The Company currently owns six buildings in Hartford, Connecticut, which comprises its headquarters. The Company currently occupies approximately 1,030,000 square feet of office space in such buildings. The Company also owns other real property in Connecticut, office buildings in Fall River, Massachusetts and in Irving, Texas and a data center located in Norcross, Georgia. In addition, the Company leases 146 field and claim offices totaling approximately 3,425,000 square feet throughout the United States under leases or subleases with third parties.
The Company leases 284,225 square feet of office space in its headquarters buildings to Citigroup. The Company leases approximately 373,000 square feet of office space at CityPlace, located in Hartford, Connecticut. The Company has agreed to exchange office space with Citigroup and, as a result, will relocate its operations from the office space at CityPlace to the six headquarters buildings and assign the lease for CityPlace to Citigroup effective April 2003. The lease with Citigroup for office space in the headquarters buildings will terminate at the same time that the exchange of office space occurs.
Cumulative effect of changes in accounting principles, net of tax (1) for the year ended December 31, 2002 consists of a loss of $242.6 million as a result of a change in accounting for goodwill and other intangible assets; (2) for the year ended December 31, 2001 includes a gain of $4.5 million as a result of a change in accounting for derivative instruments and hedging activities and a loss of $1.3 million as a result of a change in accounting for securitized financial assets; and (3) for the year ended December 31, 1999 includes a loss of $(135.0) million as a result of a change in accounting for insurance-related assessments and a gain of $22.9 million as a result of a change in accounting for insurance and reinsurance contracts that do not transfer insurance risk.
Total liabilities include a minority interest liability of $87.0 million, $1.368 billion and $1.487 billion at December 31, 2002, 1999 and 1998, respectively.
Dividends per common share reflect the recapitalization effected as part of the Company’s corporate reorganization. See note 1 to the Consolidated Financial Statements.
TPC Corporate Reorganization, Initial Public Offering and Concurrent Convertible Junior Subordinated Notes Offering
TPC transferred substantially all of its assets to affiliates of Citigroup Inc. (together with its consolidated subsidiaries, Citigroup), other than the capital stock of Travelers Insurance Group Holdings Inc. (TIGHI);
the ratio of the exercise price of the replacement option to the closing price of TPC class A common stock on August 20, 2002, immediately after the Citigroup Distribution, was the same as the ratio of the exercise price of the Citigroup option to the price of Citigroup common stock immediately before the Citigroup Distribution.
The following transactions were completed in conjunction with the corporate reorganization, offerings and 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.
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.”
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 business.
In the third quarter of 2000, the Company purchased the renewal rights to a portion of Reliance Surety’s commercial lines middle-market book of business (Reliance Middle Market). The Company also acquired the renewal rights to Frontier Insurance Group, Inc.’s environmental, excess and surplus lines casualty businesses and some classes of surety business.
During April 2000, TPC completed a cash tender offer and merger, as a result of which TIGHI became TPC’s wholly-owned subsidiary. In the tender offer and merger, TPC acquired all of TIGHI’s outstanding shares of common stock that were not already owned by TPC, representing approximately 14.8% of TIGHI’s outstanding common stock, for approximately $2.413 billion in cash financed by a loan from Citigroup.
Operating income of $855.7 million for 2001 decreased $486.0 million compared to $1.342 billion for 2000. The decrease in operating income in 2001 from 2000 primarily reflects the impact of catastrophe losses of $489.5 million associated with the terrorist attack on September 11th. The 2001 operating decrease reflects unfavorable asbestos prior year reserve development in 2001 of $122.7 million versus $32.5 million in 2000. This was offset by $132.1 million of other favorable prior year reserve development in 2001 compared to $81.9 million of other favorable prior year reserve development in 2000. Also contributing to the 2001 decrease in operating income was a $79.5 million decrease in net investment income from 2000 which largely reflects the increase in dividends and debt repayments to Citigroup, lower fixed income interest rates and lower returns for private equity investments. Partially offsetting this was lower interest expense in 2001. Underwriting gain (loss), excluding catastrophes, prior year reserve development and goodwill amortization included in operating income, increased $63.0 million to $48.1 million in 2001. The 2001 underwriting results reflect the benefit of premium rate increases, partially offset by increased loss cost trends, including increased medical costs and auto repair costs and reinsurance costs.
