On September 1, 2001, the Company vacated the 50 Prospect Street complex in Hartford, Connecticut in order to undertake a complete renovation. The Prospect Street project, which involved 460,000 square feet, was completed by the end of 2003, approximately six months ahead of schedule. The Company had entered into the various lease arrangements in Hartford, Connecticut to temporarily house the displaced operations and which will also be used to provide additional space for merger related activities.
On October 1, 2001, the Company purchased The Northland Company and its subsidiaries (Northland) from Citigroup. On October 3, 2001, Citigroup contributed the capital stock of Associates Insurance Company (Associates) to the Company. During April 2000, TPC completed a cash tender offer and acquired all of Travelers Insurance Group Holdings Inc.’s (TIGHI) outstanding shares of common stock that were not already owned by TPC for approximately $2.413 billion financed by a loan from Citigroup. On May 31, 2000, the Company acquired the surety business of Reliance Group Holdings, Inc. (Reliance Surety). Includes amounts related to Northland, Associates, the remainder of TIGHI and Reliance Surety from their dates of acquisition.
In March 2002, the Company issued common stock through its Initial Public Offering (IPO). See note 1 to the Consolidated Financial Statements.
Continuing favorable, but moderating, rate environment in excess of loss trends
Higher non-asbestos prior year reserve charges primarily related to business lines placed in runoff
Total investments of $38.7 billion; fixed maturities and short-term securities comprise 91% of total investments which is consistent with the prior year
Net unrealized gains on fixed maturities and equities securities of $1.6 billion, up $0.5 billion from the prior year
Cash flow provided from operations of $3.8 billion, up from $2.9 billion in the prior year
Atlantic Mutual - purchased renewal rights to the majority of commercial lines inland marine and ocean cargo businesses written by its Marine Division
The net proceeds from the sale of these notes were used to prepay and refinance $500.0 million of 3.60% indebtedness to Citigroup and to redeem $900.0 million aggregate principal amount of 8.00% to 8.08% junior subordinated debt securities held by subsidiary trusts. These trusts, in turn, used these funds to redeem $900.0 million of preferred capital securities.
On November 16, 2003, the Company entered into an agreement and plan of merger (the merger) with The St. Paul Companies, Inc. The transaction will be treated as a purchase business combination by the Company of St. Paul under accounting principles generally accepted in the United States of America. In this merger, the acquired entity (St. Paul) will issue the equity interests and this business combination meets the criteria of a reverse acquisition. Each share of TPC class A and class B common stock will be exchanged for 0.4334 of a share of St. Paul common stock. The transaction is subject to customary closing conditions, including the approval by the shareholders of both companies as well as certain regulatory approvals. A special shareholder meeting to consider and to vote upon the merger has been scheduled for March 19, 2004. The transaction is expected to close in the second quarter of 2004.
On March 11, 2003, TPC issued $1.4 billion of senior notes comprising $400.0 million of 3.75% senior notes due March 15, 2008, $500.0 million of 5.00% senior notes due March 15, 2013 and $500.0 million of 6.375% senior notes due March 15, 2033. The notes pay interest semi-annually on March 15 and September 15 of each year, beginning September 15, 2003, are senior unsecured obligations and rank equally with all of TPC’s other senior unsecured indebtedness. TPC may redeem some or all of the notes prior to maturity by paying a “make-whole” premium based on U.S. Treasury rates. The net proceeds from the sale of these notes were contributed to TPC’s primary subsidiary, Travelers Insurance Group Holdings Inc. (TIGHI), so that TIGHI could prepay and refinance $500.0 million of 3.60% indebtedness to Citigroup and to redeem $900.0 million aggregate principal amount of TIGHI’s 8.00% to 8.08% junior subordinated debt securities held by subsidiary trusts. These trusts, in turn, used these funds to redeem $900.0 million of preferred capital securities on April 9, 2003.
TPC transferred substantially all of its assets to affiliates of Citigroup Inc. (together with its consolidated subsidiaries, Citigroup), other than the capital stock of TIGHI;
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, 2003 and 2002, Citigroup held for their 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 continues to hold following the Citigroup Distribution pro rata with the shares held by the public and to divest the remaining shares it holds within five years following the Citigroup Distribution.
In February 2002, the Company paid a dividend of $1.000 billion to Citigroup in the form of a non-interest bearing note payable on December 31, 2002. The Company repaid this note on December 31, 2002. Also in February 2002, the Company paid an additional dividend of $3.700 billion to Citigroup in the form of a note payable in two installments. This note was substantially prepaid following the offerings. The balance of $150.0 million was due on May 9, 2004. The remaining portion of this note was prepaid on May 8, 2002. In March 2002, the Company paid a dividend of $395.0 million to Citigroup in the form of a note. This note was prepaid following the offerings.
During March 2002, the Company entered into an agreement with Citigroup (the Citigroup indemnification agreement) which provided that in any year in which the Company recorded additional asbestos-related income statement charges in excess of $150.0 million, net of any reinsurance, Citigroup would pay to the Company the amount of any such excess up to a cumulative aggregate of $800.0 million, reduced by the tax effect of the highest applicable federal income tax rate. During 2002, the Company recorded $2.945 billion of asbestos incurred losses, net of reinsurance, and accordingly fully utilized in 2002 the total benefit available under the agreement. For the year ended December 31, 2002, revenues include $520.0 million from Citigroup under this agreement. Included in federal income taxes in the consolidated statement of income is a tax benefit of $280.0 million related to the asbestos charge covered by the agreement. For additional information see “ - Asbestos Claims and Litigation.”
Prior to the 2002 Citigroup Distribution, the Company 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, the Company 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 in 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, the Company entered into an investment management agreement, which has been applied retroactive to April 1, 2002, with an affiliate of Citigroup whereby the affiliate of Citigroup is providing investment advisory and administrative services to the Company with respect to its entire investment portfolio for a period of two years and at fees mutually agreed upon, including a component based on performance. Charges incurred related to this agreement were $59.7 million for 2003 and $47.2 million for the period from April 1, 2002 through December 31, 2002. This agreement terminates on March 31, 2004. The Company intends to arrange an orderly transition of the investment management and the associated accounting and administrative services to St. Paul Travelers following the merger with St. Paul. The Company 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, were not significant to the Company’s results of operations or financial condition.
During the third quarter of 2003, the Company purchased from Royal & SunAlliance USA (RSA), an unaffiliated insurer, the renewal rights to RSA’s commercial lines national accounts, middle market and marine businesses, and standard and preferred personal lines businesses. Also during the third quarter of 2003, the Company purchased from Atlantic Mutual, an unaffiliated insurer, the renewal rights to the majority of Atlantic Mutual’s commercial lines inland marine and ocean cargo businesses written by Atlantic Mutual’s Marine Division. The minimum purchase price for both transactions, which has been paid, was $48.0 million. The final purchase price, which is currently estimated to be $84.5 million, is dependent on the level of business renewed by the Company.
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 its previously announced 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, $49.7 million of convertible notes and .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 is 6.0%. The interest rate on the notes is 6.0% payable on an interest-only basis. The notes mature 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 $125.0 million, and a group of approximately 75 senior employees of Gulf invested $14.2 million. Fifty percent of the Gulf senior employees’ investment was financed by CIRI. This financing is collateralized by the CIRI securities purchased and is forgivable if Trident achieves certain investment returns. The applicable agreements provide for registration rights and transfer rights and restrictions and other matters customarily addressed in agreements with minority investors. Gulf’s results, net of minority interest, are included in the Commercial Lines segment.
On October 1, 2001, the Company paid $329.5 million to Citigroup for The Northland Company and its subsidiaries (Northland) and Associates Lloyds Insurance Company. In addition, on October 3, 2001, the capital stock of Associates Insurance Company (Associates), with a net book value of $356.5 million, was contributed to the Company by Citigroup. These companies are principally engaged in Commercial Lines specialty and transportation businesses and Personal Lines nonstandard automobile business.
The Company provides a wide range of commercial and personal property and casualty insurance products and services to businesses, government units, associations and individuals, primarily in the United States.
The Company’s discussions related to all items, other than net income (loss), are presented on a pretax basis, unless otherwise noted.
Revenues increased $869.5 million or 6% in 2003 and $2.039 billion or 17% in 2002.
Recoveries of $520.0 million in 2002, under the Citigroup indemnification agreement, have been included in revenues as Recoveries from former affiliate.
Total claims and expenses decreased $1.620 billion or 11% in 2003 and increased $3.688 billion or 34% in 2002.
Claims and claim adjustment expenses decreased $2.020 billion or 18% in 2003 primarily due to lower unfavorable prior year reserve development in 2003 partially offset by increased loss costs, growth in business volume and higher catastrophe losses. Catastrophe losses, net of reinsurance, were $352.4 million in 2003 compared to $84.1 million in 2002. Unfavorable prior year reserve development included in claims and claim adjustment expenses was $476.0 million for 2003 compared to $3.088 billion in 2002. Unfavorable prior year reserve development in 2002 included $2.945 billion of asbestos incurred losses (prior to the benefit related to recoveries under the Citigroup indemnification agreement), compared to no asbestos incurrals in 2003. Commercial Lines had a non-asbestos related prior year reserve development charge of $688.0 million in 2003 compared to a $172.7 million charge in 2002. The most significant component of the 2003 Commercial Lines prior year reserve development charge was $521.1 million related to reserve strengthening at Gulf. Personal Lines favorable prior year reserve development was $212.0 million in 2003 compared to $29.9 million in 2002. See “- Results of Operations by Segment” for additional discussion of prior year reserve development.
Amortization of deferred acquisition costs increased $173.5 million or 10% in 2003 and $271.5 million or 18% in 2002. These increases reflect higher commission and premium taxes associated with the increases in earned premiums previously described.
The deterioration in the 2002 GAAP combined ratio before policyholder dividends resulted from the impact of higher prior year reserve development that primarily resulted from the asbestos-related charges in 2002, partially offset by lower catastrophe losses in 2002 compared to 2001 (which included the impact of the September 11, 2001 terrorist attack), the elimination of goodwill amortization and rate increases that exceeded loss cost trends.
Earned premiums increased $921.6 million or 14% in 2003 primarily due to premium rate increases, growth in targeted new business and strong customer retention. Earned premiums included Northland and Associates which decreased $213.8 million or 25% in 2003 due to the withdrawal in 2002 of business at American Equity and Associates. Earned premiums increased $1.354 billion or 25% in 2002 primarily due to premium rate increases and the full-year inclusion of Northland and Associates in 2002. Earned premiums for Northland and Associates were $846.1 million in 2002, an increase of $642.9 million over 2001 which only included the fourth quarter of 2001.
