated in Citigroup’s Capital Accumulation Plan (CAP) that provided for the issuance of shares of Citigroup common stock in the form of restricted stock awards to eligible officers and other key employees. On August 20, 2002, in connection with the Citigroup Distribution, the unvested outstanding awards of restricted stock and deferred shares held by TPC employees on that date under Citigroup CAP awards were cancelled and replaced by awards comprised primarily of 3 million newly issued shares of class A common stock at a total market value of $53 million based on the closing price of the class A common stock on August 20, 2002. These replacement awards were granted on substantially the same terms, including vesting, as the former Citigroup awards. The value of these newly issued shares along with class A and class B common stock received in the Citigroup Distribution on the Citigroup restricted shares, were equal to the value of the cancelled Citigroup restricted share awards. In addition the Board of Directors plan allows deferred receipt of shares of class A common stock (deferred stock) to a future distribution date or upon termination of their service.
For a discussion of other risks and uncertainties that could impact the Company’s results of operations or financial condition, see note 17 of notes to the Company’s consolidated financial statements.
This report may contain, and management may make, certain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical facts, may be forward-looking statements. Specifically, the Company may make forward-looking
statements about the Company’s results of operations (including, among others, premium volume and net and operating income), financial condition and liquidity; the sufficiency of the Company’s asbestos and other reserves (including, among others, asbestos claim payment patterns); the post-merger integration (including, among others, expense savings); and strategic initiatives (including, among others, the sale of the Company’s interest in Nuveen Investments). Such statements are subject to certain risks and uncertainties, many of which are difficult to predict and generally beyond the Company’s control, that could cause actual results to differ materially from those expressed in, or implied or projected by, the forward-looking information and statements.
Some of the factors that could cause actual results to differ include, but are not limited to, the following: adverse developments involving asbestos claims and related litigation; the impact of aggregate policy coverage limits for asbestos claims; the impact of bankruptcies of various asbestos producers and related businesses; the willingness of parties including the Company to settle asbestos-related litigation; the Company’s ability to fully integrate the former St. Paul and Travelers businesses in the manner or in the timeframe currently anticipated; the Company’s ability to execute announced and future strategic initiatives as planned; insufficiency of, or changes in, loss and loss adjustment expense reserves; the Company’s inability to obtain prices sought due to competition or otherwise; the occurrence of catastrophic events, both natural and man-made, including terrorist acts, with a severity or frequency exceeding the Company’s expectations; exposure to, and adverse developments involving, environmental claims and related litigation; exposure to, and adverse developments involving, construction defect claims; exposure to, and adverse developments involving, the Company’s medical malpractice and other runoff operations; exposure to, and adverse developments involving, claims related to exposure to potentially harmful products or substances, including, but not limited to, lead paint, silica and other potentially harmful substances; adverse changes in loss cost trends, including inflationary pressures in medical costs and auto and building repair costs; the effects of corporate bankruptcies and adverse economic conditions on surety bond claims; adverse developments in the cost, availability and/or ability to collect reinsurance; the ability of the Company’s subsidiaries to pay dividends to The St. Paul Travelers Companies, Inc.; adverse developments in legal proceedings, including, but not limited to, those described under “Legal Proceedings’; judicial expansion of policy coverage and the impact of new theories of liability, including with respect to, among others, coverage for asbestos and environmental claims and construction defect claims; the impact of legislative and other governmental actions, including, but not limited to, federal and state legislation related to asbestos liability reform and terrorism insurance and reinsurance (such as the extension of or replacement for the Terrorism Risk Insurance Act of 2002) and governmental actions regarding insurance companies’ compensation of brokers and agents and insurance companies’ purchase or sale of finite reinsurance; the performance of the Company’s investment portfolios, which could be adversely impacted by adverse developments in U.S. and global and financial markets, interest rates and rates of inflation; weakening U.S. and global economic conditions; larger than expected assessments for guaranty funds and mandatory pooling arrangements; a downgrade in the Company’s claims-paying and financial strength ratings; the loss or significant restriction on the Company’s ability to use credit scoring in the pricing and underwriting of Personal policies; and changes to the regulatory capital requirements.
The preparation of the consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and claims and expenses during the reporting period. Actual results could differ from those estimates.
In December 2003, the FASB issued Revised Interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46R). FIN 46R, along with its related interpretations, clarifies the application of Accounting Research Bulletin No. 51, Consolidated Financial Statements, to certain entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. FIN 46R separates entities into two groups: (1) those for which voting interests are used to determine consolidation and (2) those for which variable interests are used to determine consolidation. FIN 46R clarifies how to identify a variable interest entity (VIE) and how to determine when a business enterprise should include the assets, liabilities, non-controlling interests and results of activities of a VIE in its consolidated financial statements. A company that absorbs a majority of a VIE’s expected losses, receives a majority of a VIE’s expected residual returns, or both, is the primary beneficiary and is required to consolidate the VIE into its financial statements. FIN 46R also requires disclosure of certain information where the reporting company is the primary beneficiary or holds a significant variable interest in a VIE (but is not the primary beneficiary).
FIN 46R is effective for public companies that have interests in VIEs that are considered special-purpose entities for periods ending after December 15, 2003. Application by public companies for all other types of entities is required for periods ending after March 15, 2004. The Company adopted FIN 46R effective December 31, 2003.
The Company holds significant interests in hedge fund investments that are accounted for under the equity method of accounting and are included in other investments in the consolidated balance sheet. Hedge funds are unregistered private investment partnerships, limited liability companies (LLC), funds or pools that may invest and trade in many different markets, strategies and instruments (including securities, non-securities and derivatives). Three hedge funds were determined to be significant VIEs and have a total value for all investors combined of approximately $175 million and $326 million as of December 31, 2004 and 2003, respectively. The Company’s share of these funds has a carrying value of approximately $54 million and $93 million at December 31, 2004 and 2003, respectively. The Company’s involvement with these funds began in the third quarter of 2002.
There are various purposes for the Company’s involvement in these funds, including but not limited to the following:
to buy and sell U.S. and non-U.S. assets with primary focus on a diversified pool of structured mortgage and asset-backed securities offering attractive and relative value; and
to sell securities short primarily to exploit arbitrage opportunities in a broad range of equity and fixed income markets.
The Company has an unfunded commitment of $9 million associated with one of these funds. The Company’s exposure to loss is limited to the investment carrying amounts reported in the consolidated balance sheet.
Venture Capital Entities-In the Company’s venture capital investment portfolio, the Company has investments in small-to-medium sized companies, in which the Company has variable interests through stock ownership and, in some cases, loans. These investments are held for the purpose of generating long-term investment returns, and the companies in which the Company invests span a variety of business sectors. The Company consolidates three entities under the provisions of FIN 46R. The combined carrying value of these entities at December 31, 2004 was $5 million. The Company had an unfunded commitment of $1 million associated with one of these entities.
The following securities, which were acquired in the merger, are not consolidated under FIN 46R:
Mandatorily redeemable preferred securities of trusts holding solely the subordinated debentures of the Company-These securities were issued by five separate trusts that were established for the sole purpose of issuing the securities to investors, and are fully guaranteed by the Company. The debt that the Company issued to these trusts is included in the “Debt” section of liabilities on the Company’s consolidated balance sheet. That debt had a carrying value of $1.04 billion at December 31, 2004.
The Company has concluded that the prescription drug benefits available under the SPC postretirement benefit plan are actuarially equivalent to Medicare Part D and thus qualify for the federal subsidy under the 2003 Medicare Act. The Company also expects that the federal subsidy will offset or reduce the Company’s share of the cost of the underlying postretirement prescription drug coverage on which the subsidy is based. As a result, the estimated effect of the 2003 Medicare Act was reflected in the purchase accounting re-measurement of the SPC postretirement benefit plan on April 1, 2004. The effect of this adjustment was a $29 million reduction (with no tax effect) in the accumulated postretirement benefit obligation as of April 1, 2004 and a reduction of $2 million in net periodic postretirement benefit cost for the year ended December 31, 2004.