Revenues of $14.270 billion in 2002 increased $2.039 billion from 2001. The increase was primarily attributable to higher earned premiums due to premium rate increases, the inclusion of Northland and Associates for the full year 2002 versus the fourth quarter of 2001 and the $520.0 million benefit of the Citigroup indemnification agreement, offset by a decrease in net realized investment gains and lower net investment income. Total revenues for Northland and Associates were $1.070 billion in 2002, an increase of $815.3 million over 2001. The increase in 2002 revenue reflects a $1.744 billion increase in earned premiums, offset by a $175.8 million decrease in net realized investment gains and a $153.5 million decrease in net investment income. Net realized investment gains include $284.1 million of impairments in 2002, compared to $146.2 million in 2001. The 2002 and 2001 impairments relate primarily to corporate bonds in the energy and communications sectors. Revenues of $12.231 billion in 2001 increased $1.160 billion from 2000. The increase in revenue in 2001 from 2000 was primarily attributable to higher earned premiums, higher fee income and higher net realized investment gains, and one quarter of Northland and Associates, partially offset by a $127.6 million decrease in net investment income. The increase in 2001 revenue reflects a $948.7 million increase in earned premiums and a $275.5 million increase in net realized investment gains offset by a $127.6 million decrease in net investment income. Net realized investment gains include $20.2 million of impairments in 2000. The inclusion of Northland and Associates in the fourth quarter of 2001 added $254.4 million to full year 2001 revenues.
Earned premiums increased $1.744 billion to $11.155 billion in 2002 from $9.411 billion in 2001. The increase in earned premiums in 2002 was due to rate increases on renewal business in both Commercial Lines and Personal Lines and the full-year inclusion of Northland and Associates in 2002. Earned premiums for Northland and Associates were $958.2 million in 2002, an increase of $734.1 million over 2001 which only includes the fourth quarter of 2001. Earned premiums increased $948.7 million to $9.411 billion in 2001 primarily due to rate increases, the full-year impact of the acquisitions in 2000 of Reliance Surety and the renewal rights for the Reliance Middle Market and Frontier businesses, combined with the inclusion of Northland and Associates in the fourth quarter of 2001. The inclusion of Northland and Associates in the fourth quarter of 2001 added $224.1 million to full-year 2001 earned premiums.
dividends and debt repayments to Citigroup, lower fixed income interest rates and lower returns from private equity investments. Investment yields declined to 6.9% in 2001 from 7.6% in 2000. The inclusion of Northland and Associates in the fourth quarter of 2001 added $23.1 million to full year 2001 net investment income.
Fee income was $454.9 million in 2002, a $107.5 million increase from 2001. Fee income was $347.4 million in 2001, a $35.0 million increase from 2000. National Accounts within Commercial Lines is the primary source of fee income due to its service businesses, which include claim and loss prevention services to large companies that choose to self insure a portion of their insurance risks and claims and policy management services to workers’ compensation and automobile assigned risk plans and to self insurance pools. The increases in fee income were primarily due to the favorable rate environment and the repopulation of the involuntary pools. Claim volume under administration increased to $2.656 billion for 2002, compared to $2.252 billion for 2001 and $2.024 billion in 2000.