Commercial Lines net written premiums increased $749.9 million or 10% in 2003. The strong but moderating rate environment, growth in targeted new business, and strong customer retention across all major lines of business combined to drive premium growth. This premium growth was partially offset by the decrease in net written premiums at Northland and Associates due to the withdrawal in 2002 of business at American Equity and Associates and a one-time additional $115.0 million of net written premium in 2002 related to the termination of certain reinsurance contracts. Net written premiums for Northland and Associates were $546.8 million in 2003 compared to $824.8 million in 2002. The Commercial Lines business of Northland and Associates is included with Commercial Accounts.
Commercial Lines net written premiums in 2002 increased $1.632 billion or 28%. The 2002 increase reflected premium rate increases and the full-year inclusion of Northland and Associates. The inclusion of Northland and Associates contributed $657.4 million to the increase. Net written premiums for Northland and Associates were $824.8 million in 2002 compared to $167.4 million in 2001 which only included the fourth quarter of 2001.
In addition to fee based products, National Accounts works with national and regional brokers to provide tailored insurance coverages and programs, mainly to large corporations, and participates in state mandated residual market workers’ compensation and automobile assigned risk plans. National Accounts net written premiums increased $168.2 million or 23% in 2003 and $315.7 million or 75% in 2002. These increases in net written premiums were due to the continued benefit from rate increases, higher new business levels that, in part, resulted from the Company’s third quarter 2003 renewal rights transaction with Royal & SunAlliance and higher business volume in residual market pools.
Select Accounts serves small businesses through a network of independent agents. Select Accounts net written premiums increased $178.1 million or 10% in 2003. The increase in Select Accounts net written premiums primarily reflected renewal price change increases averaging 14% for 2003 compared to 17% for 2002, increased new business and strong retention. New business premiums in Select Accounts for 2003 were $367.8 million compared to $305.3 million in 2002. New business growth was especially strong in property, general liability and commercial multi-peril lines of business. The business retention ratio for 2003, which remained strong at 83%, compared to 80% for 2002. Select’s retention remains strongest for small commercial business handled through the Company’s Service Centers, while premium growth has been greatest in the commercial multi-peril and property product lines. Select Account net written premiums increased $156.3 million or 9% in 2002. The increase in Select Accounts net written premiums primarily reflected renewal price changes averaging 17% for 2002 compared to 14% in 2001. New business premiums in Select Accounts for 2002 were $305.3 million compared to $275.8 million in 2001. The business retention ratio for 2002, which was 80%, was consistent with 2001.
Total claims and expenses decreased $1.860 billion or 19% in 2003 and increased $3.531 billion or 54% in 2002.
Claims and claim adjustment expenses decreased $2.148 billion or 27% in 2003 primarily due to lower unfavorable prior year reserve development, partially offset by increased loss costs, growth in business volume and higher weather related catastrophe losses. Catastrophe losses, net of reinsurance, were $103.8 million in 2003 compared to no catastrophe losses in 2002. The 2003 catastrophe losses were primarily due to a severe winter storm in Colorado in the first quarter, severe storms in the second quarter in a number of Southern and Midwestern states and Hurricane Isabel in the third quarter. Unfavorable prior year reserve development included in claims and claim adjustment expenses was $688.0 million in 2003 compared to $3.118 billion in 2002. The most significant component of 2003 prior year development was Gulf reserve strengthening of $521.1 million. Reserve strengthening at Gulf primarily related to a line of business that insured the residual values of leased vehicles and that was placed in runoff in late 2001 and the resolution of a residual value claim dispute. Reserves for certain other business lines at Gulf were also strengthened as was its allowance for uncollectible reinsurance recoverables. In addition to these Gulf charges, there was additional other Commercial Lines net unfavorable prior year reserve development of $166.9 million which included a $115.0 million charge associated with American Equity and a $59.8 million increase in environmental reserves. Unfavorable prior year reserve development in 2002 included $2.945 billion of asbestos-related charges (prior to the benefit related to recoveries under the Citigroup indemnification agreement), compared to no asbestos incurrals in 2003. For additional information see “ - Asbestos Claims and Litigation”.
Claims and claim adjustment expenses increased $3.220 billion or 68% in 2002 primarily due to higher prior year reserve development, the inclusion in 2002 of the full-year results of Northland and Associates and increased loss cost trends, partially offset by no catastrophe losses. Catastrophe losses, net of reinsurance, were $723.8 million in 2001 and were primarily due to the $644.0 million of losses attributed to the terrorist attack on September 11 as well as the Seattle earthquake and Tropical Storm Allison. Included in claims and claim adjustment expenses in 2002 was unfavorable prior year reserve development of $3.118 billion compared to 2001 favorable prior year reserve development of $28.4 million. As discussed above, the most significant component in 2002 prior year reserve development was asbestos-related charges which increased $2.756 billion over 2001. Separately, the Company strengthened its environmental reserves in the 2002 fourth quarter by $100.0 million and reduced its reserves for other general liability exposures $94.8 million. These actions were taken as a result of recent payment and settlement experience. In addition, in 2003 the Company strengthened prior year reserves for certain run-off lines of business, including assumed reinsurance, and experienced favorable development in certain on-going businesses.
Amortization of deferred acquisition costs increased $110.1 million or 10% in 2003 and $207.9 million or 24% in 2002. These increases reflect higher commission and premium taxes associated with the increases in earned premiums previously described.
General and administrative expenses increased $176.4 million or 17% in 2003 and $98.8 million or 11% in 2002. These increases are related to business growth and higher contingent commissions that resulted from improved underwriting results. In addition, 2002 comparison to 2001 reflects the elimination of goodwill amortization due to the adoption of FAS 142.
GAAP combined ratios before policyholder dividends for Commercial Lines were as follows:
The deterioration in the 2002 GAAP combined ratio before policyholder dividends reflected a deterioration in the loss and LAE ratio and an improvement in the underwriting expense ratio. The deterioration in the loss and LAE ratio was primarily due to the impact of higher prior year reserve development, primarily due to the asbestos-related charges discussed above, partially offset by no catastrophe losses in 2002 compared to the impact of the terrorist attack on September 11, 2001 and rate increases that exceeded loss cost trends. The improvement in the underwriting expense ratio was primarily attributed to the benefit of premium rate increases and the elimination of goodwill amortization.
The 2003 operating income increased $145.6 million or 42%. Operating income benefited from the favorable but moderating premium rate environment in both automobile and property, increased business volumes and a continued moderation in the increase in loss costs. Operating income in 2003 included catastrophe losses of $161.6 million compared to $54.7 million in 2002. Also impacting operating income was favorable prior year reserve development in 2003 of $137.8 million ($212.0 million pretax) compared to $19.4 million ($29.9 million pretax) in 2002. Favorable prior year reserve development in 2003 resulted from improvement in non-catastrophe-related claim frequency for both homeowners and non-bodily-injury automobile businesses and a $32.5 million ($50.0 million pretax) reduction in the reserves held related to the terrorist attack on September 11 also due to lower than expected claim frequency. Despite the benefit of higher average invested assets resulting from strong cash flows from operations, 2003 after tax net investment income of $262.7 million was $16.1 million lower than 2002 reflecting the lower interest rate environment, slightly lower returns in the Company’s private equity investments and the impact of shortening the fixed maturity portfolio duration.
Operating income in 2002 increased $105.9 million or 44%. The 2002 operating income reflected an improved premium rate environment in both auto and property and a moderation in the increase in loss costs. Operating income in 2001 reflected the $41.6 million impact of the terrorist attack on September 11, 2001. Weather-related catastrophe losses of $54.7 million in 2002 compared to $44.5 million in 2001. Favorable reserve development of $19.4 million ($29.9 million pretax) in 2002 primarily related to the moderation in loss cost trends in automobile. Despite the benefit of higher average invested assets resulting from strong cash flows from operations, 2002 after tax net investment income of $278.8 million was $15.4 million lower than 2001 reflecting reduced returns in the Company’s public equity investments and the lower interest rate environment. The elimination of goodwill amortization also contributed to the increase in 2002 operating income.
Net investment income decreased $23.6 million in 2003 and $25.5 million in 2002 despite higher average invested assets resulting from strong cash flows from operations. The decline resulted from a reduction in 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 and a higher proportion of tax-exempt investments. The 2002 decline resulted from a reduction in investment yields to 6.0% from 6.9% in 2001. The decrease in yields reflected reduced returns in the Company’s public equity investments and the lower interest rate environment.
Personal Lines net written premiums by product line were as follows:
voluntary business remained favorable and averaged 81%, up one percentage point from 2002. Retention for Personal Lines products represents the estimated percentage of policies from the prior year period renewed in the current period. Automobile net written premiums in 2002 increased $252.2 million or 10%. Excluding the impact of Northland, which contributed $97.5 million and $23.7 million to 2002 and 2001, respectively, Automobile net written premiums increased 7% to $2.745 billion. Renewal price changes for standard voluntary business averaged 8% for 2002, up one percentage point from 2001. Policies in force increased 2% in 2002. Policy retention levels for standard voluntary business in 2002 remained favorable and averaged 80%, up one percentage point from 2001.
Personal Lines had approximately 5.8 million, 5.5 million and 5.4 million policies in force at December 31, 2003, 2002 and 2001, respectively.
Total claims and expenses increased $226.3 million or 5% in 2003 and $219.2 million or 5% in 2002.
Claims and claim adjustment expenses increased $128.0 million or 4% in 2003 primarily due to increased loss costs, growth in business volume and higher catastrophe losses, partially offset by favorable prior year reserve development. Catastrophe losses were $248.6 million in 2003 compared to $84.1 million in 2002. Favorable prior year reserve development was $212.0 million in 2003 compared to $29.9 million in 2002. As discussed above, favorable prior year reserve development in 2003 primarily related to property business written in 2002 and to a lesser degree automobile business written in prior years and also included a $50.0 million reduction in the reserves held related to the terrorist attack on September 11, 2001.
Claims and claim adjustment expenses increased $153.4 million or 5% in 2002 primarily due to the inclusion in 2002 of the full-year results of Northland, increased loss cost trends and higher natural catastrophe losses partially offset by the $60.0 million impact of the terrorist attack on September 11, 2001. Natural catastrophe losses were $84.1 million in 2002 compared to $72.5 million in 2001. Favorable prior year reserve development was $29.9 million in 2002 compared to $31.0 million in 2001.
Interest Expense and Other in 2003 increased $9.3 million, after tax, primarily due to higher interest costs. After tax interest expense was $104.9 million in 2003 compared to $99.6 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 and higher levels of temporary debt. Temporary financing included $550.0 million first obtained in December 2002 in connection with the fourth quarter 2002 asbestos reserve strengthening and $1.400 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 $500.0 million note to Citigroup on March 11, 2003, and to redeem $900.0 million of trust preferred securities on April 9, 2003. For additional information see “Liquidity and Capital Resources.”
After tax interest expense of $99.6 million in 2002 decreased $33.6 million from $133.2 million in 2001 due to lower average interest-bearing debt levels primarily related to the repayment of debt obligations to Citigroup in the 2002 first quarter. Included in 2001 net expense was the after tax benefit of a $5.7 million dividend from an investment that was sold to Citigroup in 2002.