Effective January 1, 2002, the Company adopted FASB Statements of Financial Accounting Standards No. 141, “Business Combinations” (FAS 141), and No. 142, Goodwill and Other Intangible Assets (FAS 142). These standards changed the accounting for business combinations by, among other things, prohibiting the prospective use of pooling-of-interests accounting and requiring companies to stop amortizing goodwill and certain intangible assets with an indefinite useful life created by business combinations accounted for using the purchase method of accounting. Instead, goodwill and intangible assets deemed to have an indefinite useful life are subject to an annual review for impairment. Other intangible assets that are not deemed to have an indefinite useful life continue to be amortized over their useful lives.
During the quarter ended March 31, 2002, the Company performed the transitional impairment tests using the fair value approach required by FAS 142. Based on these tests, the Company impaired $220 million after tax of goodwill and $23 million after tax of indefinite-lived intangible assets representing the value of insurance operating licenses, all attributable to The Northland Company and its subsidiaries (Northland), as a cumulative effect adjustment as of January 1, 2002. The fair value of the Northland reporting unit was based on the use of a multiple of earnings model. The fair value of Northland’s indefinite-lived intangible assets was based on the present value of estimated net cash flows. Northland is a component of the Commercial operating segment.
In December 2004, the FASB issued Revised Statement of Financial Standards No. 123, Share-Based Payment (FAS 123R), an amendment to FAS 123 and a replacement of APB Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. FAS 123R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award, and to recognize that cost over the requisite service period.
As of the required effective date, FAS 123R requires entities that use the fair-value method of either recognition or disclosure under FAS 123, to apply a modified version of the prospective application. Under modified prospective application, compensation cost is recognized on or after the required effective date for all unvested awards, based on their grant-date fair value as calculated under FAS 123 for either recognition or pro forma disclosure purposes. FAS 123R is effective July 1, 2005.
The Company adopted the fair value method of accounting under FAS 123 on January 1, 2003. The fair value effect of stock options is derived by the application of an option pricing model. The impact of FAS 123R will be the additional expense relating to unvested awards granted prior to January 1, 2003 and which remain outstanding on the date of adoption of FAS 123R. The Company does not expect the impact of adopting FAS 123R to have a significant effect on operations, financial condition or liquidity.
Fixed maturities include bonds, notes and redeemable preferred stocks. Fixed maturities are valued based upon quoted market prices or dealer quotes, or if quoted market prices or dealer quotes are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment. Also included in fixed maturities are loan-backed and structured securities, which are amortized
Equity securities, which include common and nonredeemable preferred stocks, are classified as available for sale and carried at fair value based on quoted market prices. Changes in fair values of equity securities, net of income tax, are charged or credited directly to shareholders’ equity.
The carrying value of real estate properties are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. The review for impairment includes an estimate of the undiscounted cash flows expected to result from the use and eventual disposition of the real estate property. An impairment loss is recognized if the expected future undiscounted cash flows exceed the carrying value of the real estate property.
Rental income is recognized on a straight line basis over the lease term. See note 6.
Real estate held for sale is carried at the lower of cost or fair value less estimated costs to sell. Fair value is established at the time of acquisition by internal analysis or external appraisers, using discounted cash flow analyses and other acceptable techniques. Thereafter, impairment is taken if the carrying value of the property exceeds its current fair value less estimated costs to sell. The Company had no real estate held for sale at December 31, 2004, and the amount held for sale at December 31, 2003 was not significant.
The Company adopted FAS 141 and FAS 142 effective January 1, 2002. Upon adoption of FAS 141 and FAS 142, the Company stopped amortizing goodwill. Instead, goodwill is tested for impairment at least annually using a two-step process. The first step is performed to identify potential impairment and, if necessary, the second step is performed for the purpose of measuring the amount of impairment, if any. Indefinite-lived intangible assets are tested for impairment at least annually. Impairment is recognized only if the carrying amount of the intangible asset exceeds its fair value.
Claims and claim adjustment expense reserves represent estimated provisions for both reported and unreported claims incurred and related expenses. The reserves are adjusted regularly based upon experience.
The Company engages in securities lending activities from which it generates net investment income from the lending of certain of its investments to other institutions for short periods of time. Effective April 1, 2004, the Company entered into a new securities lending agreement. Borrowers of these securities provide collateral equal to at least 102% of the market value of the loaned securities plus accrued interest. This collateral is held by a third party custodian, and the Company has the right to access the collateral only in the event that the institution borrowing the Company’s securities is in default under the lending agreement. Therefore, the Company does not recognize the receipt of the collateral held by the third party custodian or the obligation to return the collateral. The loaned securities remain a recorded asset of the Company.
Prior to April 1, 2004, the Company engaged in securities lending activities where it received cash and marketable securities as collateral. In those cases where cash collateral was received, the Company reinvested the collateral in a short-term investment pool, the loaned securities remained a recorded asset of the Company and a liability was recorded to recognize the Company’s obligation to return the collateral at the end of the loan. Where marketable securities had been received as collateral, the collateral was held by a third party custodian, and the Company had the right to access the collateral only in the event that the institution borrowing the Company’s securities was in default under the lending agreement. In those cases where marketable securities were received as collateral, the Company did not recognize the receipt of the collateral held by the third party custodian or the obligation to return the collateral. The loaned securities remained a recorded asset of the Company.
Also included in other liabilities is an accrual for policyholder dividends. Certain insurance contracts, primarily workers’ compensation, are participating whereby dividends are paid to policyholders in accordance with contract provisions. Net written premiums for participating dividend policies were approximately 1%, 1% and 2% of total Company net written premiums for the years ended December 31, 2004, 2003 and 2002, respectively. Policyholder dividends are accrued against earnings using best available estimates of amounts to be paid. The liability accrued for policyholder dividends totaled $28 million and $12 million at December 31, 2004 and 2003, respectively.
As a result of the merger, the Company held a 79% interest in Nuveen Investments, Inc. (“Nuveen Investments,” formerly The John Nuveen Company), at December 31, 2004. The Company consolidates
100% of Nuveen Investments’ assets, liabilities, revenues and expenses, with reductions on the balance sheet and statement of income (loss) for the minority shareholders’ proportionate interest in Nuveen Investments’ equity and earnings. Minority interest of $123 million was recorded in other liabilities at December 31, 2004.
Nuveen Investments has three principal sources of revenue: advisory fees on assets under management, including separately managed accounts, closed-end exchange-traded funds and mutual funds; underwriting and distribution revenues earned upon the sale of certain investment products; and performance fees earned on certain institutional accounts based on the performance of such accounts. Investment advisory fees are recognized as services are provided. With respect to funds, Nuveen Investments receives fees based either on each fund’s average daily net assets or on a combination of the average daily net assets and gross interest income. With respect to managed accounts, Nuveen Investments generally earns fees, on a quarterly basis, based on the value of the assets managed on a particular date, such as the last calendar day of a quarter, or on the average asset value for the period.
In connection with the merger in April 2004, the Company assumed 23 million outstanding SPC stock options, of which 4 million remained unvested and assumed approximately 240,000 of outstanding SPC restricted stock awards related to SPC equity-based compensation plans. These stock options and restricted stock awards retained the same terms and conditions that were applicable prior to the merger. At April 1, 2004, the estimated fair values of the unvested stock option awards and the restricted stock awards were $35 million and $9 million, respectively, and are included in unearned compensation as a separate component of equity. The unearned compensation expense is being recognized as a charge to income over the remaining vesting period.
The following table illustrates the effect on net income (loss) and earnings per share for each period indicated as if the Company had applied the fair value recognition provisions of FAS 123 to all outstanding and unvested stock-based employee awards.
(1) Represents compensation expense on all restricted stock awards and on stock option awards granted after January 1, 2003.