Claims and expenses were $14.530 billion in 2002 compared to $10.842 billion in 2001 and $9.207 billion in 2000. The 2002 increase was primarily due to prior year reserve development principally related to the asbestos charge taken in the fourth quarter of 2002 upon completion of the Company’s asbestos study, the inclusion in 2002 of Northland and Associates, and increased loss cost trends, partially offset by the $704.0 million impact in 2001 of the terrorist attack on September 11th. Unfavorable prior year reserve development in 2002 was $3.132 billion, compared to favorable prior year reserve development of $14.4 million in 2001. The most significant component of prior year reserve development in 2002 was asbestos-related incurrals of $2.945 billion, which increased $2.756 billion, over 2001. For additional information see “- Asbestos Claims and Litigation.” Separately, the Company strengthened its environmental reserves in the fourth quarter by $100.0 million, bringing the total to $385.5 million, and reduced its reserves for cumulative injuries other than asbestos by $94.8 million to $553.6 million. These actions were taken as a result of recent payment and settlement experience. In addition, the Company strengthened prior year reserves for certain run-off lines of business including assumed reinsurance, and experienced favorable development in certain ongoing businesses including Personal Lines Auto. Claims and expenses for Northland and Associates were $1.090 billion in 2002, an increase of $858.2 million over 2001 which only includes the fourth quarter of 2001. These increases were also partially offset by the benefit of lower interest expense, the elimination of goodwill amortization and natural catastrophe losses of $84.1 million in 2002 compared to $103.3 million in 2001. The increase in claims and expenses in 2001 was primarily the result of higher catastrophe losses of $856.3 million primarily associated with the terrorist attack on September 11th compared to $82.5 million in 2000, increased loss cost trends, lower favorable prior year reserve development of $14.4 million compared to $76.1 million in 2000 and increased claims and operating expenses related to the growth in premiums, including the full-year impact of the Reliance Surety acquisition and the acquisition of the renewal rights for the Reliance Middle Market and Frontier businesses, and the inclusion of Northland and Associates in the fourth quarter of 2001, partially offset by lower interest expense due to lower outstanding debt and lower interest rates. Results for 2000 also reflect benefits resulting from legislative actions that changed the manner in which some states finance their workers’ compensation second-injury funds, principally in New York. The inclusion of Northland and Associates in the fourth quarter of 2001 added $231.3 million to full year 2001 claims and expenses.
The Company’s effective tax (benefit) rate was (183.4)%, 23.5% and 26.4% in 2002, 2001 and 2000, respectively. The effective tax rate for 2002 reflects the impact of non-taxable recoveries of $520.0 million related to the Citigroup indemnification agreement and non-taxable investment income. The decrease in the 2001 effective tax rate from 2000 was primarily due to the impact of the losses associated with the terrorist attack on September 11th, which changed the mix of taxable and non-taxable income or loss.
Net written premiums increased $2.099 billion to $11.945 billion in 2002 from $9.846 billion in 2001. The increase in net written premiums in 2002 was due to rate increases and strong retention in both Commercial Lines and Personal Lines and the full year inclusion of Northland and Associates in 2002. Net written premiums for Northland and Associates were $935.8 million in 2002, an increase of $743.1 million over 2001 which only includes the fourth quarter of 2001. Net written premiums increased $1.002 billion to $9.846 billion in 2001 from $8.843 billion in 2000 primarily due to rate increases, the full year impact of the acquisitions in 2000 of Reliance Surety and the
renewal rights for the Reliance Middle Market and Frontier businesses, combined with the inclusion of Northland and Associates in the fourth quarter of 2001. The inclusion of Northland and Associates in the fourth quarter of 2001 added $192.7 million to full year 2001 net written premiums.
The deterioration in the 2001 GAAP combined ratio includes the impact of the terrorist attack on September 11th and higher asbestos prior year reserve development, partially offset by higher favorable other prior year reserve development. The improvement in the GAAP combined ratio, excluding catastrophes, prior year reserve development, and goodwill amortization, from 2000 to 2001, reflects an improvement in the loss and LAE ratio and a deterioration in the underwriting expense ratio. The improvement in the loss and LAE ratio is primarily due to premium growth related to rate increases and the impact of the increase in the Commercial Lines Bond business, primarily associated with the ongoing business associated with the Reliance Surety acquisition, which generally has a lower loss and LAE ratio.