In some instances, policyholders continue to assert that their claims for asbestos-related insurance are not subject to aggregate limits on coverage and that each individual bodily injury claim should be treated as a separate occurrence under the policy. It is difficult to predict whether these policyholders will be successful on both issues or whether the Company will be successful in asserting additional defenses. To the extent both issues are resolved in policyholders’ favor and other additional Company defenses are not successful, the Company’s coverage obligations under the policies at issue would be materially increased and bounded only by the applicable per occurrence limits and the number of asbestos bodily injury claims against the policyholders. Accordingly, it is difficult to predict the ultimate size of the claims for coverage not subject to aggregate limits.
In addition, proceedings have been launched directly against insurers, including the Company, challenging insurers’ conduct in respect of asbestos claims, including in some cases with respect to previous settlements. The Company anticipates the filing of other direct actions against insurers, including the Company, in the future. Particularly in light of jurisdictional issues, it is difficult to predict the outcome of these proceedings, including whether the plaintiffs will be able to sustain these actions against insurers based on novel legal theories of liability. (Also see “-Legal Proceedings.”)
The Company also compares its historical direct and net loss and expense paid experience, year-by-year, to assess any emerging trends, fluctuations or characteristics suggested by the aggregate paid activity. As anticipated, losses paid have increased in 2003 compared to prior years. There has been acceleration in the amount of payments, including those from prior settlements of coverage disputes entered into between the Company and certain of its policyholders. Approximately 57% in 2003 and 54% in 2002 of total paid losses relate to policyholders with whom the Company previously entered into settlement agreements that limit the Company’s liability. Net asbestos losses paid were $451.8 million for 2003 compared to $361.1 million for 2002, reflective of the items previously described.
At December 31, 2003, asbestos reserves were $2.977 billion compared to $3.404 billion as of December 31, 2002. The decrease is reflective of the $451.8 million of payments made during the course of 2003, partly offset by accretion of discounts of $24.2 million on reserves for certain policyholders with structured agreements. Other than accretion of discounts, there were no additions to asbestos reserves in 2003 compared to an addition of $2.945 billion in 2002.
Assumed reinsurance exposure primarily consists of reinsurance of excess coverage, including various pool participations.
In addition to incurred but not reported, or 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, policyholders for which there is, or may be litigation and direct actions against the Company. During 2003, $117.0 million and $31.2 million of reserves were recategorized from unallocated IBNR to policyholders with settlement agreements and other policyholders subject to home office review, respectively, due to additional settlements and further development consistent with Company expectations for potential development. This follows the analysis conducted during the Company’s annual ground up review of asbestos policyholders that was completed during the fourth quarter of 2003.
Includes $800.0 million related to asbestos incurrals subject to the Citigroup indemnification agreement in 2002.
The Company’s reserving methodology is preferable to one based on “identified claims” because 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 settlement between the Company and the policyholder extinguishes any obligation the Company may have under any policy issued to the policyholder for past, present and future environmental liabilities and extinguishes 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 2003, there were 103 policyholders tendering an environmental remediation-type claim to the Company for the first time. This compares to 110 policyholders doing so in 2002 and 134 policyholders in 2001. The Company’s review of policyholders tendering claims for the first time has indicated that they are fewer in number and lower in severity. In addition, 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.
As of December 31, 2003, the number of policyholders with pending coverage litigation disputes pertaining to environmental claims was 189, approximately 8% less than the number pending as of December 31, 2002, and approximately 12% less than the number pending as of December 31, 2001. The Company has resolved, for approximately $2.025 billion (before reinsurance), the environmental liabilities presented by 5,904, or 92%, of the total 6,436 policyholders who have tendered environmental claims to the Company through December 31, 2003. The Company generally has been successful in resolving the Company’s coverage litigation disputes and continues to reduce the Company’s potential exposure through settlements with some policyholders. However, continued increases in settlement amounts have led the Company to add $59.8 million to its environmental reserves in the fourth quarter of 2003.
As a result of the processes and procedures described above, management believes that the reserves carried for asbestos and environmental claims at December 31, 2003 are appropriately established based upon known facts, current law and management’s judgment. However, the uncertainties surrounding the final resolution of these claims continue, and it is presently not possible to estimate the ultimate exposure for asbestos and environmental claims and related litigation. As a result, the reserve is subject to revision as new information becomes available. The continuing uncertainties include, without limitation, the risks and lack of predictability inherent in major litigation, any impact from the bankruptcy protection sought by various asbestos producers and other asbestos defendants, a further increase or decrease in asbestos and environmental claims which cannot now be anticipated, the role of any umbrella or excess policies the Company has issued, the resolution or adjudication of some disputes pertaining to the amount of available coverage for asbestos claims in a manner inconsistent with 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. 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. Also see “-Legal Proceedings.”
The Company’s invested assets at December 31, 2003 totaled $38.653 billion, including $348.8 million of securities in process of settlement, of which 91% was invested in fixed maturity and short-term investments, 2% in common stocks and other equity securities, 1% in mortgage loans and real estate held for sale and 6% in other investments. Excluding the impact of securities lending, unrealized investment gains and losses, receivables for investment sales and payables on investment purchases, the pretax average yield was 5.3%, 6.0% and 6.9% for the years ended December 31, 2003, 2002 and 2001, respectively, and the after tax average yield was 4.0%, 4.4% and 5.0% for the years ended December 31, 2003, 2002 and 2001, respectively.
At December 31, 2003, the Company held CMOs with a fair value of $3.932 billion. Approximately 46% of CMO holdings were fully collateralized by GNMA, FNMA or FHLMC securities at that date, and the balance was fully collateralized by portfolios of individual mortgage loans. In addition, the Company held $3.802 billion of GNMA, FNMA, FHLMC or FHA mortgage-backed pass-through securities at December 31, 2003. Virtually all of these securities are rated Aaa.
The 2003 year continued to see a significant increase in the number of downgrades by rating agencies for property casualty insurance companies. Many competitors are experiencing pressure on their capitalization levels due to underperforming investment portfolios and the need to strengthen prior year reserves, especially for asbestos liabilities. This pressure has caused many competitors to sell, discontinue or shrink certain books of business.
As required by various state laws and regulations, the Company’s insurance subsidiaries are subject to assessments from state-administered guaranty associations, second-injury funds and similar associations. In the opinion of the Company’s management, these assessments will not have a material impact on the Company’s results of operations.
Some social, economic, political and litigation issues have led to an increased number of legislative and regulatory proposals aimed at addressing the cost and availability of some types of insurance as well as the claim and coverage obligations of insurers. While most of these provisions have failed to become law, these initiatives may continue as legislators and regulators try to respond to public availability, affordability and claim concerns and the resulting laws, if any, could adversely affect the Company’s ability to write business with appropriate returns.
On November 26, 2002, the Terrorism Risk Insurance Act of 2002 (the Terrorism Act) was enacted into Federal law and established 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 committed by or on behalf of a foreign interest. In order for a loss to be covered under the Terrorism Act (i.e., 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 Insurance Program (the Program) generally requires that all commercial property/casualty insurers licensed in the U.S. participate in the Program. The Program became effective upon enactment and terminates on December 31, 2005. The amount of compensation paid to participating insurers under the Program is 90% of subject losses, after an insurer deductible, subject to an annual cap. The deductible under the Program was 7% for 2003, and is 10% for 2004 and 15% for 2005. 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 Program also contains an annual cap that limits the amount of subject losses to $100 billion aggregate during a program year. 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 deductible under this Federal program is $927.7 million for 2004. Due to the high level of the deductible, in the opinion of the Company’s management, the bill will have little impact on the price or availability of terrorism coverage in the marketplace. The Company had no terrorism-related losses in 2003.
In National Accounts, where programs include risk management services, such as claims settlement, loss control and risk management information services, generally offered in connection with a large deductible or self-insured program, and risk transfer, typically provided through a retrospectively rated or guaranteed cost insurance policy, new business levels increased in 2003 due to a significant renewal rights transaction and to a reduction in the number of competitors in the marketplace. Customer retention has remained consistent with prior periods. The Company has benefited from higher rates and believes that pricing will continue to stay firm into 2004. However, the Company will still continue to selectively reject business that is not expected to produce acceptable returns. The Company anticipates that the premium and fee income growth experienced in 2003 will continue into 2004. Included in National Accounts is service fee income for policy and claim administration of various states’ Workers’ Compensation Residual Market pools. After several years of depopulation, these pools began to repopulate in 2000 and grow significantly. Premium that the Company services for these pools grew 24% in 2003 and is expected to modestly grow in 2004.
Commercial Accounts achieved price increases on renewal business of 10%, 22% and 19% during 2003, 2002 and 2001, respectively, improving the overall profit margin in this business, more than offsetting the impacts of rising loss cost, reinsurance costs and lower investment yields. The 2003 price increases began moderating compared to the 2002 price increases. New business levels also increased during 2003 across most products where Commercial Accounts benefited from the Company’s underwriting specialization, financial strength and limits capacity. In 2004, the Company will continue to seek increased new business levels on products producing acceptable returns, higher retention rates on its existing business and overall rate increases, although the rate of increase may vary by line of business and, on an overall basis, may moderate compared to 2003.
In Gulf, rate increases began in most lines of business in 2001 and accelerated significantly in 2002. Rate increases continued in 2003, but at a slower pace than in 2002. Although specific increases varied by region, industry and product, improvement was consistent across all product lines, with increases averaging well above loss cost trends. During 2003, Gulf significantly strengthened its reserve position, due to adverse development from prior accident years in both residual value and core specialty lines.
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.”
During 2003, the personal auto market continued to increase rates in an effort to obtain profitability targets. These increases, along with maintaining underwriting discipline and focusing on risk segmentation has made significant progress towards rate adequacy. Personal Lines automobile rates are expected to increase in 2004, moderating slightly from 2003 levels.
Prior to the 2002 Citigroup Distribution, the Company 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, the Company 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, the Company entered into an investment management agreement, which has been applied retroactively to April 1, 2002, with an affiliate of Citigroup whereby the affiliate of Citigroup is providing investment advisory and administrative services to the Company with respect to its entire investment portfolio for a period of two years and at fees mutually agreed upon, including a component based on performance. Charges incurred related to this agreement were $59.7 million for 2003 and $47.2 million for the period from April 1, 2002 through December 31, 2002. This agreement terminates on March 31, 2004. The Company intends to arrange an orderly transition of the investment management and the associated accounting and administrative services to St. Paul Travelers following the merger with St. Paul. The Company 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.
Liquidity is a measure of a company’s ability to generate sufficient cash flows to meet the short and long-term cash requirements of its business operations. The liquidity requirements of the Company’s business have been met primarily by funds generated from operations, asset maturities and income received on investments. Cash provided from these sources is used primarily for claims and claim adjustment expense payments and operating expenses. Catastrophe claims, the timing and amount of which are inherently unpredictable, may create increased liquidity requirements. The timing and amount of reinsurance recoveries may be affected by reinsurer solvency and increasingly by reinsurance coverage disputes. Additionally, recent increases in asbestos-related claim payments, as well as potential judgments and settlements arising out of litigation, may also result in increased liquidity requirements. In the opinion of the Company’s management, the Company’s future liquidity needs will be met from all of the above sources.