The Company may use derivative financial instruments, including interest rate swaps, equity swaps, credit derivatives, options, forward contracts and financial futures, as a means of hedging exposure to interest rate, equity price change and foreign currency risk. The Company’s insurance subsidiaries do not hold or issue derivative instruments for trading purposes. The Company recognizes all derivatives, including certain derivative instruments embedded in other contracts, as either assets or liabilities in the consolidated balance sheet and measures those instruments at fair value. Where applicable, hedge accounting is used to account for derivatives. To qualify for hedge accounting, the changes in value of the derivative must be expected to substantially offset the changes in value of the hedged item. Hedges are monitored to ensure that there is a high correlation between the derivative instruments and the hedged investment. Derivatives that do not qualify for hedge accounting are marked to market with the changes in market value reflected in the consolidated statement of income in net realized investment gains (losses).
Interest rate swaps, equity swaps, credit derivatives, options and forward contracts were not significant at December 31, 2004 and 2003.
National Accounts provides casualty products and services to large companies, with particular emphasis on workers’ compensation, general liability and automobile liability. National Accounts also includes the Company’s residual market business, which primarily offers workers’ compensation products and services to the involuntary market.
Commercial also includes the Special Liability Group (which manages the Company’s asbestos and environmental liabilities); the reinsurance, health care, and certain international runoff operations; and policies written by the Company’s wholly-owned subsidiary Gulf Insurance Company (Gulf), which was placed into runoff during the second quarter of the year. These operations are collectively referred to as Commercial Other.
The Specialty segment was created upon the merger of TPC and SPC. It combined SPC’s specialty operations with TPC’s Bond and Construction operations, which were included in TPC’s Commercial segment prior to the merger. The Specialty segment provides a full range of standard and specialized insurance coverages and services through dedicated underwriting, claims handling and risk management groups. The segment comprises two primary groups: Domestic Specialty and International Specialty.
Domestic Specialty includes several marketing and underwriting groups, each of which possesses customer expertise and offers products and services to address its respective customers’ specific needs. These groups include Financial and Professional Services, Bond, Construction, Technology, Ocean Marine, Oil and Gas, Public Sector, Underwriting Facilities, Umbrella/Excess & Surplus Group, Discover Re and Personal Catastrophe Risk.
International Specialty includes coverages marketed and underwritten to several specialty customer groups within the United Kingdom, Canada and the Republic of Ireland and the Company’s participation in Lloyd’s.
(3) Represents adjustments to conform SPC’s accounting policies to those of TPC’s.
(5) Represents the excess of the purchase price (cost) over the amounts assigned to the assets acquired and liabilities assumed. None of the goodwill is expected to be deductible for tax purposes. See notes 4 and 11.
(6) Represents identified finite and indefinite life intangible assets, primarily customer-related insurance intangibles and management contracts and customer relationships associated with Nuveen Investments, Inc.’s (Nuveen Investments) asset management business. See note 4.
(7) An adjustment has been applied to SPC’s claims and claim adjustment expense reserves and reinsurance recoverables at the acquisition date to estimate their fair value. The fair value adjustment of $191 million was based on management’s estimate of nominal claim and claim expense reserves and reinsurance recoverables (after adjusting for conformity with the acquirer’s accounting policy on discounting of workers’ compensation reserves), expected payment patterns, the April 1, 2004 U.S. Treasury spot rate yield curve, a leverage ratio assumption (reserves to statutory surplus), and a cost of capital expressed as a spread over risk-free rates. The method used calculates a risk adjustment to a risk-free discounted reserve that will, if reserves run off as expected, produce results that yield the assumed cost-of-capital on the capital
(b) Contract-based intangibles include management contracts associated with Nuveen Investments’ asset management business based on the present value of expected cash flows related to the management contracts. Amounts related to this business are included at the Company’s 79% approximate ownership interest of Nuveen Investments.
The following unaudited pro forma information presents the combined results of operations of TPC and SPC for the twelve months ended December 31, 2004 and 2003, respectively, with pro forma purchase accounting adjustments as if the acquisition had been consummated as of the beginning of the periods presented. This pro forma information is not necessarily indicative of what would have occurred had the acquisition and related transactions been made on the dates indicated, or of future results of the Company.
On May 28, 2004, The Travelers Indemnity Company (Indemnity), a subsidiary of the Company, completed its previously announced transaction with Trident II, L.P., Marsh & McLennan Capital Professionals Fund, L.P., Marsh & McLennan Employees’ Securities Company, L.P. and Trident Gulf Holding, LLC (collectively, Trident) to purchase all of the outstanding shares (8,970,000 shares) of the mandatorily convertible preferred stock of Commercial Insurance Resources, Inc. (CIRI) held by Trident at a purchase price of $8.83 per share and the convertible notes held by Trident for $46 million. By June 30, 2004, Indemnity completed its purchase from employees of $7 million of the mandatorily convertible preferred stock at a purchase price of $8.83 per share, convertible notes with an aggregate principal amount of $4 million, and common equity of $3 million at a purchase price of $8.83 per share. The notes that were previously issued to employees to finance 50% of their investment in CIRI were assumed by Indemnity as part of the agreement to purchase the employees’ investments in CIRI. The excess of the cost to repurchase the minority interest over the minority interest carrying value on the consolidated balance sheet was recorded as a charge to additional paid-in capital during the second quarter.
As a result of these transactions, TIGHI and its property and casualty insurance subsidiaries became TPC’s principal asset.
On March 21, 2002, TPC issued 231 million shares of its class A common stock in an initial public offering (IPO), representing approximately 23% of TPC’s common equity. After the IPO, Citigroup beneficially owned all of the 500 million shares of TPC’s outstanding class B common stock, each share of which is entitled to seven votes, and 269 million shares of TPC’s class A common stock, each share of which is entitled to one vote, representing at the time 94% of the combined voting power of all classes of TPC’s voting securities and 77% of the equity interest in TPC. (All class A and class B share amounts presented are unadjusted for the merger of TPC and SPC). Concurrent with the IPO, TPC issued $893 million aggregate principal amount of 4.5% convertible junior subordinated notes which mature on April 15, 2032. The IPO and the offering of the convertible notes are collectively referred to as the offerings.
Pursuant to TPC’s corporate reorganization, TPC’s consolidated financial statements included the accounts of its primary subsidiary, TIGHI, a property casualty insurance holding company. Also included were the accounts of CitiInsurance International Holdings Inc. and its subsidiaries (CitiInsurance), the principal assets of which are investments in the property casualty and life operations of Fubon Insurance Co., Ltd. and Fubon Assurance Co., Ltd., with respect to results prior to March 1, 2002.
On August 20, 2002, Citigroup made a tax-free distribution to its stockholders (the Citigroup Distribution), of a portion of its ownership interest in TPC, which, together with the shares issued in the IPO, represented more than 90% of TPC’s common equity and more than 90% of the combined voting power of TPC’s outstanding voting securities. For each 100 shares of Citigroup outstanding common stock, approximately 4.32 shares of TPC class A common stock and 8.88 shares of TPC class B common stock were distributed. At December 31, 2004, Citigroup held for its own account approximately 6.50% of the Company’s outstanding common stock. At December 31, 2003 and 2002, Citigroup held for its own account 9.87% and 9.95%, respectively, of TPC’s common equity and 9.87% and 9.98%, respectively, of the combined voting power of TPC’s outstanding voting securities. Citigroup received a private letter ruling from the Internal Revenue Service that the Citigroup Distribution was tax-free to Citigroup, its stockholders and TPC. As part of the ruling process, Citigroup agreed to vote the shares it continued to hold following the Citigroup Distribution pro rata with the shares held by the
At December 31, 2001, TPC had a note payable to Citigroup in the amount of $1.20 billion, in conjunction with its purchase of TIGHI’s outstanding shares in April 2000. On February 7, 2002, this note agreement was replaced by a new note agreement. Under the terms of the new note agreement, interest accrued on the aggregate principal amount outstanding at the commercial paper rate (the then current short-term rate) plus 10 basis points per annum. Interest was compounded monthly. This note was prepaid following the offerings.