Net of benefit of $520.0 million related to asbestos incurrals subject to the Citigroup indemnification agreement in 2002.
gains compared to 2001. Revenues of $7.771 billion in 2001 increased $935.6 million from 2000. The increase in 2001 reflected higher earned premiums, higher fee income and higher realized investment gains and one quarter of Northland and Associates, partially offset by a decrease in net investment income. The inclusion of Northland and Associates in the fourth quarter of 2001 added $231.3 million to full year 2001 revenues.
Net investment income was $1.495 billion for 2002, a decrease of $121.0 million from $1.616 billion in 2001. Lower average investment yields reflected reduced returns in the Company’s public equity investments and the lower interest rate environment, partially offset by an increase in average invested assets due to the inclusion of Northland and Associates and increased cash flow from operations. Net investment income related to Northland and Associates was $88.2 million in 2002, an increase of $65.8 million over 2001 which only includes the fourth quarter of 2001. Net investment income was $1.616 billion in 2001, a decrease of $96.9 million from $1.713 billion in 2000. This decrease largely reflects the increase in dividends and debt repayments to Citigroup, lower fixed income interest rates and lower returns from private equity investments. The inclusion of Northland and Associates in the fourth quarter of 2001 added $22.4 million to full year 2001 net investment income.
Fee income was $454.9 million in 2002, a $107.5 million increase from 2001. Fee income was $347.4 million in 2001, a $35.0 million increase from 2000. National Accounts is the primary source of fee income due to its service businesses, which include claim and loss prevention services to large companies that choose to self insure a portion of their insurance risks and claims and policy management services to workers’ compensation and automobile assigned risk plans and to self-insurance pools. The increases in fee income were primarily due to the favorable rate environment and the repopulation of the involuntary pools. Claim volume under administration increased to $2.656 billion for 2002, compared to $2.252 billion in 2001 and $2.024 billion in 2000.
Recoveries of $520.0 million under the Citigroup indemnification agreement have been included in revenues as Recoveries from former affiliate.
Other revenues decreased to $32.1 million in 2002, from $41.4 million in 2001. Other revenues increased $25.3 million to $41.4 million in 2001 from $16.1 million in 2000.
Commercial Lines net written premiums were $7.370 billion in 2002 compared to $5.738 billion in 2001 and $5.031 billion in 2000. The 2002 increase reflects 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, including approximately $115.0 million relating to the termination of certain reinsurance contracts in 2002. Net written premiums related to Northland and Associates were $824.8 million in 2002, compared to $167.4 million in 2001 which only includes the fourth quarter of 2001. The Commercial Lines business of Northland and Associates is included with Commercial Accounts. The 2001 increase reflected the impact of the improving rate environment. The 2001 increase also includes the full-year impact of the acquisition in 2000 of the renewal rights for the Reliance Middle Market business, the acquisition in 2000 of the renewal rights for the Frontier business in Gulf, the impact of the ongoing business associated with the Reliance Surety acquisition in Bond combined with net written premiums related to the fourth quarter inclusion of Northland and Associates in 2001. The inclusion of Northland and Associates in the fourth quarter of 2001 added $167.4 million to full year 2001 net written premiums. Included in Bond net written premiums in 2000 is an increase of $130.7 million due to a reinsurance transaction associated with the acquisition of the Reliance Surety business.
state mandated residual market workers’ compensation and automobile assigned risk plans. National Accounts net written premiums were $734.6 million in 2002 compared to $418.9 million in 2001. This increase in net written premiums was due to renewal price increases, higher new business levels and the repopulation of residual market pools. National Accounts net written premiums were $418.9 million in 2001 compared to $352.3 million in 2000. This increase was primarily due to the purchase of less reinsurance, reflecting the shift in business mix from guaranteed cost products to loss-sensitive products, combined with the repopulation of the involuntary pools.
Gulf markets products to national, mid-sized and small customers and distributes them through both wholesale brokers and retail agents and brokers throughout the United States with particular emphasis on executive and
professional liability products. Gulf net written premiums were $579.4 million in 2002, compared to $608.2 million in 2001. Gulf’s decision to exit non-core businesses, including assumed reinsurance, transportation, residual value and property, offset increases in Gulf’s core specialty lines, resulting in an overall decrease in Gulf net written premiums. Gulf net written premiums were $608.2 million in 2001, compared to $517.4 million in 2000. This increase primarily reflected the full-year impact of the renewal rights for the Frontier business and participation in the London market.
