Certain statements in this document, as well as certain statements incorporated by reference herein, may be considered to be "forward looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995, such as statements that include the words or phrases "will likely result", "are expected to", "will continue", "is anticipated", "estimate", "project" or similar expressions. In particular, this report includes forward looking statements relating, but not limited to, the Corporation's recent sale activities, reinsurance programs, and future premium and investment income growth. Such statements are subject to certain risks and uncertainties. The factors which could cause actual results to differ materially from those suggested by any such statements include, but are not limited to, those discussed or identified from time to time in the Corporation's public filings with the Securities & Exchange Commission and specifically to: risks or uncertainties associated with the Corporation's announced sale activities relating to portions of its non-property and casualty business, or associated with its expectations of proceeds deployment, asset valuations, or premium and investment income growth projections, product initiatives, and new cash available for investment, and, more generally, to: general economic conditions including changes in interest rates and the performance of the financial markets, changes in domestic and foreign laws, regulations and taxes, changes in competition and pricing environments, regional or general changes in asset valuation, the occurrence of significant natural disasters, the inability to reinsure certain risks economically, the adequacy of loss reserves, as well as general market conditions, competition, pricing and restructurings.
Net income amounted to $513 million in 1996 compared with $697 million in 1995 and $528 million in 1994. Net income in 1996 reflects a fourth quarter charge of $160 million after taxes related to the write-down of the carrying value of certain real estate assets.
Operating income from continuing operations, which excludes realized investment gains and losses, was $434 million in 1996 compared with $584 million in 1995 and $473 million in 1994.
Property and casualty income in 1996 was similar to that in 1995, which was significantly higher than 1994 income. Property and casualty income after taxes was $561 million in 1996 compared with $563 million in 1995 and $467 million in 1994. Earnings in 1996 reflect lower underwriting income compared with 1995 due to substantially higher catastrophe losses, resulting primarily from the winter storms in the eastern part of the United States in the first quarter. Investment income increased in 1996 compared with the prior year. Earnings in 1995 benefited from highly profitable underwriting results and an increase in investment income compared with 1994. Earnings in 1994 were adversely affected by higher catastrophe losses, resulting from the earthquake in California and the winter storms in the eastern and midwestern parts of the United States.
Net premiums written amounted to $4.8 billion in 1996, an increase of 11% compared with 1995. Net premiums written increased 9% in 1995 compared with 1994. Personal coverages accounted for $1,039 million or 22% of 1996 premiums written, commercial coverages for $3,532 million or 74% and reinsurance assumed for $203 million or 4%. More than half of the 1996 premium growth was due to changes in certain reinsurance agreements, which are discussed below.
For many years, a portion of the U.S. insurance business written by the Corporation's property and casualty subsidiaries has been reinsured on a quota share basis with a subsidiary of the Sun Alliance Group plc. Similarly, a subsidiary of the Corporation has assumed a portion of Sun Alliance's property and casualty business on a quota share basis. Effective January 1, 1996, the agreements pertaining to the exchange of reinsurance were amended to reduce the portion of each company's business reinsured with the other. Consequently, during 1996, the Corporation's property and casualty subsidiaries retained a greater portion of the business they wrote directly and assumed less reinsurance from Sun Alliance. As a result of these changes in retention, net premiums written in 1996 increased by $64 million for the personal classes and $138 million for the commercial classes and decreased by $88 million for reinsurance assumed. There was an additional impact on net premiums written in the first quarter of 1996 due to the effect of the portfolio transfers of unearned premiums as of January 1, 1996 resulting from these changes. The effect of these portfolio transfers was an increase in net premiums written of $31 million for the personal classes and $61 million for the commercial classes and a decrease of $65 million for reinsurance assumed.
The loss ratio was 66.2% in 1996 compared with 64.7% in 1995 and 67.0% in 1994. The loss ratios continue to reflect the favorable experience resulting from the consistent application of our disciplined underwriting standards. Losses from catastrophes represented 3.1, 1.5 and 4.5 percentage points of the loss ratio in 1996, 1995, and 1994, respectively.