Prior to the 2002 Citigroup Distribution, TPC provided and purchased services to and from Citigroup affiliated companies, including facilities management, banking and financial functions, benefit coverages, data
The following presents a summary of the Company’s intangible assets by major asset class as of December 31, 2004:
carrying amount of $555 million and accumulated amortization of $133 million. All of these intangible assets were customer-related and subject to amortization.
(1) Operating revenues exclude net realized investment gains (losses). Operating income (loss) equals net income (loss) excluding the after-tax impact of net realized investment gains (losses) and cumulative effect of changes in accounting principles when applicable. For 2002, operating income also excludes non-recurring restructuring charges related to periods prior to the spin-off from Citigroup.
(2) It is not practicable to restate assets by segment for prior periods.
(1) The primary components of other assets in 2004 were deferred taxes, prepaid pension costs and invested assets.
At December 31, 2004 and 2003, the Company’s insurance subsidiaries had $3.39 billion and $2.37 billion, respectively, of securities on deposit at financial institutions in certain states pursuant to the respective states’ insurance regulatory authorities.
The Company’s subsidiaries, Unionamerica and St. Paul Re-U.K., and the Company’s operations at Lloyd’s (all acquired in the merger) are required, as accredited U.S. reinsurers, to hold certain investments in trust in the United States. These trust funds had a fair value of $359 million at December 31, 2004. Additionally, Unionamerica, St. Paul Re-U.K. and Discover Re have funds deposited with third parties to be used as collateral to secure various liabilities on behalf of insureds, cedants and other creditors. These funds had a fair value of $55 million at December 31, 2004. There is also $95 million of other investments being used as collateral to secure our obligations under a series of insurance transactions.
An investment in a fixed maturity or equity security which is available for sale is impaired if its fair value falls below its book value and the decline is considered to be other-than-temporary. Factors considered in determining whether a decline is other-than-temporary include the length of time and the extent to which fair value has been below cost, the financial condition and near-term prospects of the issuer, and the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.
Additionally, for certain securitized financial assets with contractual cash flows (including asset-backed securities), EITF 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets, requires the Company to periodically update its best estimate of cash flows over the life of the security. If management determines that the fair value of its securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the last revised estimate, considering both timing and amount, then an other-than-temporary impairment is recognized.
Index to Financial Statements THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
analysis of investments with gross unrealized investment losses that have fair values less than 80% of amortized cost during successive quarterly periods over a rolling one-year period;
consideration of evidential matter, including an evaluation of factors or triggers that would or could cause individual investments to qualify as having other-than-temporary impairments and those that would not support other-than-temporary impairment; and
determination of the status of each analyzed investment as other than temporary or not, with documentation of the rationale for the decision.
The quarterly valuation procedures described above are in addition to the portfolio managers’ ongoing responsibility to frequently monitor developments affecting those invested assets, paying particular attention to events that might give rise to impairment write-downs.
Aggregate annual maturities on mortgage loans are $16 million, $23 million, $32 million, $17 million, and $103 million for 2005, 2006, 2007, 2008 and 2009 and thereafter, respectively.
Underperforming mortgage loans, which include delinquent loans, loans in the process of foreclosure and loans modified at interest rates below market, were $4 million and $31 million at December 31, 2004 and 2003, respectively.
At December 31, 2004 and 2003, the Company had concentrations of credit risk in tax-exempt investments of the state of Texas of $2.30 billion and $1.54 billion, respectively, of the state of Illinois of $1.50 billion and $872 million, respectively, and of the state of New York of $1.44 billion and $1.35 billion, respectively.
Earnings per share (EPS) has been computed in accordance with Statement of Financial Accounting Standards No. 128, Earnings per Share (FAS 128). Basic EPS is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. The computation of diluted EPS reflects the effect of potentially dilutive securities.
The weighted average number of common shares outstanding applicable to basic and diluted EPS for all periods prior to April 1, 2004 have been restated to reflect the exchange of each share of TPC common stock for 0.4334 shares of the Company’s common stock.
As discussed in more detail in Note 1 of this report, the Company implemented the provisions of FASB Emerging Issues Task Force (EITF) 04-8, The Effect of Contingently Convertible Debt on Diluted Earnings per Share, which provided new guidance on the dilutive effect of contingently convertible debt instruments. Net income per diluted share for the year ended December 31, 2004 excluded the weighted average effects of the 4.50% convertible junior subordinated notes convertible into 16.7 million shares of common stock as the impact would be anti-dilutive. Net income per diluted share for the year ended December 31, 2003 was restated from $3.88 to $3.80, while net income per diluted share for the year ended December 31, 2002 was not restated as the impact would be anti-dilutive.
Certain of the assumed reinsurance contracts that the Company has entered into with non-affiliated companies on an excess of loss basis do not transfer insurance risk. These contracts are accounted for using deposit accounting and are included in other liabilities in the consolidated balance sheet and totaled $405 million and $325 million at December 31, 2004 and 2003, respectively.
The Company entered into commutation agreements with a major reinsurer, effective June 30, 2004, resulting in a charge of $153 million for amounts received less than the reinsurance recoverable balances of approximately $1.26 billion. In connection with the commutation, the Company also entered into a new reinsurance agreement effective April 1, 2004, that provides $300 million aggregate coverage for the 2000 accident year exposures written by SPC. Because the new agreement is for events occurring prior to the effective date of the agreement, the resulting $59 million gain has been deferred and will be recognized in earnings as amounts are recovered from the reinsurer. Under the terms of these agreements, the Company received net cash of approximately $867 million.
In 1996, Lloyd’s of London (Lloyd’s) restructured its operations with respect to claims for years prior to 1993 and reinsured these claims into Equitas Limited (Equitas). Amounts recoverable from unaffiliated insurers at December 31, 2004 and 2003 included $90 million and $269 million, respectively, recoverable from Equitas. During the first quarter of 2004, TPC entered into an agreement to settle all current and future reinsurance claims against certain underwriters at Lloyd’s reinsured by Equitas. Under terms of this settlement, the Company received $245 million, resolving approximately $255 million of TPC’s net claim balances from Equitas. Virtually all of the $90 million reinsurance recoverables relating to Equitas remaining at December 31, 2004 relate to SPC.
The table below is a reconciliation of beginning and ending property casualty reserve balances for claims and claim adjustment expenses.
(1) SPC net claims and claim adjustment expense reserves at April 1, 2004. SPC gross reserves at that date were $19.50 billion. SPC reinsurance recoverables on unpaid losses at April 1, 2004 were $5.85 billion.
The asbestos provision primarily resulted from an increase in litigation costs and activity surrounding peripheral defendants. With regard to the environmental provision, new claims for hazardous waste and pollution continue to decline, though the pace of the decrease has slowed. The average severity of claims has increased, however, leading the Company to conclude that reserves for environmental losses needed to be increased. The majority of the asbestos and environmental provision is included in the Commercial segment. Also included in net unfavorable prior year reserve development of $1.18 billion in the Commercial segment was $38 million related to the commutation of agreements with a major reinsurer along with a strengthening of Gulf reserves, which was more than offset by favorable prior year reserve development in core Commercial operations due to reductions in the frequency of non-catastrophe related losses.
The Specialty segment recorded prior year reserve development of $1.59 billion and included $500 million and $300 million of net unfavorable prior year reserve development related to the construction and surety reserves, respectively, acquired in the merger, as well as a $252 million charge related to a specific construction contractor and $75 million related to the commutation of agreements with a major reinsurer. Results in 2004 also reflected $150 million of unfavorable prior year reserve development recorded in TPC’s Construction operation prior to the merger, other reserve increases, and a charge to increase the allowance for estimated amounts due from a co-surety on a specific construction contractor claim.
For each of the years ended December 31, 2004, 2003 and 2002, changes in allocations between accident years of loss adjustment expenses, pursuant to regulatory reporting requirements, are included in claims and claim adjustment expenses for claims arising in prior years and did not impact results of operations.
The fair value adjustments to the acquired claims and claim adjustment expense reserves and reinsurance recoverables as of April 1, 2004, the merger date, are reported as intangible assets and are being amortized over the expected payout period of the acquired reserves. See note 2.