Commercial Lines claims and expenses of $10.039 billion in 2002 increased $3.531 billion from 2001 and increased $1.338 billion in 2001 compared to 2000. The 2002 increase was primarily related to asbestos 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 the $644.0 million of losses attributed to the effect of the terrorist attack in 2001. Included in claims and expenses in 2002 is unfavorable prior year reserve development of $3.162 billion compared to 2001 unfavorable prior year reserve development of $16.6 million. The most significant component in 2002 prior year reserve development was asbestos incurred losses which increased $2.756 billion over 2001. For additional information see “- Asbestos Claims and Litigation”. Separately, the Company strengthened its environmental reserves in the fourth quarter by $100.0 million, bringing the total to $385.5 million, and reduced its reserves for cumulative injuries other than asbestos by $94.8 million to $553.6 million. These actions were taken as a result of recent payment and settlement experience. In addition, the Company strengthened prior year reserves for certain run-off lines of business, including assumed reinsurance, and experienced favorable development in certain ongoing businesses. Claims and expenses for Northland and Associates were $967.7 million in 2002, an increase of $761.1 million over 2001 which only includes the fourth quarter of 2001. The increase was also partially offset by the elimination of goodwill amortization and by reduced catastrophe losses. The 2001 increase was primarily due to higher catastrophe losses primarily associated with the terrorist attack on September 11th, increased loss cost trends, including increased medical costs, auto repair costs, higher losses and operating expenses associated with the growth in premium and claims volume including the full-year impact of the Reliance Surety acquisition and the acquisition of the renewal rights for the Reliance Middle Market and Frontier businesses, and the inclusion of Northland and Associates in the fourth quarter of 2001, partially offset by higher favorable prior year reserve development. The inclusion of Northland and Associates in the fourth quarter of 2001 added $206.6 million to full year 2001 claims and expenses.
There were no catastrophe losses in 2002 or 2000. Catastrophe losses, net of taxes and reinsurance, were $470.5 million in 2001. Catastrophe losses in 2001 were primarily due to the terrorist attack on September 11th, the Seattle earthquake and Tropical Storm Allison.
The deterioration in the 2001 GAAP combined ratio resulted primarily from the impact of the terrorist attack on September 11th. The improvement in the GAAP combined ratio, excluding catastrophes, prior year reserve development and goodwill amortization, from 2000 to 2001, reflects an improvement in the loss and LAE ratio, partially
Other revenues were $80.1 million in 2002, a $6.8 million increase from 2001. Premium installment charges are the primary source of Personal Lines other income. The increase in other revenues was primarily due to the full-year inclusion of Northland in 2002. Other revenues increased $2.5 million to $73.3 million in 2001.
Automobile net written premiums increased 10% to $2.843 billion in 2002. 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. Renewal price change for Personal Lines products represents the estimated average change in premium on policies that renew, including rate and exposure changes, versus the average premium on those same policies for their prior term. Policy retention levels for standard voluntary business remained favorable and averaged 80%. 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 increased 9% to $2.591 billion in 2001, 8% excluding the impact of
Northland. Renewal price changes for standard voluntary business averaged 7% for 2001. Policy retention levels for 2001 standard voluntary business were comparable to 2000 and averaged 79%.
Personal Lines claims and expenses were $4.331 billion in 2002 compared to $4.115 billion in 2001 and $3.715 billion in 2000. The 2002 increase was primarily attributed to the inclusion in 2002 of the full-year results of Northland and increased loss cost trends partially offset by the effects of the terrorist attack on September 11th in 2001. Claims and expenses for Northland were $121.8 million in 2002, an increase of $97.1 million over 2001 which only includes the fourth quarter of 2001. During 2002, Personal Lines experienced a moderation in the rise in auto loss costs. The 2002 amount includes $29.9 million of favorable prior year reserve development versus $31.0 million in 2001. Also impacting year over year results were higher natural catastrophe losses and the benefit of the elimination of goodwill amortization. The increase in claims and expenses in 2001 reflects $60.0 million of catastrophe losses associated with the terrorist attack on September 11th. The increase also reflects the impact of increased loss cost trends and lower favorable prior year reserve development. The inclusion of Northland in the fourth quarter of 2001 added $24.7 million to full-year 2001 claims and expenses.