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.
Debt securities for which fair value is less than 80% of amortized cost for more than one quarter are evaluated for other-than-temporary impairment. A debt security is impaired if it is probable that the Company will not be able to collect all amounts due under the security’s contractual terms.
The length of time and the extent to which fair value has been below cost. It is likely that the decline will become “other than temporary” if the market value has been below cost for six to nine months or more;
The financial condition and near-term prospects of the issuer. The issuer may be experiencing depressed and declining earnings relative to competitors, erosion of market share, deteriorating financial position, lowered dividend payments, declines in securities ratings, bankruptcy, and financial statement reports that indicate an uncertain future. Also, the issuer may experience specific events that may influence its operations or earnings potential, such as changes in technology, discontinuation of a business segment, catastrophic losses or exhaustion of natural resources.
Equity investments are impaired when it becomes probable that the Company will not recover its cost over the expected holding period. Public equity investments (i.e., common stocks) trading at a price that is less than 80% of cost for more than one quarter are reviewed for impairment. Investments accounted for using the equity method of accounting are evaluated for impairment any time the investment has sustained losses and/or negative operating cash flow for a period of 9 months or more. Events triggering the other-than-temporary impairment analysis of public and non-public equities may include the following, in addition to the considerations noted above for debt securities:
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;
Factors that raise doubts about the investee’s ability to continue as a going concern, such as negative cash flows from operations, working-capital deficiencies, investment advisors’ recommendations, or non-compliance with regulatory capital requirements or debt covenants;
The securities owned continue to generate reasonable earnings and dividends, despite a general stock market decline;
The investment is performing as expected and is current on all expected payments;
The specific circumstances that led to the impairments described above did not materially impact other individual investments held during 2003. The Company continues to evaluate current developments in the market that have the potential to affect the valuation of the Company’s investments.
The Company believes that the prices of the securities identified above were temporarily depressed primarily as a result of market dislocation and generally poor cyclical economic conditions. Further, unrealized losses as of December 31, 2003 represent less than 1% of the portfolio, and, therefore, any impact on the Company’s financial position would not be significant.
At December 31, 2003, non-investment grade securities comprised 6% of the Company’s fixed income investment portfolio. Included in those categories at December 31, 2003 were securities in an unrealized loss position that, in the aggregate, had an amortized cost of $251.3 million and a fair value of $232.1 million, resulting in a net pretax unrealized loss of $19.2 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, 2003, and accounted for 13% of the total pretax unrealized loss in the fixed income portfolio.
Following are the pretax realized losses on investments sold during the year ended December 31, 2003:
At December 31, 2003, total cash and short-term invested assets aggregating $212.3 million were held at TPC and TIGHI. 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 to TPC, primarily additional dividends from the Company’s operating subsidiaries, are considered sufficient to meet the liquidity requirements of TPC and TIGHI. These liquidity requirements include primarily, shareholder dividends and debt service. In addition, 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 $250.0 million 45-month revolving line of credit (the 45-Month Line of Credit), and (ii) a $250.0 million 364-day revolving line of credit (the 364-Day Line of Credit and, together with the 45-Month Line of Credit, the 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. Borrowings under the Lines of Credit may be made, at TPC’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. Each Line of Credit includes a commitment fee and, for any date on which advances exceed 50% of the total commitment, a utilization fee. The applicable margin and the rates on which the commitment fee and the utilization fee are based vary based upon TPC’s long-term senior unsecured non-credit-enhanced debt ratings. Each Line of Credit requires TPC to comply with various covenants, including the maintenance of minimum statutory capital and surplus of $5.5 billion and a maximum ratio of total consolidated debt to total capital of 45%. At December 31, 2003, the Company was in compliance with these financial covenants. In addition, an event of default will occur if there is a change in control (as defined in the Lines of Credit agreements) of TPC. The proposed merger with St. Paul would constitute such a change in control of TPC; however the Company has obtained a waiver from Citibank of the event of default that otherwise would have occurred in connection with the proposed merger with St. Paul.
Net cash flows used in financing activities totaled $1.099 billion, $800.1 million and $1.083 billion in 2003, 2002 and 2001, respectively. Cash flows used in financing activities in 2003 were primarily attributable to the redemption of $900.0 million aggregate principal amount of TIGHI’s junior subordinated debt securities held by subsidiary trusts, the repayment of $700.0 million of notes payable to a former affiliate and the repayment of $550.0 million of short-term debt. Funds used in these repayments were primarily provided by TPC’s issuance of $1.400 billion of senior notes on March 11, 2003 and by cash flows provided by operating activities. These refinancing activities were initiated with the objective of lowering the average interest rate on the Company’s total outstanding debt. Also reflected in 2003 was the issuance of $550.0 million of short-term Floating Rate Notes which were used to repay the $550.0 million Promissory Note due in January 2004. Net cash flows used in financing activities in 2003 also included dividends paid to shareholders of $281.8 million. The 2002 cash flows used in financing activities reflects the repayment of $6.349 billion of notes payable to a former affiliate. These payments were partially offset by the receipt of $4.090 billion from the first quarter 2002 initial public offering and the issuance of $917.3 million of convertible notes payable. The 2001 cash flows used in financing activities reflects the repayment of $1.040 billion of notes payable to a former affiliate and the payment of $526.0 million of dividends.
In February 2002, TPC paid a dividend of $1.000 billion to Citigroup in the form of a non-interest bearing note payable on December 31, 2002. On December 31, 2002, this note was repaid in its entirety. Also in February 2002, TPC paid an additional dividend of $3.700 billion to Citigroup in the form of a note payable in two installments. This note was substantially prepaid following the offerings. The balance of $150.0 million was due on May 9, 2004. This note was prepaid on May 8, 2002. In March 2002, TPC paid a dividend of $395.0 million to Citigroup in the form of a note. This note was prepaid following the offerings.
In August 2002, CIRI issued $49.7 million aggregate principal amount of 6.0% convertible notes which will mature on December 31, 2032 unless earlier redeemed or repurchased. See note 8 of notes to the Company’s consolidated financial statements for a further discussion.
In December 2002, TPC entered into a loan agreement with an unaffiliated lender and borrowed $550.0 million under a promissory note due in January 2004. The Promissory Note carried a variable interest rate of LIBOR plus 25 basis points per annum. On February 5, 2003, TPC issued $550.0 million of Floating Rate Notes due in February 2004. The proceeds from these notes were used to repay the $550.0 million due on the Promissory Note. The Floating Rate Notes also carried a variable interest rate of LIBOR plus 25 basis points per annum. On March 14, 2003 and June 17, 2003, the Company repurchased $75.0 million and $24.0 million, respectively, of the Floating Rate Notes at par plus accrued interest. The remaining $451.0 million were repaid on September 5, 2003.
The following table excludes contractual obligations for claim and claim adjustment expense reserves and short-term obligations. The contractual obligations, which include only liabilities at December 31, 2003 with a cash payment requirement for settlement, are as follows:
Includes agreements with vendors to purchase system software administration and maintenance services.
Represents estimated timing for fulfilling unfunded commitments for investments in real estate partnerships, private equities and hedge funds.
The Company’s principal insurance subsidiaries are domiciled in the State of Connecticut. The insurance holding company law of Connecticut 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 ended the preceding December 31, in each case determined in accordance with statutory accounting practices. This declaration or payment is further limited by adjusted unassigned surplus, as determined in accordance with statutory accounting practices. The insurance holding company laws of other states in which the Company’s subsidiaries are domiciled generally contain similar, although in some instances somewhat more restrictive, limitations on the payment of dividends. A maximum of $1.647 billion is available by the end of 2004 for such dividends without prior approval of the Connecticut Insurance Department.
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, 2003, all of the Company’s insurance subsidiaries had adjusted capital in excess of amounts requiring any company or regulatory action.
Total claims and claim adjustment expense reserves were $34.573 billion at December 31, 2003. The Company maintains property and casualty loss reserves to cover estimated ultimate unpaid liability for losses and loss adjustment expenses with respect to reported and unreported claims incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability, but instead represent estimates, generally utilizing actuarial projection techniques at a given accounting date. These reserve estimates are expectations of what the ultimate settlement and administration of claims will cost based on the Company’s assessment of facts and circumstances then known, review of historical settlement patterns, estimates of trends in claims severity, frequency, legal theories of liability and other factors. Variables in the reserve estimation process can be affected by both internal and external events, such as changes in claims handling procedures, economic inflation, legal trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant reporting lags between the occurrence of the policyholder event and the time it is actually reported to the insurer. Reserve estimates are continually refined in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. Adjustments to reserves are reflected in the results of the periods in which the estimates are changed. Because establishment of reserves is an inherently uncertain process involving estimates, currently established reserves may not be sufficient. If estimated reserves are insufficient, the Company will incur additional income statement charges.
Some of the Company’s loss reserves are for asbestos and environmental claims and related litigation which aggregated $3.267 billion at December 31, 2003. While the ongoing study of asbestos claims and associated liabilities and of environmental claims considers the inconsistencies of court decisions as to coverage, plaintiffs’ expanded theories of liability, and the risks inherent in major litigation and other uncertainties, in the opinion of the Company’s management, it is possible that the outcome of the continued uncertainties regarding asbestos-related claims could result in liability in future periods that differ from current reserves by an amount that could be material to the Company’s future operating results and financial condition. See the preceding discussion of Asbestos Claims and Litigation and Environmental Claims and Litigation.
Total reinsurance recoverables were $11.174 billion at December 31, 2003 and included $2.018 billion from servicing carrier arrangements with various involuntary assigned risk pools and $2.411 billion of structured settlement annuities. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business.
Claims and claim adjustment expense reserves by product line were as follows:
Asbestos and environmental reserves are included in the General liability and Commercial multi-peril 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”.
Claims and claim adjustment expense reserves represent management’s estimate of the unpaid liability for claim and claim adjustment expenses. 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. The process of analyzing reserves for a component is undertaken on a regular basis, generally quarterly, in light of continually updated information.
Multiple estimation methods are available for the analysis of ultimate claim liabilities Each estimation method has its own set of assumption variables, and its own advantages and disadvantages, with no single estimation method being better than the others in all situations and no one set of assumption variables being meaningful for all product line components. The relative strengths and weaknesses of the particular estimation methods when applied to a particular group of claims can also change over time (and potentially for each reporting date). Therefore, the actual choice of estimation method(s) can change with each evaluation. The estimation method(s) chosen are those that are believed to produce the most reliable indication at that particular evaluation date for the claim liabilities being evaluated.