In March 2002, Citigroup entered into an agreement under which it provided TPC with financial support for asbestos claims and related litigation, in any year that TPC’s insurance subsidiaries record asbestos-related income statement charges in excess of $150 million, net of any reinsurance, up to a cumulative aggregate of $800 million, reduced by the tax effect of the highest applicable federal income tax rate. During 2002, TPC recorded $2.95 billion of asbestos incurred losses, net of reinsurance, and accordingly has fully utilized the total benefit available under the agreement.
In establishing environmental reserves, the Company evaluates the exposure presented by each policyholder and the anticipated cost of resolution, if any. In the course of this analysis, the Company considers the probable liability, available coverage, relevant judicial interpretations and historical value of similar exposures. In addition, the Company considers the many variables presented, such as the nature of the alleged activities of the policyholder at each site; the allegations of environmental harm at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of environmental harm and the corresponding remedy at each site; the nature of government enforcement activities at each site; the ownership and general use of each site; the overall nature of the insurance relationship between the Company and the policyholder, including the role of any umbrella or excess insurance the Company has issued to the policyholder; the involvement of other insurers; the potential for other available coverage, including the number of years of coverage; the role, if any, of non-environmental claims or potential non-environmental claims, in any resolution process; and the applicable law in each jurisdiction. Conventional actuarial techniques are not used to estimate these reserves. In 2004, the Company recorded a pretax charge of $290 million, net of reinsurance, to increase environmental reserves due to revised estimates of costs related to recent settlement initiatives. Net environmental losses paid were $152 million, $155 million and $161 million for the years ended December 31, 2004, 2003 and 2002, respectively.
The following table presents the unamortized fair value adjustment and the related effective interest rate on the debt instruments acquired in the merger:
Commercial Paper-The Company maintains an $800 million commercial paper program with $1 billion of back-up liquidity, consisting entirely of bank credit agreements. Interest rates on commercial paper issued in 2004 ranged from 1.1% to 2.8%.
Medium-Term Notes-The medium-term notes outstanding at December 31, 2004 bear interest rates ranging from 6.4% to 7.4%, with a weighted average rate of 6.8%. Maturities range from 5 to 15 years after the issuance dates. During 2004, medium-term notes having a par value of $59 million matured or were repurchased.
Nuveen Investments’ Debt-In September 2003, Nuveen Investments issued $300 million of 4.22% notes in a private placement. The notes mature in 2008. A portion of the proceeds was used to refinance existing debt and repay a $105 million loan from SPC. The remainder was used for Nuveen Investments’ general corporate purposes. The carrying value of Nuveen Investments’ debt in the foregoing table included the unamortized gains from the cancellation of prior interest rate swap transactions in connection with the private placement, as well as unamortized private placement debt issue costs.
will be convertible into shares of common stock at a conversion rate of 1.0808 shares of common stock for each $57.68 principal amount of notes (equivalent to an initial conversion price of $53.37 per share of common stock), subject to adjustment in certain events. On or after April 18, 2007, the notes may be redeemed at the Company’s option. The Company is not required to make mandatory redemption or sinking fund payments with respect to the notes. The notes are general unsecured obligations and are subordinated in right of payment to all existing and future Senior Indebtedness. The notes are also effectively subordinated to all existing and future indebtedness and other liabilities of any of the Company’s current or future subsidiaries.
Effective April 17, 2003, TPC entered into the following line of credit agreements with Citibank, a subsidiary of Citigroup, TPC’s former parent: (i) a $250 million 45-month revolving line of credit (the 45-Month Line of Credit), and (ii) a $250 million 364-day revolving line of credit (the TPC 364-Day Line of Credit and, together with the 45-Month Line of Credit, the TPC Lines of Credit). TPC may, with Citibank’s consent, extend the commitment of the 364-day Line of Credit for additional 364-day periods under the same terms and conditions. TPC has the option, provided there is no default or event of default, to convert outstanding advances under the 364-Day Line of Credit at the commitment termination date to a term loan maturing no later than one year from the commitment termination date.
As a result of the expiration of the SPC 364-Day Line of Credit and the TPC 364-Day Line of Credit, the Company entered into a new $480 million 364-day revolving line of credit agreement (the STA 364-Day Line of Credit) with a syndicate of banks. As of December 31, 2004, the Company has access to the following bank credit lines: (i) the $250 million 45-Month Line of Credit, (ii) the $270 million 5-Year Line of Credit, and (iii) the $480 million STA 364-Day Line of Credit (collectively, the Company Line of Credit). The Company Line of Credit supports the Company’s commercial paper program.
Borrowings under the Company Line of Credit may be made, at the Company’s option, at a variable interest rate equal to either the lender’s base rate plus an applicable margin or at LIBOR plus an applicable margin. The Company Line of Credit includes a commitment fee and, for any date on which advances exceed 50% of the total
Event of Default. An event of default will occur if there is a change in control (as defined in the 45-Month Line of Credit and 5-Year Line of Credit agreements). The merger of TPC and SPC did constitute a change in control for both TPC and SPC; however, both entities did obtain a waiver from their respective banks of that event of default. There were no amounts outstanding under the Company Line of Credit at December 31, 2004.
For the period ending March 27, 2002, the Company was included in the consolidated federal income tax return filed by Citigroup. Citigroup allocated federal income taxes to its subsidiaries on a separate return basis adjusted for credits and other amounts required by the consolidation process. Any resulting liability was paid currently to Citigroup. Any credit for losses was paid by Citigroup currently to the extent that such credits were for tax benefits that have been utilized in the consolidated federal income tax return.
As of March 28, 2002, as a result of the IPO, the Company is no longer included in the Citigroup consolidated federal income tax return. As of that date, the Company began filing its own consolidated federal income tax return. The Company’s intercompany tax sharing agreement was amended to include the SPC companies effective with their acquisition on April 1, 2004.
U.S. income taxes have not been provided on $149 million of the Company’s foreign operations’ undistributed earnings as of December 31, 2004, as such earnings are intended to be permanently reinvested in those operations. Furthermore, any taxes paid to foreign governments on these earnings may be used as credits against the U.S. tax on any dividend distributions from such earnings.
TIGHI, in 1996, formed statutory subsidiary business trusts under the laws of the State of Delaware, which issued Trust Securities representing undivided beneficial interests in the assets of the trust. The gross proceeds of the Trust Securities were invested in Junior Subordinated Deferrable Interest Debentures (Junior Subordinated Debentures) of its parent (TPC). On April 9, 2003, TIGHI redeemed the $900 million aggregate principal of the TIGHI 8.00% to 8.08% Junior Subordinated Debentures held by the subsidiary trusts. The subsidiary trusts, in turn, used these funds to redeem the $900 million liquidation value of the Trust Securities.
The Company’s preferred shareholders’ equity represents the par value of preferred shares outstanding that the Company assumed in the merger related to The St. Paul Companies, Inc. Stock Ownership Plan (SOP) Trust, less the remaining principal balance on the SOP Trust debt. The SOP Trust borrowed funds from a U.S. underwriting subsidiary to finance the purchase of the preferred shares, and the Company guaranteed the SOP debt.
On April 1, 2004, each issued and outstanding share of TPC class A and class B common stock (including the associated preferred stock purchase rights) was exchanged for 0.4334 of a share of the Company’s common stock. See note 2.
The Company is governed by the Minnesota Business Corporation Act. All authorized shares of voting common stock have no par value. Shares of common stock reacquired are considered treasury shares. The number of authorized shares of the company is 1.75 billion.
The articles of incorporation allow the Company to issue five million undesignated shares. The Board of Directors may designate the type of shares and set the terms thereof. The Board designated 1,450,000 shares as Series B Convertible Preferred Stock in connection with the formation of the Stock Ownership Plan.
The Company’s 2004 Incentive Plan, the SPC 1994 Stock Incentives Plan and the TPC 2002 Incentive Plan provide settlement alternatives to employees in which the Company repurchases shares to cover tax withholding costs and exercise costs. At December 31, 2004 and 2003, the Company had purchased $14 million and $18 million, respectively, of its common stock under this plan.