LAE ratio and in the underwriting expense ratio. The deterioration in the loss and LAE ratio reflects increased loss cost trends partially offset by the growth in premiums due to rate increases. The deterioration in the underwriting expense ratio is due to higher commission expense associated with the mix of business.
Because each policyholder presents different liability and coverage issues, the Company generally evaluates the exposure presented by each policyholder on a policyholder-by-policyholder basis. In the course of this evaluation, the Company considers: available insurance coverage, including the role of any umbrella or excess insurance the Company has issued to the policyholder; limits and deductibles; an analysis of each policyholder’s potential liability; the jurisdictions involved; past and anticipated future claim activity and loss development on pending claims; past settlement values of similar claims; allocated claim adjustment expense; potential role of other insurance; the role, if any, of non-asbestos claims or potential non-asbestos claims in any resolution process; and applicable coverage defenses or determinations, if any, including the determination as to whether or not an asbestos claim is a products/completed operation claim subject to an aggregate limit and the available coverage, if any, for that claim. Once the gross ultimate exposure for indemnity and related claim adjustment expense is determined for each policyholder by each policy year, the Company calculates a ceded reinsurance projection based on any applicable facultative and treaty reinsurance, as well as past ceded experience. Adjustments to the ceded projections also occur due to actual ceded claim experience and reinsurance collections. Conventional actuarial methods are not utilized to establish asbestos reserves. The Company’s evaluations have not resulted in any meaningful data from which an average asbestos defense or indemnity payment may be determined.
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. Losses paid have increased in 2002 compared to prior years. There has been an acceleration in recent quarters in the amount of payments, including those from prior settlements of coverage disputes entered into between the Company and certain of its policyholders. For 2002, approximately 54% of total paid losses relate to policyholders with whom the Company previously entered into settlement agreements that limit the Company’s liability. Net losses paid were $361.1 million for 2002 compared to $174.8 million for 2001 reflective of the items described above.
At December 31, 2002, asbestos reserves were $3.404 billion, an increase of $2.584 billion compared to $820.4 million as of December 31, 2001. Net incurred losses and loss adjustment expenses were $2.945 billion for 2002 compared to $188.8 million for 2001. This charge was partially offset by an after tax benefit of $520.0 million, included in revenues, related to recoveries from full utilization of the Citigroup indemnification agreement. The increase in reserves is based on the Company’s analysis of asbestos claim and litigation trends. As part of a periodic, ground-up study of asbestos reserves, the Company studied the implications of these and other significant developments, with special attention to major asbestos defendants and non-products claims alleging that the Company’s coverage obligations are not subject to aggregate limits. In addition, Company management expanded its historical methodology in response to recent trends. This included further categorization of policyholders, conducting an examination of recent claim activity from policyholders reporting claims for the first time, and a review of past settlements.
Other policyholders with active claims are annually identified as Home Office Review or Field Office Review policyholders. Policyholders are identified for Home Office Review based upon, among other factors: aggregate payments in excess of a specified threshold (currently $100,000), perceived level of exposure, number of reported claims, products/completed operations and potential “non-product” exposures, size of policyholder and geographic distribution of products or services sold by the policyholder.
The Company continues to receive claims from policyholders which allege that they are liable for injury or damage arising out of their alleged disposition of toxic substances. Mostly, these claims are due to various legislative as well as regulatory efforts aimed at environmental remediation. For instance, the Comprehensive Environmental Response, Compensation and Liability Act, or CERCLA, enacted in 1980 and later modified, enables private parties as well as federal and state governments to take action with respect to releases and threatened releases of hazardous substances. This federal statute permits the recovery of response costs from some liable parties and may require liable parties to undertake their own remedial action. Liability under CERCLA may be joint and several with other responsible parties.