Our expense ratio was 32.1% in 1996 and 1995 and 32.5% in 1994. Expenses were reduced in 1994 by a contingent profit sharing accrual of $11 million related to a medical malpractice reinsurance agreement.
As a result of the 1996 merger of Sun Alliance with Royal Insurance Holdings plc, the unwinding of our reinsurance agreements with Sun Alliance was accelerated. Effective January 1, 1997, the agreements pertaining to the exchange of reinsurance on a quota share basis were terminated. As a result of the termination of these agreements, our net premiums written are expected to increase in 1997 by approximately $125 million for the personal classes and approximately $250 million for the commercial classes. Personal and commercial net premiums written will also include approximately $65 million and $110 million, respectively, in the first quarter of 1997 due to the effect of the portfolio transfer of unearned premiums as of January 1, 1997 resulting from the termination of the agreements. Net premiums written for reinsurance assumed, which were $203 million in 1996, are expected to be negligible in 1997 as the reduction in premiums related to the portfolio transfer of unearned premiums to Sun Alliance as of January 1, 1997 will be offset by the effect of the lag in our reporting of the business we assumed from Sun Alliance for the second half of 1996.
The impact on underwriting results in 1997 of the termination of the reinsurance agreements with Sun Alliance and the changes to our casualty reinsurance program is not expected to be significant. Management believes that the retention of a greater portion of the business underwritten by the property and casualty subsidiaries will have a positive impact on net income in the future.
Premiums from personal insurance increased 20% in 1996 compared with a 5% increase in 1995. More than half of the growth in 1996 was due to the changes in the reinsurance agreement with Sun Alliance which resulted in both the portfolio transfer of unearned premiums as of January 1, 1996 and an increase in our retention percentage for these classes.
Other personal coverages, which include insurance for personal valuables and excess liability, were highly profitable in each of the past three years. Personal excess liability results improved in 1995 and 1996 due to favorable loss experience. Our automobile business produced profitable results in each of the last three years. Results in 1996 and 1995 were particularly strong due to lower loss frequency and severity. Automobile results were adversely affected each year by losses from the mandated business that we are required by law to accept for those individuals who cannot obtain coverage in the voluntary market.
Premiums from commercial insurance increased 15% in 1996 compared with 9% in 1995. Approximately 40% of the 1996 growth in premiums was due to the changes in the reinsurance agreement with Sun Alliance which resulted in both the portfolio transfer of unearned premiums as of January 1, 1996 and an increase in our retention percentage for these classes. In addition, premium growth in 1996 for the excess liability component of our casualty coverages and for our executive protection coverages benefited from the changes in our casualty excess of loss reinsurance program. Excluding the effects of these changes in our reinsurance agreements, premium growth in 1996 and 1995 was due primarily to the selective writing of new accounts, exposure growth on existing business and the purchase of additional coverages by current customers. Premium growth was particularly strong outside the United States. The competitive market worldwide has continued to place significant pressure on prices and has made price increases difficult to achieve for most coverages. Our strategy of working closely with our customers and our ability to differentiate our products have enabled us to renew a large percentage of our business.
Our commercial insurance business produced near breakeven underwriting results in each of the past three years. The combined loss and expense ratio was 99.7% in 1996 compared with 99.3% in 1995 and 99.4% in 1994.
Results in our other commercial classes were slightly profitable in 1996 compared with unprofitable results in 1995 and 1994. The improvement was attributable to our surety business which had highly profitable results in 1996. Results for this class were unprofitable in 1995 due to several large losses.
Loss reserves are our property and casualty subsidiaries' largest liability. At the end of 1996, gross loss reserves totaled $9.5 billion compared with $9.6 billion and $8.9 billion at year-end 1995 and 1994, respectively. Reinsurance recoverable on such loss reserves was $1.8 billion at year-end 1996 compared with $2.0 billion at the end of 1995 and 1994. As a result of the changes in the reinsurance agreements with Sun Alliance, there were portfolio transfers of gross loss reserves and reinsurance recoverable as of January 1, 1996. The effect of these portfolio transfers was a decrease in gross loss reserves of $209 million and a decrease in reinsurance recoverable of $244 million.