The Company entered into a commitment, in conjunction with the August 2002 Citigroup Distribution, to acquire the Company common stock held by the Citigroup Capital Accumulation Program (Citigroup CAP) upon forfeiture of plan participants for which it prepaid $15 million. This commitment expires over three years upon vesting of the Citigroup CAP participants. In March 2004, Citigroup accelerated the vesting of their CAP participant awards, and accordingly, the Company has no further obligation to acquire the company stock held by Citigroup CAP. The Company has 63,321 shares due from Citigroup for unvested shares and a prepaid balance due from Citigroup of $7 million. At December 31, 2003 and 2002, TPC had acquired $4 million and $1 million, respectively, of its common stock pursuant to this arrangement.
Common shares acquired under these plans are reported as treasury stock in the consolidated balance sheet.
The Company’s insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of insurance regulatory authorities. A maximum of $2.61 billion is available in 2005 for such dividends without prior approval of the
After the merger, the Company’s Board of Directors adopted The St. Paul Travelers Companies, Inc. 2004 Stock Incentive Plan (the 2004 Incentive Plan), which also was approved by the Company’s shareholders on July 28, 2004. The purposes of the 2004 Incentive Plan are to reward the efforts of the Company’s non-employee directors, executive officers and other employees and to attract new personnel by providing incentives in the form of stock-based awards. The 2004 Incentive Plan permits grants of nonqualified stock options, incentive stock options, stock appreciation rights, restricted stock, deferred stock, stock units, performance awards and other stock-based or stock-denominated awards with respect to the Company’s common stock. The maximum number of shares of the Company’s common stock that may be issued pursuant to awards granted under the 2004 Incentive Plan is 35 million shares, subject to additional shares that may be available for awards as described below.
In connection with the adoption of the 2004 Incentive Plan, the legacy Travelers Property Casualty Corp. 2002 Stock Incentive Plan (legacy TPC 2002 Incentive Plan) and the legacy St. Paul Global Stock Option Plan (legacy Global Stock Option Plan), which ceased granting awards after 2001, were terminated. The legacy St. Paul Amended and Restated 1994 Stock Incentive Plan (legacy SPC 1994 Stock Plan) had expired on May 4, 2004 by its own terms, and other legacy SPC stock plans had either terminated or had no shares available for future grant. The legacy TPC 2002 Incentive Plan was the only plan pursuant to which TPC could make stock-based awards prior to the merger. Outstanding grants were not affected by the plans’ termination including the grant of reload options related to prior option grants under the legacy TPC 2002 Incentive Plan and the legacy SPC 1994 Stock Plan.
The Company established an Equity Awards program under the 2004 Incentive Plan, pursuant to which the Company may issue stock option awards to eligible officers and key employees. Under the Equity Awards program, stock option awards are granted having a ten-year term with an exercise price equal to the fair market value of the Company’s common stock on the date of grant. Generally, the stock options vest over a four year period, with 50% of the option shares vesting on the 2nd anniversary of the date of grant, and 25% of the option shares vesting on each of the 3rd and 4th anniversaries of the grant date. Except as the Compensation Committee of the Board may allow in the future, stock options cannot be sold or transferred by the participant.
On August 20, 2002, in connection with the Citigroup Distribution, Citigroup stock option awards held by TPC employees on that date under various legacy Citigroup incentive plans were cancelled and replaced with stock option awards (replacement awards) to purchase TPC’s common stock under the TPC 2002 Incentive plan. These replacement awards were granted on substantially the same terms, including vesting, as the former Citigroup awards. Reflecting adjustment for the merger, the total number of the Company’s common stock subject to the replacement awards was 25 million shares of which 11 million shares were vested and therefore exercisable. The number of shares of TPC’s common stock to which the replacement awards related and the per share exercise price of the replacement awards were determined so that:
the intrinsic value of each Citigroup option, which was the difference between the closing price of Citigroup’s common stock on August 20, 2002, and the exercise price of the Citigroup options, was preserved in each replacement award for TPC’s common stock; and
the ratio of the exercise price of the replacement award to the closing price of the Company’s common stock on August 20, 2002, immediately after the Citigroup Distribution, was the same as the ratio of the exercise price of the Citigroup option to the price of Citigroup common stock immediately before the Citigroup Distribution.
Information with respect to stock option activity under the Company’s stock option plans for the years ended December 31, 2004, 2003 and 2002 is as follows:
In connection with SPC options assumed in the merger, the estimated fair value of all the outstanding SPC stock options at April 1, 2004 was $186 million and was included in the determination of the purchase price based upon the announcement date market price per share of SPC common stock, using an option-pricing model. The unvested stock option awards require the holder to render service during the vesting period and are therefore considered unearned compensation. At April 1, 2004, the estimated fair values of the unvested awards were $35 million and have been included in unearned compensation as a separate component of equity. The unearned compensation expense is being recognized as a charge to income over the remaining vesting period.
On April 1, 2004, in accordance with the merger agreement, the restricted stock awards and deferred stock awards of the legacy TPC 2002 Incentive Plan were converted to restricted stock awards and deferred stock awards in the Company’s common stock. These restricted stock awards and deferred stock awards retained substantially the same terms and conditions that were applicable prior to the conversion. The 0.4334 merger exchange ratio was applied to the outstanding TPC restricted stock awards and deferred stock awards to reflect this conversion.
The TPC restricted stock awards granted under the legacy TPC 2002 Incentive Plan were awarded to eligible officers and key employees through TPC’s Capital Accumulation Program (TPC CAP). Under this plan, certain TPC CAP participants received part of their annual bonus awards in restricted stock, and at their election, part in stock options. The number of shares included in the restricted stock award was calculated at a 25% discount from the market price on the date of the award and generally vested in full after a three-year period. Except under limited circumstances, during this period the stock cannot be sold or transferred by the participant, who is required to render service to the Company during the restricted period. Awards granted to non-U.S. participants were in the form of deferred stock awards. These deferred stock awards are subject to the same conditions as the restricted stock awards except that the shares are not issued until the vesting criteria are satisfied.
Prior to the IPO, TPC participated in Citigroup’s Capital Accumulation Plan (Citigroup CAP) that provided for the issuance of shares of Citigroup common stock in the form of restricted stock awards to eligible officers and other key employees with substantially the same terms as the TPC’s 2002 CAP.
Information with respect to restricted stock and deferred stock awards is as follows:
In addition, the St. Paul Travelers Deferred Compensation Plan for Non-Employee Directors and legacy SPC and TPC directors’ plans allow deferred receipt of shares of common stock (deferred stock) to a future distribution date or upon termination of a director’s service. The after-tax compensation cost associated with this plan was not significant in 2004, 2003 and 2002.
In addition to the Company’s equity-based compensation plans discussed above, Nuveen Investments has an equity-based compensation plan in which awards are granted in Nuveen Investments’ publicly traded common stock. The after-tax compensation cost associated with these awards included in the Company’s earnings was approximately $9 million.
Prior to December 31, 2004, both TPC and SPC sponsored qualified non-contributory defined benefit pension plans. On December 31, 2004, the qualified noncontributory defined benefit pension plans of TPC and SPC were merged to form one plan. The Company sponsors the merged plan, which covers substantially all employees and provides benefits under a cash balance formula, except that employees satisfying certain age and service requirements remain covered by a prior final pay formulas. In addition, the Company and TPC sponsor nonqualified defined benefit pension plans which cover certain highly-compensated employees and also sponsor postretirement health and life insurance benefit plans for employees satisfying certain age and service requirements and for certain retirees. Prior to the August 20, 2002 Citigroup Distribution, substantially similar benefits were provided to TPC employees through plans sponsored by Citigroup.
The accumulated benefit obligation for the Company’s defined benefit pension plans was $1.73 billion and $574 million at December 31, 2004 and 2003, respectively.