Sudden changes generally cause a one-time shift in claim liability estimates, although there may be some lag in reliable quantification of their impact. Evolutionary changes generally cause a series of shifts in claim liability estimate, as each component of the evolutionary change becomes evident and estimable.
General liability reserves are generally analyzed as two components: primary and excess/umbrella, with the primary component generally analyzed separately for bodily injury and property damage. Bodily injury liability payments reimburse the claimant for damages pertaining to physical injury as a result of the policyholder’s legal obligation arising from non-intentional acts such as negligence, subject to the insurance policy provisions. In some cases the damages can include future wage loss (which is a function of future earnings power and wage inflation) and future medical treatment costs. Property damage liability payments result from damages to the claimant’s private property arising from the policyholder’s legal obligation for non-intentional acts. In most cases, property damage losses are a function of costs as of the loss date, or soon thereafter. In addition, sizable unique exposures are reviewed separately, such as asbestos, environmental, other mass torts, construction defect, and large unique accounts that would otherwise distort the analysis. These unique categories often require reserve analyses that do not rely on traditional actuarial methods.
Commercial multi-peril provides a combination of property and liability coverage typically for small businesses and, therefore, includes both short and long tail coverages. For property coverage, it generally takes a relatively short period of time to close claims, while for the other coverages, generally for the liability coverages, it takes a longer period of time to close claims.
The commercial automobile product line is a mix of property and liability coverages and, therefore, includes both short and long tail coverages. The payments that are made quickly typically pertain to auto physical damage (property) claims and property damage (liability) claims. The payments that take longer to finalize and are more difficult to estimate relate to bodily injury claims. This mixture of claim payments creates a moderate estimation risk.
Workers’ compensation is 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.
1 These are administrative bodies that evaluate whether or not a given claim for workers’ compensation benefits is valid. Duties include the determination of whether a given injury arose out of the scope of employment, or the determination of the degree of injury where disputes exist.
Changes in the cost of medical treatments and underlying fee schedules (“inflation”)
Fidelity is 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 low severity, high frequency nature of small commercial fidelity losses provides for stability in loss estimates whereas, the high severity, low frequency 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 high severity, low frequency policies.
Homeowners is considered a short tail coverage. Most payments are related to the property portion of the policy, where the claim reporting and settlement process is generally restricted to the insured and the insurer. Claims on property coverage are typically reported soon after the actual damage occurs, although delays of several months are not unusual. The claim is settled when the two parties agree on the amount due in accordance with the policy contract language and the appropriate payment is made (or alternatively, the property replacement/repair is performed by the insurer). The resulting settlement process is typically fairly short term, although exceptions do exist.
The liability portion of the homeowners policy generates claims which take longer to pay due to the involvement of litigation and negotiation. In addition, reserves related to umbrella coverages have greater uncertainty since umbrella liability payments are often made far into the future.
Some of the other factors that could cause actual results to differ include, but are not limited to, the following: the Company’s inability to obtain price increases due to competition or otherwise; the performance of the Company’s investment portfolios, which could be adversely impacted by adverse developments in U.S. and global financial markets, interest rates and rates of inflation; weakening U.S. and global economic conditions; insufficiency of, or changes in, loss reserves; 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; the impact of 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 home repair costs; developments relating to coverage and liability for mold claims; the effects of corporate bankruptcies 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 Company; adverse outcomes in legal proceedings; judicial expansion of policy coverage and the impact of new theories of liability; the impact of legislative actions, including federal and state legislation related to asbestos liability reform; 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 Lines policies; and amendments and changes to the risk-based capital requirements. The Company’s forward-looking statements speak only as of the date of this report or as of the date they are made, and the Company undertakes no obligation to update these forward-looking statements.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Travelers Property Casualty Corp. and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for goodwill and other intangible assets in 2002 and its methods of accounting for derivative instruments and hedging activities and for securitized financial assets in 2001.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) 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.
The adoption of FIN 46R did not have any impact on the Company’s consolidated financial condition or results of operations as no consolidation was required. However, the Company holds interests in hedge fund investments that are considered significant under FIN 46R, and the hedge funds are accounted for under the equity method of accounting and are included in other invested assets in the consolidated balance sheet.
To seek capital appreciation by investing and trading in securities, including without limitation investments in common stock, bonds, notes, debentures, investment contracts, partnership interests, options, warrants.
To exploit arbitrage opportunities in a broad range of equity and fixed income markets.
In December 2003, the FASB issued a revised Statement of Financial Accounting Standards No. 132, “Employers’ Disclosures about Pensions and Other Postretirement Benefits” (Revised FAS 132). The Revised FAS 132 does not change the measurement or recognition provisions required by FASB Statements No. 87, “Employers’ Accounting for Pensions,” No. 88, “Employers’ Accounting for Settlements and Curtailments of Defined Benefits Pension Plans and Termination of Benefits,” and No. 106, “Employers’ Accounting for Postretirement Benefits Other Than Pensions.” This statement retains the disclosure requirements of the original FAS 132 issued in February 1998 and requires additional disclosures about the assets, obligations, cash flows and net periodic benefit cost of defined benefit pension plans and other defined benefit postretirement plans. The Revised FAS 132 is effective for fiscal years ending after December 15, 2003, except for disclosures of estimated future benefit payments, which are effective for fiscal years ending after June 15, 2004. Interim period disclosures are effective for interim periods beginning after December 15, 2003. Effective December 31, 2003, the Company adopted the Revised FAS 132.
Effective December 31, 2003, the Company adopted FASB Emerging Issues Task Force (EITF) Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (EITF 03-01). EITF 03-01 requires that certain quantitative and qualitative disclosures be made for debt and marketable equity securities classified as available for sale or held to maturity that are impaired at the balance sheet date but for which an other-than-temporary impairment has not been recognized.
Effective January 1, 2003, the Company adopted the fair value method of accounting for its employee stock-based compensation plans as defined in FAS 123. FAS 123 indicates that the fair value based method is the preferred method of accounting. The Company has elected to use the prospective recognition transition alternative of FAS 148. Under this alternative only the awards granted, modified, or settled after January 1, 2003 will be accounted for in accordance with the fair value method. The adoption of FAS 123 did not have a significant impact on the Company’s results of operations, financial condition or liquidity.
Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity
A financial instrument, other than an outstanding share, that, at inception, embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation, and that requires or may require the issuer to settle the obligation by transferring assets (for example, a forward purchase contract or written put option on the issuer’s equity shares that is to be physically settled or net cash settled);
A financial instrument that embodies an unconditional obligation, or a financial instrument other than an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a variable number of its equity shares,
if, at inception, the monetary value of the obligation is based solely or predominantly on any of the following: (a) a fixed monetary amount known at inception, (b) variations in something other than the fair value of the issuer’s equity shares, or (c) variations inversely related to changes in the fair value of the issuer’s equity shares.
The adoption of FAS 150 did not impact the Company’s consolidated financial statements.
The Company stopped amortizing goodwill on January 1, 2002. Net income and earnings per share adjusted to exclude goodwill amortization expense for the year ended December 31, 2001 is as follows:
Effective January 1, 2001, the Company adopted FASB Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (FAS 133). FAS 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives), and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the consolidated balance sheet and measure those instruments at fair value. If certain conditions are met, a derivative may be specifically designated as (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment, (b) a hedge of the exposure to variable cash flows of a recognized asset or liability or a forecasted transaction, or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available for sale security, or a foreign-currency-denominated forecasted transaction. The accounting for changes in the fair value of a derivative (that is, gains and losses) depends on the intended use of the derivative and the resulting designation.
In April 2003, the FASB issued Statement of Financial Standards No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (FAS 149), which amends and clarifies the accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under FAS 133. FAS 149 amends FAS 133 for decisions made as part of the Derivatives Implementation Group process that effectively required amendments to FAS 133. FAS 149 also clarifies under what circumstances a contract with an initial net investment and purchases and sales of when-issued securities that do not yet exist meet the characteristics of a derivative. In addition, it clarifies when a derivative contains a financing component that warrants special reporting in the statement of cash flows. FAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. The adoption of FAS 149 did not have a significant impact on the Company’s results of operations, financial condition or liquidity.
Effective April 1, 2001, the Company adopted EITF Issue 99-20, “Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets” (EITF 99-20). EITF 99-20 provides new guidance on the recognition and measurement of interest income and impairment on certain investments, e.g., certain asset-backed securities. The recognition of impairment resulting from the adoption of EITF 99-20 is to be recorded as a cumulative effect adjustment as of the beginning of the fiscal quarter in which it is adopted. Interest income on beneficial interests falling within the scope of EITF 99-20 is to be recognized prospectively. As a result of adopting EITF 99-20, the Company recorded a charge of $1.3 million after tax, reflected as a cumulative effect adjustment. The implementation of this EITF did not have a significant impact on results of operations, financial condition or liquidity.
Mortgage loans are carried at amortized cost. A mortgage loan is considered impaired when it is probable that the Company will be unable to collect principal and interest amounts due. For mortgage loans that are determined to be impaired, a reserve is established for the difference between the amortized cost and fair market value of the underlying collateral. In estimating fair value, the Company uses interest rates reflecting the current real estate financing market returns. Impaired loans were not significant at December 31, 2003 and 2002.
Net realized investment gains and losses are included as a component of pretax revenues based upon specific identification of the investments sold on the trade date. A decline in the value of a security below its amortized cost basis is assessed to determine if the decline is other-than-temporary. If so, the security is deemed to be impaired, and a charge is recorded in net realized investment gains and losses.
The carrying amount of intangible assets that are not deemed to have an indefinite useful life is regularly reviewed for indicators of impairments in value in accordance with FAS 144. Impairment is recognized only if the carrying amount of the intangible asset is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the fair value of the asset.
In determining claims and claim adjustment expense reserves, the Company carries on a continuing review of its overall position, its reserving techniques and its reinsurance. The reserves are also reviewed periodically by a qualified actuary employed by the Company. These reserves represent the estimated ultimate cost of all incurred claims and claim adjustment expenses. Since the reserves are based on estimates, the ultimate liability may be more or less than such reserves. The effects of changes in such estimated reserves are included in the results of operations in the period in which the estimates are changed. Such changes may be material to the results of operations and financial condition and could occur in a future period.
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. The Company either receives cash or marketable securities as collateral equal to at least the market value of the loaned securities plus accrued interest. Collateral is marked to market daily. In those cases where cash collateral is received, the Company reinvests the collateral in a short-term investment pool, the loaned securities remain a recorded asset of the Company and a liability is recorded to recognize the Company’s obligation to return the collateral at the end of the loan. Where marketable securities have been received as collateral, the collateral is held by a third party custodian (tri-party lending agreement), 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. In those cases where marketable securities are received as collateral, 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.