During 1996, we experienced overall favorable development of $43 million on loss reserves established as of the previous year-end. This compares with favorable development of $36 million in 1995 and $30 million in 1994. Such redundancies were reflected in operating results in these respective years. Each of the past three years benefited from favorable claim severity trends for certain liability classes; this was offset each year in varying degrees by increases in loss reserves relating to asbestos and toxic waste claims.
The uncertainties relating to asbestos and toxic waste claims on insurance policies written many years ago are exacerbated by judicial and legislative interpretations of coverage that in some cases have tended to erode the clear and express intent of such policies and in others have expanded theories of liability. The industry is engaged in extensive litigation over these coverage and liability issues and is thus confronted with a continuing uncertainty in its efforts to quantify these exposures.
Pacific Indemnity, Continental Casualty and Fibreboard entered into a trilateral agreement to settle all present and future asbestos-related bodily injury claims resulting from insurance policies that were, or may have been, issued to Fibreboard by the two insurers. The trilateral agreement will be triggered if the global settlement agreement is disapproved by the United States Supreme Court. Pacific Indemnity's obligation under the trilateral agreement is therefore similar to, and not duplicative of, that under those agreements described above.
Court affirmed the 1995 judgments of the District Court. The affirmation of these agreements had no effect on the amount of loss reserves provided for the settlement. A petition for re-hearing the global settlement agreement before the entire Fifth Circuit Court was denied. An appeal to the United States Supreme Court by the objectors to the global settlement has been filed and the Supreme Court will decide whether to hear this matter. The trilateral agreement, however, was not appealed to the United States Supreme Court and is now final. As a result, management believes that the uncertainty of Pacific Indemnity's exposure with respect to asbestos-related bodily injury claims against Fibreboard has been eliminated.
Our other remaining asbestos exposures are mostly peripheral defendants, including a mix of manufacturers and distributors of certain products that contain asbestos as well as premises owners. Generally, these insureds are named defendants on a regional rather than a nationwide basis. We continue to receive notices of new asbestos claims and new exposures on existing claims as more peripheral parties are drawn into litigation to replace the now defunct mines and bankrupt manufacturers.
Management believes that the aggregate loss reserves of the property and casualty subsidiaries at December 31, 1996 were adequate to cover claims for losses which had occurred, including both those known to us and those yet to be reported. In establishing such reserves, management considers facts currently known and the present state of the law and coverage litigation. However, given the expansion of coverage and liability by the courts and the legislatures in the past and the possibilities of similar interpretations in the future, particularly as they relate to asbestos and toxic waste claims, as well as the uncertainty in determining what scientific standards will be deemed acceptable for measuring hazardous waste site clean-up, additional increases in loss reserves may emerge which would adversely affect results in future periods. The amount cannot reasonably be estimated at the present time.
Investment income after taxes increased 7% in both 1996 and 1995. Growth was primarily due to increases in invested assets, which reflected strong cash flow from operations over the period, offset somewhat in 1996 by lower yields on new investments.
New cash available for investment was approximately $1,215 million in 1996 compared with $495 million and $725 million in 1995 and 1994, respectively. New cash in 1996 included $191 million received in January as a result of the commutation of a stop loss reinsurance agreement related to medical malpractice unpaid claims arising from business written prior to 1985. The lower amount in 1995 was due to the designation of $480 million of new cash as funds held for asbestos-related settlement. Income on these assets accrued for the benefit of participants in the class settlement of asbestos-related bodily injury claims against Fibreboard.