The pretax minimum liability included in other comprehensive income was $10 million at both December 31, 2004 and 2003.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (2003 Medicare Act) was enacted. The 2003 Medicare Act introduces a prescription drug benefit under Medicare Part D as well as a federal subsidy to sponsors of retiree health care benefit plans that provide a benefit that is at least actuarially equivalent to Medicare Part D. The Company has concluded that prescription drug benefits available under the SPC postretirement benefit plan are actuarially equivalent to Medicare Part D and thus qualify for the federal subsidy under the 2003 Medicare Act. The Company also expects that the Federal subsidy will offset or reduce the Company’s share of the cost of the underlying postretirement prescription drug coverage on which the subsidy is based. As a result, the estimated effect of the 2003 Medicare Act was reflected in the purchase accounting remeasurement of the SPC postretirement benefit plan on April 1, 2004. The effect of this adjustment was a $29 million reduction (with no tax effect) in the accumulated postretirement benefit obligation as of
April 1, 2004 and a reduction of $2 million in net periodic postretirement benefit cost for the year ended December 31, 2004. See note 1.
The following table summarizes the components of net benefit expense recognized in the consolidated statement of income for the benefit plans for the years ended December 31, 2004 and 2003 and for the period August 20, 2002 through December 31, 2002.
The Company’s share of expenses related to these plans for the period January 1, 2002 to August 20, 2002 was not significant.
The percentage of the fair value of pension plan assets held by asset category is as follows:
Equity securities include 797,600 shares of the Company’s common stock with a market value of $30 million at December 31, 2004.
Rent expense was $214 million, $115 million and $123 million in 2004, 2003 and 2002, respectively. Rent expense related to certain leases in 2002 was shared by TPC and a former affiliate on a cost allocation method based generally on estimated usage by department. In conjunction with the Citigroup Distribution, TPC purchased certain properties from Citigroup.
Future minimum annual rental payments under noncancellable operating leases are $171 million, $149 million, $127 million, $100 million, $68 million and $124 million for 2005, 2006, 2007, 2008, 2009 and 2010 and thereafter, respectively. Future sublease rental income of approximately $69 million will partially offset these commitments.
For net investment hedges in which derivatives hedge the foreign currency exposure of a net investment in a foreign operation, the accounting treatment will similarly depend on the effectiveness of the hedge. The effective portion of the change in fair value of the derivative hedging the net investment, including any forward premium or discount, is reflected in the accumulated other changes in equity from nonowner sources as part of the foreign currency translation adjustment. For the years ended December 31, 2004 and 2003, the amount included in the foreign currency translation adjustment in equity from nonowner sources was a $4 million loss and a $17 million loss, respectively. The ineffective portion is reflected in net realized investment gains (losses).
The Company also purchases investments that have embedded derivatives, primarily convertible debt securities. These embedded derivatives are carried at fair value with changes in value reflected in net realized investment gains (losses). The Company bifurcates an embedded derivative where a) the economic characteristics and risks of the embedded instrument are not clearly and closely related to the economic characteristics and risks of the host contract, b) the entire instrument would not otherwise be remeasured at fair value, and c) a separate instrument with the same terms of the embedded instrument would meet the definition of a derivative under FAS 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133). Derivatives embedded in convertible debt securities are reported on a combined basis with their host instrument and are classified as fixed maturity securities.
The Company engaged in U.S. Treasury note futures transactions to modify the duration of the investment portfolio. The Company enters into 90 day futures contracts on 2 year, 5 year, 10 year and 30 year U.S. Treasury notes which require a daily mark to market settlement with the broker. The notional value of the open U.S. Treasury futures contracts was $1.33 billion and $1.48 billion at December 31, 2004 and December 31, 2003, respectively. These derivative instruments are not designated and do not qualify as hedges under FAS 133 and as such the daily mark to market settlement is reflected in net realized investment gains (losses). Net realized investment gains (losses) in 2004 and 2003 included losses of $44 million and $27 million, respectively, related to U.S. Treasury futures contracts which are settled daily.
During the third quarter of 2004, the Company terminated its interest rate swap agreements which had been acquired in the merger. The notional value of these swaps was $730 million at the time of the termination. These interest rate swap agreements were used to manage exposure of certain of its fixed rate debt to changes in interest rates. These derivative instruments did not qualify for continued hedge accounting following the merger and, as such, the mark-to-market changes in fair value were reflected in net realized investment gains and losses prior to the termination of these agreements.
The Company uses various financial instruments in the normal course of its business. Certain insurance contracts are excluded by FAS 107, Disclosures about Fair Value of Financial Instruments, and, therefore, are not included in the amounts discussed.
The carrying values of $1.23 billion and $284 million of financial instruments classified as other assets approximated their fair values at December 31, 2004 and 2003, respectively. The carrying values of $4.94 billion and $2.69 billion of financial instruments classified as other liabilities at December 31, 2004 and 2003, respectively, also approximated their fair values. Fair value is determined using various methods including discounted cash flows, as appropriate for the various financial instruments.
The carrying value and fair value of the Company’s debt at December 31, 2004 was $6.62 billion and $6.78 billion, respectively. The respective totals at December 31, 2003 were $2.68 billion and $2.77 billion.
While the Company cannot predict the outcome of the appeals of the various ACandS rulings or other legal actions, based on these rulings, the Company would not have any significant obligations remaining under any policies issued by TPC to ACandS.
In October 2001 and April 2002, two purported class action suits (Wise v. Travelers and Meninger v. Travelers), were filed against TPC and other insurers (not including SPC) in state court in West Virginia. These cases were subsequently consolidated into a single proceeding in Circuit Court of Kanawha County, West Virginia. Plaintiffs allege that the insurer defendants engaged in unfair trade practices by inappropriately handling and settling asbestos claims. The plaintiffs seek to reopen large numbers of settled asbestos claims and to impose liability for damages, including punitive damages, directly on insurers. Lawsuits similar to Wise were filed in Massachusetts and Hawaii (these suits are collectively referred to as the “Statutory and Hawaii Actions”). Also, in November 2001, plaintiffs in consolidated asbestos actions pending before a mass tort panel of judges in West Virginia state court moved to amend their complaint to name TPC as a defendant, alleging that TPC and other insurers breached alleged duties to certain users of asbestos products. In March 2002, the court granted the motion to amend. Plaintiffs seek damages, including punitive damages. Lawsuits seeking similar relief and raising allegations similar to those presented in the West Virginia amended complaint are also pending in Ohio and Texas state courts against TPC and SPC and in Louisiana state court against TPC (the claims asserted in these suits, together with the West Virginia suit, are collectively referred to as the “Common Law Claims”).
On November 19, 2003, the parties advised the bankruptcy court that a settlement of the Statutory and Hawaii Actions had been reached. This settlement includes a lump sum payment of up to $412 million by TPC, subject to a number of significant contingencies. After continued meetings with the mediator, the parties advised the bankruptcy court on May 25, 2004 that a settlement resolving substantially all pending and similar future Common Law Claims against TPC had also been reached. This settlement requires a payment of up to $90 million by TPC, subject to a number of significant contingencies. Each of these settlements is contingent upon, among other things, an order of the bankruptcy court clarifying that all of these claims, and similar future asbestos-related claims against TPC, are barred by prior orders entered by the bankruptcy court in connection with the original Johns-Manville bankruptcy proceedings.
Beginning in August 2004, following post-merger announcements by the Company, various shareholders of the Company commenced fourteen putative class action lawsuits against the Company and certain of its current and former officers and directors in the United States District Court for the District of Minnesota. Plaintiff shareholders allege that certain disclosures relating to the April 2004 merger between TPC and SPC contained false or misleading statements with respect to the value of SPC’s loss reserves in violation of federal securities laws. The complaints do not specify damages. These actions have been consolidated under the caption In re St. Paul Travelers Securities Litigation. Plaintiffs have not yet filed a consolidated class action complaint. An additional putative class action based on the same allegations was brought in New York State Supreme Court. This action was subsequently transferred to, and is currently pending in, the District of Minnesota.