Included in other liabilities in the consolidated balance sheet is the Company’s estimate of its liability for guaranty fund and other insurance-related assessments. The liability for expected state guaranty fund and other premium-based assessments is recognized as the Company writes or becomes obligated to write or renew the premiums on which the assessments are expected to be based. The liability for loss-based assessments is recognized as the related losses are incurred. At December 31, 2003 and 2002, the Company had a liability of $180.3 million and $171.1 million, respectively, for guaranty fund and other assessments and related recoveries of $15.1 million and $14.3 million, respectively. The liability for such assessments and their related recoveries are not discounted for the time value of money. The assessments are expected to be paid over a period ranging from one year to the life expectancy of certain workers’ compensation claimants and the recoveries are expected to occur over the same period of time.
The provision for federal income taxes comprises two components, current income taxes and deferred income taxes. Deferred federal income taxes arise from changes during the year in cumulative temporary differences between the tax basis and book basis of assets and liabilities.
The Company has an employee stock incentive compensation plan that includes stock option programs and restricted stock programs.
For stock-based employee awards granted, modified, or settled after December 31, 2002, the Company applies the FAS 123 fair value method of accounting. Under this method, compensation cost is measured at the grant date based on the fair value of the award and recognized ratably over the vesting period. For restricted stock the fair value is measured at the market price of a share on the grant date while for stock options the fair value is derived by the application of an option pricing model at date of grant.
For stock-based employee awards granted prior to January 1, 2003, the Company accounts for these awards under the recognition and measurement principles of Accounting Principles Board Opinion No. 25 (APB 25), “Accounting for Stock Issued to Employees”, and related interpretations. The Company continues to apply the APB 25 accounting guidance for these awards as the Company elected to use the prospective recognition transition alternative of FAS 148. Under this method, compensation cost is measured at grant date based upon the market value of the underlying stock at the date of grant less any amount that the employee is required to pay and recognized ratably over the vesting period. For employee restricted stock awards, the awards are granted at the market value of the underlying stock on grant date and accordingly the market value of these awards is recognized as compensation expense ratably over the vesting period. For employee stock option awards, the awards are granted at an exercise price equal to the market value of the underlying common stock on the date of the grant and accordingly there has been no employee compensation expense recognized in earnings for the stock option awards granted prior to adoption of the FAS 123 fair value method of accounting on January 1, 2003.
Additionally, in conjunction with the Citigroup Distribution in August 2002, the Company issued replacement awards for Citigroup awards. These replacement awards were issued at the intrinsic value of each Citigroup option and the ratio of exercise price per share to the market value per share was not reduced. Accordingly there was no compensation cost recognized in earnings for these replacement awards.
The 2003 and 2002 effect of applying the fair value based method to all outstanding and unvested stock-based employee awards in the Company’s class A common shares is as follows:
Represents compensation expense on all restricted stock awards and on stock option awards granted after January 1, 2003.
The 2001 effect of applying the fair value based method to all outstanding and unvested stock-based employee awards in Citigroup’s common stock is as follows:
The Company uses 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.
Commercial Lines offers a broad array of property and casualty insurance and insurance-related services. Protection is afforded to customers of Commercial Lines for the risks of property loss such as fire and windstorm, financial loss such as business interruption from property damage, liability claims arising from operations and workers’ compensation benefits through insurance products where risk is transferred from the customer to Commercial Lines. Coverages include workers’ compensation, general liability, commercial multi-peril, commercial automobile, property, fidelity and surety, professional liability, and several miscellaneous coverages.
Gulf markets products to national, mid-sized and small customers, and distributes them through both wholesale brokers and retail agents. Gulf provides a broad range of specialty coverages, including management and professional liability, excess and surplus lines, environmental, umbrella and fidelity. Gulf also provides insurance products specifically designed for financial institutions, the entertainment industry and sports organizations.
On November 16, 2003, the Company entered into an agreement (the merger agreement) and plan of merger (the merger) with The St. Paul Companies, Inc. (St. Paul). The transaction will be treated as a purchase business combination by the Company of St. Paul under GAAP. In this merger, the acquired entity (St. Paul) will issue the equity interests, and this business combination meets the criteria of a reverse acquisition. Each share of TPC class A and class B common stock will be exchanged for 0.4334 of a share of St. Paul common stock. The transaction is subject to customary closing conditions, including the approval by the shareholders of both companies as well as certain regulatory approvals. A special shareholder meeting to consider and to vote upon the merger has been scheduled for March 19, 2004. The transaction is expected to close in the second quarter of 2004.
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 its previously announced 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, $49.7 million of convertible notes and .4 million common shares for a purchase price of $8.83 per share, representing a 24% ownership interest, on a fully diluted basis. The dividend rate on the preferred stock is 6.0%. The interest rate on the notes is 6.0% payable on an interest-only basis. The notes mature 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 $125.0 million, and a group of approximately 75 senior employees of Gulf invested $14.2 million. Fifty percent of the Gulf senior employees’ investment was financed by CIRI. This financing is collateralized by the CIRI securities purchased and is forgivable if Trident achieves certain investment returns. The applicable agreements provide for registration rights and transfer rights and restrictions and other matters customarily addressed in agreements with minority investors. Gulf’s results, net of minority interest, are included in the Commercial Lines segment.
On October 1, 2001, the Company paid $329.5 million to Citigroup for The Northland Company and its subsidiaries and Associates Lloyds Insurance Company. These entities had a combined net book value of $572.1 million. The excess of this net book value over the purchase price was reflected as a contribution to the Company. In addition, on October 3, 2001, the capital stock of Associates Insurance Company, with a net book value of $356.5 million, was contributed to the Company. These acquisitions were accounted for as transfers of net assets between entities under common control. The prior period financial statements were not restated due to immateriality.
The primary component of Interest Expense and Other is after-tax interest expense of $104.9 million, $99.6 million and $133.2 million in 2003, 2002 and 2001, respectively.
The Company makes investments in collateralized mortgage obligations (CMOs). CMOs typically have high credit quality, offer good liquidity, and provide a significant advantage in yield and total return compared to U.S. Treasury securities. The Company’s investment strategy is to purchase CMO tranches which offer the most favorable return given the risks involved. One significant risk evaluated is prepayment sensitivity. This drives the investment process to generally favor prepayment protected CMO tranches including planned amortization classes and last cash flow tranches. The Company does invest in other types of CMO tranches if a careful assessment indicates a favorable risk/return tradeoff. The Company does not purchase residual interests in CMOs.
At December 31, 2003 and 2002, $561.6 million and $580.5 million, respectively, of securities were on loan for which cash collateral was received. There were not any securities on loan under tri-party lending agreements at December 31, 2003 and 2002. At December 31, 2003, $134.8 million of securities were subject to dollar-roll repurchase agreements. There were not any securities subject to such agreements at December 31, 2002.
Proceeds from sales of fixed maturities classified as available for sale were $8.343 billion, $12.519 billion and $14.469 billion in 2003, 2002 and 2001, respectively. Gross gains of $281.7 million, $570.9 million and $599.3 million and gross losses of $147.2 million, $148.4 million and $158.6 million, respectively, were realized on those sales.
At December 31, 2003 and 2002, TPC’s insurance subsidiaries had $2.373 billion and $2.052 billion, respectively, of securities on deposit at financial institutions in certain states pursuant to the respective states’ insurance regulatory authorities.
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-back securities), EITF 99-20 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. A debt security is impaired if it is probable that the Company will not be able to collect all amounts due under the security’s contractual terms. Equity investments are impaired when it becomes apparent that the Company will not recover its cost over the expected holding period. Further, for securities expected to be sold, an other-than-temporary impairment charge is recognized if the Company does not expect the fair value of a security to recover the cost prior to the expected date of sale.
The Company’s process for reviewing invested assets for impairments during any quarter includes the following:
Discussion 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;
Determination of the status of each analyzed investment as other-than-temporary or not, with documentation of the rationale for the decision.
Aggregate annual maturities on mortgage loans are $28.8 million, $7.7 million, $14.4 million, $38.6 million, $19.8 million and $101.5 million for 2004, 2005, 2006, 2007, 2008 and 2009 and thereafter, respectively. There are no mortgage loans that are past due.
At December 31, 2003 and 2002, the Company had concentrations of credit risk in tax-exempt investments of the State of Texas of $1.540 billion and $1.386 billion, respectively, and of the State of New York of $1.350 billion and $1.269 billion, respectively.
The Company had customer-related intangible assets with a gross carrying amount of $555.1 million and $470.6 million as of December 31, 2003 and 2002, respectively, and with accumulated amortization of $133.1 million and $90.8 million as of December 31, 2003 and 2002, respectively, which are included in other assets in the consolidated balance sheet. Amortization expense was $42.2 million, $35.4 million and $34.5 million for the years ended December 31, 2003, 2002 and 2001, respectively. Intangible assets amortization expense is estimated to be $50.6 million, $48.1 million, $47.0 million, $47.0 million and $41.6 million in 2004, 2005, 2006, 2007 and 2008, respectively.
The allowance for estimated uncollectible reinsurance recoverables was $386.4 million and $329.1 million at December 31, 2003 and 2002, respectively.
The increase in the claims and claim adjustment expense reserves in 2003 from 2002 was primarily due to net prior year reserve strengthening, principally in Commercial Lines, and growth in business volume in both Commercial Lines and Personal Lines. Partially offsetting the above were net payments of $607.0 million in 2003 for asbestos and environmental claims.
The claims and claim adjustment expense reserves included $3.267 billion and $3.790 billion for asbestos and environmental-related claims, net of reinsurance, at December 31, 2003 and 2002, respectively.
At December 31, 2003, asbestos reserves, net of reinsurance, were $2.977 billion, a decrease of $427.6 million compared to $3.404 billion as of December 31, 2002. The decrease is reflective of the $451.8 million of payments made during the course of 2003, partly offset by accretion of discounts of $24.2 million on reserves for certain policyholders with structured agreements. Other than accretion of discounts, there were no additions to asbestos reserves in 2003 compared to an addition of $2.945 billion in 2002.
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 $250.0 million 45-month revolving line of credit (the 45-Month Line of Credit), and (ii) a $250.0 million 364-day revolving line of credit (the 364-Day Line of Credit and, together with the 45-Month Line of Credit, the 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. Borrowings under the Lines of Credit may be made, at TPC’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. Each Line of Credit includes a commitment fee and, for any date on which advances exceed 50% of the total commitment, a utilization fee. The applicable margin and the rates on which the commitment fee and the utilization fee are based vary based upon TPC’s long-term senior unsecured non-credit-enhanced debt ratings. Each Line of Credit requires TPC to comply with various covenants, including the maintenance of minimum statutory capital and surplus of $5.5 billion and compliance with a ratio of total consolidated debt to total capital of 45%. At December 31, 2003, the Company was in compliance with these financial covenants. In addition, an event of default will occur if there is a change in control (as defined in the Lines of Credit agreements) of TPC. The proposed merger with St. Paul would constitute such a change of control of TPC; however the Company has obtained a waiver from Citibank of the event of default that otherwise would have occurred in connection with the proposed merger with St. Paul. There were no amounts outstanding under the Lines of Credit at December 31, 2003.