In 1996, we invested new cash primarily in mortgage-backed securities and tax-exempt bonds. In 1995, we invested new cash primarily in tax-exempt bonds. In 1994, we invested new cash primarily in taxable bonds and, to a lesser extent, tax-exempt bonds. In each year, we tried to achieve the appropriate mix in our portfolio to balance both investment and tax strategies.
The property and casualty subsidiaries have consistently invested in high quality marketable securities. Taxable bonds in our domestic portfolio comprise U.S. Treasury, government agency and corporate issues. Approximately 90% of the taxable bonds are either backed by the U.S. Government or rated AA or better by Moody's or Standard & Poor's. Of the tax-exempt bonds, practically all are rated A or better, with more than half rated AAA. Both taxable and tax-exempt bonds have an average maturity of approximately 9 years. Actual maturities could differ from contractual maturities because borrowers may have the right to call or prepay obligations. Equity securities are high quality and readily marketable.
In October 1996, the Corporation announced that it was exploring the possible sale of all or a significant portion of its real estate assets. During February 1997, indications of interest in purchasing substantially all of our commercial properties were received from several parties. In March 1997, the Corporation announced that it had entered into an agreement with a prospective purchaser to perform due diligence in anticipation of executing a contract for the sale of these properties. In addition, we are continuing to explore the sale of our residential and retail properties.
Because the plan to pursue the sale of these assets in the near term represented a change in circumstances relating to the manner in which these assets are expected to be used, we reassessed the recoverability of their carrying value. As a result, we recorded an impairment loss of $255 million, or $160 million after tax, in the fourth quarter of 1996 to reduce the carrying value of these assets to their estimated fair value.
We plan to retain approximately $380 million of undeveloped land which we expect will be developed in the future. In addition, we plan to retain certain commercial properties and land parcels under lease.
Revenues were $320 million in 1996, $288 million in 1995 and $205 million in 1994. Revenues in 1996 and 1995 included higher levels of revenues from residential development. Revenues in 1996 also included the sale of rental properties while 1995 revenues included the land sale. Over the past several years, revenues from our commercial real estate activities have come primarily from ongoing income from owned properties and from management and financing activities related to previously sold properties or properties held in joint ventures.
Our commercial real estate activities traditionally centered around acquiring suburban, multi-site land parcels in locations considered prime for office development and then developing the land in progressive stages. In the late 1980s, we expanded our activities to include a few metropolitan office building projects. We developed real estate properties ourselves rather than through third party developers. We are distinguished from most other real estate developers in that we coordinated all phases of the development process from concept to completion. Upon completion of development, the properties were either owned and operated for our own account or sold to third parties. We directly manage virtually all of the properties which we either own or have sold and retained interests in through secured loans.
of the property in the future through an assumed holding period, based on our intended use of the property. The time value of money is not considered in assessing whether impairment has occurred. If it is determined that impairment has occurred, measurement of such impairment is based on the fair value of the assets. The $255 million write-down of real estate assets in 1996 was made in accordance with the provisions of SFAS No. 121. No similar write-down was recorded in 1995 or 1994.
In accordance with SFAS No. 107, Disclosures About Fair Value of Financial Instruments, the fair value of loans receivable is estimated individually as the value of the discounted cash flows of the loan, subject to the estimated fair value of the underlying collateral. The fair value of the loans represents a point-in-time estimate that is not relevant in predicting future earnings or cash flows related to such loans. At December 31, 1996, the aggregate fair value of the loans was $487 million and the carrying value was $502 million.
The write-downs related to the real estate assets we plan to dispose of in the near term are based on the estimated fair value of these assets, which reflects the amounts we expect to realize from the sales. The recoverability of the carrying value of the remaining real estate assets is assessed based on our ability to fully recover costs through a future revenue stream. The process by which SFAS No. 121 is applied and necessary write-downs are calculated assumes that these properties will be developed and disposed of over a period of time. The assumptions reflect a continued improvement in demand for office space, an increase in rental rates and the ability and intent to obtain financing in order to hold and develop the remaining properties and protect our interests over the long term. Management believes that the carrying values of both the assets to be disposed of and the remaining assets are recoverable. However, if the assumptions related to these assets are modified in the future, it is possible that additional losses may be recognized.