2004), the plaintiff shareholder alleges state law claims, including breach of fiduciary duty, based on the Company’s alleged mismanagement of and failure to make disclosure relating to the practice of paying brokers commissions on a contingent basis. The derivative actions have been consolidated for pretrial proceedings as Rowe, et al. v. Fishman, et al. In the fifth of these actions, an alleged beneficiary of the Company’s 401(k) savings plan has commenced a putative class action in the District of Minnesota against the Company and certain of its current and former officers and directors captioned Spiziri v. The St. Paul Travelers Companies, Inc., et al. (Dec. 28, 2004). The plaintiff alleges violations of the Employee Retirement Income Security Act based on allegations similar to those alleged in In re St.Paul Travelers Securities Litigation.
The Company believes that these lawsuits have no merit and intends to defend vigorously; however, the Company is not able to provide any assurance that one or more of these proceedings will not be material to the Company’s results of operations in a future period. The Company is obligated to indemnify its officers and directors to the extent provided under Minnesota law. As part of that obligation, the Company will advance officers and directors attorneys’ fees and other expenses they incur in defending these lawsuits.
In previous filings, the Company reported on a series of purported class actions and one multi-party action brought in various courts around the United States against certain of TPC’s subsidiaries, dozens of other insurers and the National Council on Compensation Insurance. The allegations in the actions were substantially similar, and generally alleged that the defendants conspired to collect excessive or improper premiums on loss-sensitive workers’ compensation insurance policies in violation of state insurance laws, antitrust laws, and state unfair trade practices laws. The plaintiffs in the actions do not specify damages. TPC has vigorously defended the actions, with all but a few of the actions having been dismissed to date. In addition, the plaintiffs’ attempts to obtain class certification have not been successful. Under the present circumstances, the Company does not believe its remaining exposure to be significant.
From time to time the Company is involved in proceedings addressing disputes with its reinsurers regarding the collection of amounts due under the Company’s reinsurance agreements. These proceedings may be initiated by the Company or the reinsurers and may involve the terms of the reinsurance agreements, the coverage of particular claims, exclusions under the agreements, as well as counterclaims for rescission of the agreements. One of these disputes is the action described in the following paragraph.
Gulf, a wholly-owned subsidiary of TPC, brought an action on May 22, 2003, as amended on May 12, 2004, in the Supreme Court of New York, County of New York (Gulf Insurance Company v. Transatlantic Reinsurance Company, et al.), against Transatlantic Reinsurance Company (Transatlantic), XL Reinsurance America, Inc. (XL), Odyssey America Reinsurance Corporation (Odyssey), Employers Reinsurance Company (Employers) and Gerling Global Reinsurance Corporation of America (Gerling), to recover amounts due under reinsurance contracts issued to Gulf and related to Gulf’s February 2003 settlement of a coverage dispute under a vehicle residual value protection insurance policy. The reinsurers have asserted counterclaims seeking rescission of the vehicle residual value reinsurance contracts issued to Gulf and unspecified damages for breach of contract. Separate actions filed by Transatlantic and Gerling have been consolidated with the original Gulf action for pre-trial purposes. On October 1, 2003, Gulf entered into a final settlement agreement with Employers, and all claims and counterclaims with respect to Employers have been dismissed.
Venture Capital-The Company has long-term commitments to fund venture capital investments through its subsidiary, St. Paul Venture Capital VI, LLC, through new and existing partnerships and certain other venture capital entities. The Company’s total future estimated obligations related to its venture capital investments were $289 million at December 31, 2004. In the normal course of business, the Company has unfunded commitments to partnerships, joint ventures and certain private equity investments in which it invests. These additional commitments were $483 million and $652 million at December 31, 2004 and 2003, respectively.
In the ordinary course of selling business entities to third parties, the Company has agreed to indemnify purchasers for losses arising out of breaches of representations and warranties with respect to the business entities being sold, covenants and obligations of the Company and/or its subsidiaries following the close, and in certain cases obligations arising from undisclosed liabilities, adverse reserve development, premium deficiencies or certain named litigation. Such indemnification provisions generally survive for periods ranging from 12 months following the applicable closing date to the expiration of the relevant statutes of limitations, or in some cases agreed upon term limitations. As of December 31, 2004, the aggregate amount of the Company’s quantifiable indemnification obligations in effect for sales of business entities was $1.94 billion. Certain of these contingent obligations are subject to deductibles which have to be incurred by the obligee before the Company is obligated to make payments.
Prior to the Citigroup Distribution, TPC provided and purchased services to and from Citigroup affiliated companies, including facilities management, banking and financial functions, benefit coverages, data processing services, and short-term investment pool management services. Charges for these shared services were allocated at cost. In connection with the Citigroup Distribution, TPC and Citigroup and its affiliates entered into a transition services agreement for the provision of certain of these services, tradename and trademark and similar agreements related to the use of trademarks, logos and tradenames and an amendment to the March 26, 2002 Intercompany Agreement with Citigroup. During the first quarter of 2002, Citigroup provided investment advisory services on an allocated cost basis, consistent with prior years. On August 6, 2002, TPC entered into an investment management agreement, which was applied retroactively to April 1, 2002, with an affiliate of Citigroup whereby the affiliate of Citigroup provided investment advisory and administrative services to TPC with respect to its entire investment portfolio for a period of two years and at fees mutually agreed upon, including a component based on investment performance. This agreement was modified and extended through the first quarter of 2005. Charges incurred related to this agreement were $58 million for the year ended December 31, 2004, $60 million for the year ended December 31, 2003 and $47 million for the period from April 1, 2002 through December 31, 2002. TPC and Citigroup also agreed upon the allocation or transfer of certain other liabilities and assets, and rights and obligations in furtherance of the separation of operations and ownership as a result of the Citigroup Distribution. The net effect of these allocations and transfers, in the opinion of management, was not significant to the Company’s results of operations or financial condition.
Included in revenues in the consolidated statement of income (loss) for 2002 was $520 million from the Citigroup indemnification agreement.
The Company had notes payable to Citigroup of $700 million at December 31, 2002, which was repaid during 2003. Interest expense included in the consolidated statement of income was $9 million and $18 million in for the years ended December 31, 2003 and 2002, respectively.
At December 31, 2003, TPC had $15 million of securities pledged as collateral to Citigroup to support a letter of credit facility for certain of TPC’s surety customers.
The Company purchases annuities from former affiliates to settle certain claims. Through 2004, the Company had agreed to use TIC as the most preferred provider of annuities, as long as Citigroup maintains competitive ratings and its products are competitively priced. Reinsurance recoverables at December 31, 2004 and 2003 included $718 million and $761 million, respectively, related to these annuities.
Employee termination and relocation costs consist primarily of severance benefits for which payments will be substantially completed by the end of 2006. Costs to exit leases include remaining lease obligations on properties to be vacated by the Company and are expected to be fully paid by the end of 2007. Other exit costs include the remaining costs related to a redundant computer software contract which are expected to be fully paid by the end of 2005. Adjustments during 2004 primarily represent changes in the original estimate as a result of new information which became available to the Company.
There were no significant noncash financing or investing activities for the years ended December 31, 2004 and 2003 other than the acquisition of SPC (See note 2). In 2002, TPC paid dividends of $5.10 billion to Citigroup in the form of notes payable. These notes were all repaid during 2002.
21. CONSOLIDATING FINANCIAL STATEMENTS OF THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
The following consolidating financial statements of the Company and its subsidiaries have been prepared pursuant to Rule 3-10 of Regulation S-X. These consolidating financial statements have been prepared from the Company’s financial information on the same basis of accounting as the consolidated financial statements. The St. Paul Travelers Companies, Inc. has fully and unconditionally guaranteed certain debt obligations of TPC, its wholly-owned subsidiary, which totaled $2.64 billion as of December 31, 2004.
21. CONSOLIDATING FINANCIAL STATEMENTS OF THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES, Continued
(1) Due to the averaging of shares, quarterly earnings per share may not add to the total for the full year. Historical earnings per share data for 2003 and the first quarter of 2004 were restated to reflect the impact of the merger with SPC.