During May 2002, TPC fully and unconditionally guaranteed the payment of all principal, premiums, if any, and interest on certain debt obligations of its wholly-owned subsidiary TIGHI. TPC is deemed to have no independent assets or operations except for its wholly-owned subsidiary TIGHI. Consolidated financial statements of TIGHI have not been presented herein or in any separate reports filed with the Securities and Exchange Commission because management has determined that such financial statements would not be material to holders of TIGHI debt. The guarantees pertain to the $150.0 million 6.75% Notes due 2006 and the $200.0 million 7.75% Notes due 2026 included in long-term debt, and the $900.0 million of TIGHI-obligated mandatorily redeemable securities of subsidiary trusts holding solely junior subordinated debt securities of TIGHI (TIGHI Securities).
CIRI also issued $85.9 million of mandatorily convertible preferred stock during August 2002. The declaration and payment of dividends to holders of CIRI’s convertible preferred stock will be at the discretion of the CIRI Board of Directors and if declared, paid on a cumulative basis for each share of convertible preferred stock at an annual rate of 6% of the stated value per share of the convertible preferred stock. Dividends of $5.1 million and $2.2 million were declared and paid during 2003 and 2002, respectively.
In December 2002, the Company entered into a loan agreement with an unaffiliated lender and borrowed $550.0 million under a Promissory Note due in January 2004. The Promissory Note carried a variable interest rate of LIBOR plus 25 basis points per annum. On February 5, 2003, the Company issued $550.0 million of Floating Rate Notes due in February 2004, which was included in short-term debt in the condensed consolidated balance sheet. The proceeds from these notes were used to prepay the $550.0 million due on the Promissory Note. The Floating Rate Notes also carry a variable interest rate of LIBOR plus 25 basis points per annum. On March 14, 2003 and June 17, 2003, the Company repurchased $75.0 million and $24.0 million, respectively, of the Floating Rate Notes at par plus accrued interest. The remaining $451.0 million were repaid on September 5, 2003.
These senior notes were sold to qualified institutional buyers as defined under Rule 144A under the Securities Act of 1933 (the Securities Act) and outside the United States in reliance on Regulation S under the Securities Act. Accordingly, the notes (the restricted notes) were not registered under the Securities Act or any state securities laws and could not be transferred or resold except pursuant to certain exemptions. As part of this offering, TPC agreed to file a registration statement under the Securities Act to permit the exchange of the notes for registered notes (the Exchange Notes) having terms identical to those of the senior notes described above (Exchange Offer). On April 14, 2003, TPC initiated the Exchange Offer pursuant to a Form S-4 that was filed with the Securities and Exchange Commission. Accordingly, each series of Exchange Notes has been registered under the Securities Act, and the transfer restrictions and registration rights relating to the restricted notes do not apply to the Exchange Notes. As of May 13, 2003 (the Expiration Date of the Exchange Offer), 99.8%, 99.4% and 100% of TPC’s 5, 10, and 30-year restricted notes, respectively, were exchanged for Exchange Notes.
Additional tax benefits attributable to employee stock plans allocated directly to shareholders’ equity were $6.3 million, $2.6 million and $.3 million for the years ended December 31, 2003, 2002 and 2001, respectively.
The current federal income tax payable was $226.4 million and $179.5 million at December 31, 2003 and 2002, respectively and is included in other liabilities in the consolidated balance sheet.
For the period ending March 27, 2002, the Company is included in the consolidated federal income tax return filed by Citigroup. Citigroup allocates 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 is paid currently to Citigroup. Any credits for losses will be paid by Citigroup currently to the extent that such credits are for tax benefits that have been utilized in the consolidated federal income tax return.
In the opinion of the Company’s management, realization of the recognized deferred federal income taxes of $677.9 million is more likely than not based on expectations as to the Company’s future taxable income. The Company has reported income (loss) before federal income taxes, minority interest and cumulative effect of changes in accounting principles of $1.120 billion on average over the last three years and has generated federal taxable income exceeding $448.1 million on average in each year during the same period.
TIGHI formed statutory business trusts under the laws of the state of Delaware, which exist for the exclusive purposes of (i) issuing Trust Securities representing undivided beneficial interests in the assets of the Trust; (ii) investing the gross proceeds of the Trust Securities in Junior Subordinated Deferrable Interest Debentures (Junior Subordinated Debentures) of its parent; and (iii) engaging in only those activities necessary or incidental thereto. These Junior Subordinated Debentures and the related income effects are eliminated in the consolidated financial statements. On April 9, 2003, TIGHI redeemed the TIGHI debentures held by the subsidiary trusts. The subsidiary trusts, in turn, used these funds to redeem the TIGHI securities. The financial structure of each of Travelers P&C Capital I and Travelers P&C Capital II (the subsidiary trusts) at December 31, 2002 was as follows:
The obligations of TIGHI with respect to the TIGHI Debentures, when considered together with certain undertakings of TIGHI with respect to the subsidiary trusts, constitute full and unconditional guarantees by TIGHI of the subsidiary trusts’ obligations under the respective TIGHI Securities. The TIGHI Securities are classified in the consolidated balance sheet as “TIGHI-obligated mandatory redeemable securities of subsidiary trusts holding solely junior subordinated debt securities of TIGHI” at their liquidation value of $900.0 million. Distributions on the TIGHI Securities have been classified as interest expense in the consolidated statement of income.
TPC’s common stock consists of class A and class B common stock. On all matters submitted to vote of the TPC shareholders, holders of class A and class B common stock are entitled to one and seven votes per share, respectively.
Under the Company’s shareholder rights plan, each outstanding share of the Company’s class A and class B common stock carries with it the right to acquire one-thousandth of a share of the Series A Preferred Stock. These Rights trade with the Company’s common stock and will expire on March 20, 2012, unless the Rights are earlier redeemed. Such Rights are not presently exercisable and have no voting rights. At December 31, 2003 and 2002, there were no shares of preferred stock, including the Series A Preferred Stock, issued or outstanding.
Prior to the execution of the merger agreement, the Company amended its shareholder rights plan to permit execution of the merger agreement and the consummation of the transactions contemplated by the merger agreement, including the merger, without triggering the separation or exercise of the shareholder rights. In addition, pursuant to the amendment, the Rights will cease to be exercisable upon consummation of the merger. The Company’s Board of Directors adopted that amendment, and the amendment became effective, on November 16, 2003.
During September 2002, the Board of Directors approved a $500.0 million share repurchase program. Purchases of class A and class B common stock may be made from time to time in the open market, and it is expected that funding for the program will principally come from operating cash flow. During 2003, TPC repurchased approximately 2.6 million shares of class A common stock at a total cost of $40.0 million, representing the first acquisition of shares under this program.
Shares acquired under these plans are reported as treasury stock in the consolidated balance sheet.
Statutory net income (loss) of TIGHI’s insurance subsidiaries was $1.952 billion, ($973.6) million and $1.090 billion for the years ended December 31, 2003, 2002 and 2001, respectively. Statutory capital and surplus of TIGHI’s insurance subsidiaries was $8.444 billion and $7.287 billion at December 31, 2003 and 2002, respectively.
Includes foreign currency translation adjustments, changes in value of private equity securities and the cumulative effect of the change in accounting for derivative instruments and hedging activities.
The Company’s Board of Directors, in connection with the IPO, adopted the Travelers Property Casualty Corp. 2002 Stock Incentive Plan (the 2002 Incentive Plan). The 2002 Incentive Plan permits grants of stock options, restricted stock, deferred stock and other stock-based awards. The purposes of the 2002 Incentive Plan are to attract and retain employees by providing compensation opportunities that are competitive with other companies, provide incentives to those employees who contribute significantly to the Company’s long-term performance and growth, and align employees’ long-term financial interests with those of the Company’s shareholders. The maximum number of shares of class A common stock that may be issued pursuant to awards granted under the 2002 Incentive Plan is 120.0 million shares.
The Company’s Board of Directors, in connection with the IPO, also adopted the Travelers Property Casualty Corp. Compensation Plan for Non-Employee Directors (the Directors Plan). Under the Directors Plan, the directors receive their annual fees in the form of Company common stock. Each director may choose to receive a portion of their fees in cash to pay taxes. Directors may also defer receipt of shares of class A common stock to a future distribution date or upon termination of their service. The shares of class A common stock issued under the Directors Plan come from the 2002 Incentive Plan.
On August 20, 2002, in connection with the Citigroup Distribution, Citigroup stock option awards held by Company employees on that date under Citigroup’s various stock option plans were cancelled and replaced with stock option awards (replacement awards) to purchase the Company’s class A common stock under the Company’s own incentive plan. These replacement awards were granted on substantially the same terms, including vesting, as the former Citigroup awards. The total number of the Company’s class A common stock subject to the replacement awards was 56.9 million shares of which 24.6 million shares were then exercisable. The number of shares of the Company’s class A common stock to which the replacement awards relate 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 the Company’s class A common stock; and
Information with respect to stock option activity under the Company’s stock option plans for the years ended December 31, 2003 and 2002 is as follows:
The following table summarizes the information about stock options outstanding under the Company’s stock option plans at December 31, 2003 and 2002:
On August 20, 2002, in connection with the Citigroup Distribution, the unvested outstanding awards of restricted stock and deferred shares held by Company employees on that date under Citigroup CAP awards, were cancelled and replaced by awards comprised primarily of 3.1 million newly issued shares of class A common stock at a total market value of $53.3 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.
The after-tax compensation cost charged to earnings for these restricted stock and deferred stock awards was $17.1 million, $17.0 million and $19.4 million for the years ended December 31, 2003, 2002 and 2001, respectively.
Awards issued prior to 2002 were granted in Citigroup stock options. The estimated fair value effect of stock options for 2001 were derived by applying the following significant assumptions underlying the Citigroup stock option plan.
Prior to the Citigroup Distribution, the Company participated in non-contributory defined benefit pension plans and a postretirement health care and life insurance benefit plan sponsored by Citigroup. The Company’s share of net expense (credit) related to these plans was $(3.9) million for January 1, 2002 through August 20, 2002 and $11.7 million for 2001.
August 20, 2002 is the beginning of the year for 2002 as TPC-sponsored plans began on that date.
For pension plans with an accumulated benefit obligation in excess of plan assets, the aggregate projected benefit obligation and the aggregate accumulated benefit obligation were each $27.6 million at December 31, 2003 and were $521.0 million and $476.0 million, respectively, at December 31, 2002.
The Company does not have a best estimate of contributions expected to be paid to the qualified pension plan during the next fiscal year at this time. However, the maximum tax deductible contribution to the qualified pension plan for 2004 is currently estimated to be $40.0 million, which may be contributed on or before September 15, 2005.
In choosing the expected long-term rate of return, the Company’s Pension Plan Investment Committee considered the historical returns of the S&P 500 Index and the Lehman Aggregate Index in conjunction with today’s economic and financial market conditions.