It is expected that funds received from any real estate asset sales will be used substantially to reduce debt currently supporting the real estate business. Cash from operations combined with the ability to utilize the Corporation's borrowing facilities would provide sufficient funds to repay any debt due in 1997 not otherwise repaid.
Net investment gains (losses) realized by the Corporation and its property and casualty insurance subsidiaries were as follows:
The unrealized appreciation or depreciation of investments carried at market value, which includes equity securities and fixed maturities classified as available-for-sale, is reflected in a separate component of shareholders' equity, net of applicable deferred income tax.
The unrealized market appreciation before tax of those fixed maturities of the Corporation and its property and casualty insurance companies carried at amortized cost was $130 million, $178 million and $28 million at December 31, 1996, 1995 and 1994, respectively. Such unrealized appreciation was not reflected in the consolidated financial statements.
The results of the life and health insurance operations for the three years ended December 31, 1996 were as follows:
Earnings from personal insurance were $42 million in 1996 compared with $37 million in 1995 and $33 million in 1994. The earnings increase in 1996 was primarily due to lower expense levels. Earnings in 1995 benefited from favorable mortality. Premiums and policy charges amounted to $338 million in 1996 compared with $311 million in 1995 and $272 million in 1994. New sales of personal insurance as measured by annualized premiums were $104 million in 1996 compared with $112 million in 1995 and $97 million in 1994.
In 1996, we reduced the portfolio of mortgage-backed securities by approximately $100 million. Proceeds from the sale of these securities and new cash were invested primarily in corporate bonds. In 1995, new cash was invested primarily in mortgage-backed securities and, to a lesser extent, corporate bonds and U.S. Treasury securities. In 1994, new cash was invested primarily in mortgage-backed securities.
The life and health subsidiaries held fixed maturity securities with a carrying value of $2.9 billion and $2.7 billion at December 31, 1996 and 1995, respectively. Corporate bonds comprised 48% and 39% of the portfolio at year-end 1996 and 1995, respectively, and mortgage-backed securities comprised 38% and 47% of the portfolio at year-end 1996 and 1995, respectively. Approximately 90% of the
On March 1, 1996, the Board of Directors approved an increase in the number of authorized shares of common stock of the Corporation from 300 million shares to 600 million shares. At the same time, the Board of Directors approved a two-for-one stock split payable to shareholders of record as of April 19, 1996.
In February 1994, the Board of Directors authorized the repurchase of up to 10,000,000 shares of common stock. During 1994, the Corporation repurchased approximately 2,000,000 shares in open-market transactions at a cost of $72 million. During 1996, the Corporation repurchased an additional 1,700,000 shares at a cost of $83 million. In March 1997, the Board of Directors replaced the 1994 program with a new share repurchase program, which authorizes the repurchase of up to 17,500,000 shares of common stock. It is expected that the Corporation will use a substantial portion of the proceeds from the sale of the life and health insurance operations to repurchase shares.
The Corporation has outstanding $90 million of unsecured 8 3/4% notes due in 1999. In 1997 and 1998, the Corporation will pay as a mandatory sinking fund an amount sufficient to redeem $30 million of principal.
The Corporation has a revolving credit agreement with a group of banks that provides for unsecured borrowings of up to $300 million. There have been no borrowings under this agreement. The agreement terminates on July 15, 1997 at which time any loans then outstanding become payable. Management anticipates that a similar credit agreement will replace this agreement. The Corporation had additional unused lines of credit of approximately $140 million at December 31, 1996.
Consolidated financial statements of the Corporation at December 31, 1996 and 1995 and for each of the three years in the period ended December 31, 1996 and the Report of Independent Auditors thereon and the Corporation's unaudited quarterly financial data for the two-year period ended December 31, 1996 are incorporated by reference from the Corporation's 1996 Annual Report to Shareholders, pages 42 through 66.