As an indicator of sensitivity, increasing the assumed health care cost trend rate by 1% would have increased the accumulated postretirement benefit obligation by $.8 million at December 31, 2003 and 2002 and the aggregate of the service and interest cost components of net postretirement benefit expense by less than $.1 million for 2003 and 2002. Decreasing the assumed health care cost trend rate by 1% would have decreased the accumulated postretirement benefit obligation at December 31, 2003 and 2002 by $.8 million and $.7 million, respectively, and the aggregate of the service and interest cost components of net postretirement benefit expense by less than $.1 million for 2003 and 2002.
The following table summarizes the components of net benefit expense recognized in the consolidated statement of income for TPC’s plans for the period August 20, 2002 through December 31, 2002 and for the year ended December 31, 2003.
The Company’s Pension Plan Investment Committee has established a target investment asset allocation of 60% invested in an S&P 500 index fund and 40% in a Lehman Brothers Aggregate Bond Index fund. In establishing this investment asset allocation for the plan, the Pension Plan Investment Committee took into account, among other factors, the information provided to it by the plan’s actuary, information relating to the historical investment returns of the S&P 500 and Lehman Brothers Aggregate Bond Index, asset diversification and market conditions at the time each contribution to the plan was to be invested. The Pension Plan Investment Committee periodically reviewed the plan’s investment performance and asset allocation during 2003, and has adhered to that allocation.
Prior to the Citigroup Distribution, most leasing functions for TPC and its subsidiaries were administered by the Company. Rent expense related to these leases was shared by a former affiliate and the Company on a cost allocation method based generally on estimated usage by department. In conjunction with the Citigroup Distribution, the Company purchased certain properties from Citigroup. Rent expense was $115.3 million, $123.3 million and $121.0 million in 2003, 2002 and 2001, respectively.
To qualify as a hedge, the hedge relationship is designated and formally documented at inception detailing the particular risk management objective and strategy for the hedge, which includes the item and risk that is being hedged, the derivative that is being used, as well as how effectiveness is being assessed. A derivative has to be highly effective in accomplishing the objective of offsetting either changes in fair value or cash flows for the risk being hedged.
For fair value hedges, changes in the fair value of derivatives are reflected in net realized investment gains (losses), together with changes in the fair value of the related hedged item. The Company did not utilize fair value hedges during the years ended December 31, 2003 and 2002.
For cash flow hedges, the accounting treatment depends on the effectiveness of the hedge. To the extent these derivatives are effective in offsetting the variability of the hedged cash flows, changes in the derivatives’ fair value will not be included in current earnings but are reported in accumulated other changes in equity from nonowner sources. These changes in fair value will be included in the earnings of future periods when earnings are also affected by the variability of the hedged cash flows. At December 31, 2003, the amount that the Company expects to include in net realized investment gains (losses) over the next twelve months for these cash flow hedges is not significant. To the extent these derivatives are not effective, changes in their fair value are immediately included in net realized investment gains (losses). The Company’s cash flow hedges primarily include hedges of floating rate available-for-sale securities and certain forecasted transactions up to a maximum tenure of one year. While the earnings impact of cash flow hedges is similar to the previous accounting practice, the amounts included in the accumulated other changes in equity from nonowner sources will vary depending on market conditions.
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, 2003 and 2002, the amount included in the foreign currency translation adjustment in equity from nonowner sources was a $17.0 million loss and an $8.5 million loss, respectively. The ineffective portion is reflected in net realized investment gains (losses).
The effectiveness of these hedging relationships is evaluated on a retrospective and prospective basis using quantitative measures of correlation. If a hedge relationship is found to be ineffective, it no longer qualifies as a hedge, and any excess gains or losses attributable to such ineffectiveness as well as subsequent changes in fair value are recognized in net realized investment gains (losses). During the years ended December 31, 2003 and 2002, the Company realized gains of zero and $3.8 million, respectively, from hedge ineffectiveness.
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. Derivatives embedded in convertible debt securities are reported on a combined basis with their host instrument and are classified as fixed maturity securities.
At December 31, 2003 and 2002, investments in fixed maturities had a fair value, which equaled carrying value, of $33.046 billion and $30.003 billion, respectively. The fair value of investments in fixed maturities for which a quoted market price or dealer quote are not available was $685.4 million and $892.5 million at December 31, 2003 and 2002, respectively. See note 1.
In the ordinary course of its insurance business, the Company receives claims for insurance arising under policies issued by the Company asserting alleged injuries and damages from asbestos and other hazardous waste and toxic substances which are the subject of related coverage litigation, including, among others, the litigation described below. The Company continues to be subject to aggressive asbestos-related litigation. The conditions surrounding the final resolution of these claims and the related litigation continue to change.
The Company is involved in a bankruptcy and other proceedings relating to ACandS, Inc. (ACandS), formerly a national installer of products containing asbestos. The proceedings involve disputes as to whether and to what extent any of ACandS’ potential liabilities for bodily injury asbestos claims were covered by insurance policies issued by the Company. There were a number of developments in the proceedings since the beginning of 2003 including two decisions which were favorable to the Company. These developments and the status of the various proceedings are described below.
ACandS filed for bankruptcy in September 2002 (In re: ACandS, Inc., pending in the U.S. Bankruptcy Court for the District of Delaware). On January 26, 2004 the bankruptcy court issued a decision rejecting confirmation of ACandS’ proposed plan of reorganization. The bankruptcy court found, consistent with the Company’s objections to ACandS’ proposed plan, that the proposed plan was not fundamentally fair, was not proposed in good faith and did not comply with Section 524(g) of the Bankruptcy Code. ACandS has filed a notice of appeal of the bankruptcy court’s decision and has filed objections to the bankruptcy court’s findings of fact and conclusions of law in the United States District Court. The Company has moved to dismiss the appeal and objections and has also filed an opposition to ACandS’ objections.
All three of the ongoing proceedings were stayed pending the bankruptcy court’s ruling on ACandS’ plan of reorganization. In light of the issuance of that ruling, the Company is now evaluating its next steps in the proceedings. The Company believes that the findings of the Bankruptcy Court support various of the Company’s assertions in the proceedings.
In October 2001 and April 2002, two purported class action suits (Wise v. Travelers, and Meninger v. Travelers), were filed against the Company and other insurers in state court in West Virginia. The plaintiffs in these cases, which were subsequently consolidated into a single proceeding in Circuit Court of Kanawha County, West Virginia, 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 have been filed in Massachusetts (2002) and Hawaii (filed in 2002, and served in May 2003) (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 the Company as a defendant, alleging that the Company 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 against the Company in Louisiana, Ohio and Texas state courts (these suits, together with the West Virginia suit, are collectively referred to as the “common law claims”).
All of the actions described in the preceding paragraph, other than the Hawaii Actions, are currently subject to a temporary restraining order entered by the federal bankruptcy court in New York, which had previously presided over and approved the reorganization in bankruptcy of the Company’s former policyholder Johns Manville. In August 2002, the bankruptcy court conducted a hearing on the Company’s motion for a preliminary injunction prohibiting further prosecution of the lawsuits pursuant to the reorganization plan and related orders. At the conclusion of this hearing, the court ordered the parties to mediation, appointed a mediator and continued the temporary restraining order. During 2003, the same bankruptcy court extended the existing injunction to apply to an additional set of cases filed in various state courts in Texas and Ohio as well as to the attorneys who are prosecuting these cases. The order also enjoins these attorneys and their respective law firms from commencing any further lawsuits against the Company based upon these allegations without the prior approval of the court. The parties have met with the mediator several times, and on November 19, 2003, the parties advised the bankruptcy court that a settlement in principle of the Statutory and Hawaii Actions had been reached. This settlement in principle is subject to a number of significant contingencies, including the execution of a definitive settlement agreement. In addition, the bankruptcy court must issue an order approving the settlement agreement and clarifying certain prior orders of the bankruptcy court concerning the scope and breadth of the injunction previously entered by that court in the Johns Manville proceeding. All of these orders must become final and all appeals seeking to reverse these orders must have been denied in order for the settlement to take effect. The bankruptcy court will also hold hearings with respect to the Company’s motion for a permanent injunction with respect to all of the pending common law claims. If the Company is successful in finalizing its settlement of the Statutory and Hawaii Actions and obtains the permanent injunction it is seeking with respect to the common law claims, then the Statutory and Hawaii Actions will have been resolved and the pending common law claims will have been enjoined. It is not possible to predict how the court will rule on the motion for a permanent injunction with respect to the common law claims or the motion to approve the settlement of the Statutory and Hawaii Actions, even assuming that the settlement in principle of these actions is finalized and reduced to an executed, definitive settlement agreement. If all of the conditions of the Statutory and Hawaii settlement in principle are not satisfied, or to the extent that the bankruptcy court does not enter the permanent injunction sought by the Company with respect to the common law claims, then the temporary restraining order currently in effect will be lifted and the Company will again be subject to the pending litigation and could be subject to additional litigation based on similar theories of liability.
Under the merger agreement, each of St. Paul and the Company has agreed to pay the other party a fee of $300 million in cash in any of the following payment events:
if (i) prior to termination, an Acquisition Proposal (as defined in the merger agreement) relating to the paying party was made or renewed and not publicly withdrawn at least 20 days prior such party’s shareholder vote, (ii) either party terminates the merger agreement following the paying party’s failure to obtain its required shareholder approval and (iii) within 18 months following termination, the paying party enters into a definitive agreement for, or consummates, an Acquisition Proposal; or
if (i) prior to termination, an Acquisition Proposal relating to the paying party was made or renewed and not publicly withdrawn at least 20 days prior to the termination of the merger agreement, (ii) either party exercises its right to terminate the merger agreement based on the merger not having been consummated on or before November 30, 2004 and (iii) within 18 months following termination, the paying party enters into a definitive agreement for, or consummates, an Acquisition Proposal.
The Company has line of credit agreements with Citigroup. See note 8.
The Company had notes payable to Citigroup of $700.0 million at December 31, 2002, which was repaid during 2003. Interest expense included in the consolidated statement of income was $9.1 million, $18.1 million and $8.7 million in 2003, 2002 and 2001, respectively. See note 8.
On October 1, 2001, the Company paid $329.5 million to Citigroup for The Northland Company and its subsidiaries and Associates Lloyds Insurance Company. In addition, on October 3, 2001, the capital stock of Associates Insurance Company, with a net book value of $356.5 million, was contributed to the Company. See note 2.
At December 31, 2003 and 2002, the Company had $14.6 million and $60.2 million, respectively, of securities pledged as collateral to Citigroup to support a letter of credit facility for certain of the Company’s surety customers.
The Company participates in reinsurance agreements with TIC, a former affiliate. See note 6.
There were no significant noncash financing or investing activities for the year ended December 31, 2003. In 2002, TPC paid dividends of $5.095 billion to Citigroup in the form of notes payable. These notes were all repaid during 2002. On October 3, 2001, the capital stock of Associates Insurance Company, with a net book value of $356.5 million, was contributed to the Company.