The Company’s reserves for environmental claims are not established on a claim-by-claim basis. The Company carries an aggregate bulk reserve for all of the Company’s environmental claims that are in dispute until the dispute is resolved. This bulk reserve is established and adjusted based upon the aggregate volume of in-process environmental claims and the Company’s experience in resolving those claims. At December 31, 2002, approximately 81% of the net environmental reserve (approximately $311.8 million) is carried in a bulk reserve and includes unresolved and incurred but not reported environmental claims for which the Company has not received any specific claims as well as for the anticipated cost of coverage litigation disputes relating to these claims. The balance, approximately 19% of the net environmental reserve (approximately $73.7 million), consists of case reserves for resolved claims.
policy issued to the policyholder for past, present and future environmental liabilities as well as 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. Provisions of these agreements also include appropriate indemnities and hold harmless provisions to protect the Company. The Company’s general purpose in executing these agreements is to reduce the Company’s potential environmental exposure and eliminate the risks presented by coverage litigation with the policyholder and related costs.
In establishing environmental reserves, the Company evaluates the exposure presented by each policyholder and the anticipated cost of resolution, if any, for each policyholder on a quarterly basis. In the course of this analysis, the Company considers the probable liability, available coverage, relevant judicial interpretations and historical value of similar exposures. In addition, the Company considers the many variables presented, such as the nature of the alleged activities of the policyholder at each site; the allegations of environmental harm at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of environmental harm and the corresponding remedy at each site; the nature of government enforcement activities at each site; the ownership and general use of each site; the overall nature of the insurance relationship between the Company and the policyholder, including the role of any umbrella or excess insurance the Company has issued to the policyholder; the involvement of other insurers; the potential for other available coverage, including the number of years of coverage; the role, if any, of non-environmental claims or potential non-environmental claims, in any resolution process; and the applicable law in each jurisdiction. Conventional actuarial techniques are not used to estimate these reserves.
Over the past three years, the Company has experienced a substantial reduction in the number of policyholders with pending coverage litigation disputes, a continued reduction in the number of policyholders tendering for the first time an environmental remediation-type claim to the Company, as well as a continued reduction in the number of policyholders with active environmental claims.
As of December 31, 2002, the number of policyholders with pending coverage litigation disputes pertaining to environmental claims was 205, approximately 5% less than the number pending as of December 31, 2001, and approximately 16% less than the number pending as of December 31, 2000. Also, in 2002, there were 110 policyholders tendering for the first time an environmental remediation-type claim to the Company. This compares to 134 policyholders doing so in 2001 and 158 policyholders in 2000. The Company’s review of policyholders tendering claims for the first time has indicated that they are fewer in number and lower in severity. More specifically, policyholders are smaller in size, have fewer sites per policyholder, they are lower tier defendants, and regulatory agencies are utilizing risk based analysis and more efficient clean-up technologies.
The Company has resolved, for approximately $1.952 billion (before reinsurance), the environmental liabilities presented by 5,807, or 92%, of the total 6,342 policyholders who have tendered environmental claims to the Company through December 31, 2002. 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, recent increases in settlement amounts have led the Company to increase its environmental reserves by $100.0 million in the fourth quarter of 2002.
CIOTA claims are generally submitted to the Company under general liability policies and often involve an allegation by a claimant against a policyholder that the claimant has suffered injuries as a result of long-term or continuous exposure to potentially harmful products or substances. These potentially harmful products or substances include, but are not limited to, lead paint, pesticides, pharmaceutical products, silicone-based personal products, solvents, latex gloves, silica and other potentially harmful substances.
To the extent disputes exist between the Company and a policyholder regarding the coverage available for CIOTA claims, the Company resolves the disputes, where feasible, through settlement with the policyholder or through coverage litigation. Historically, the Company’s experience has indicated that policyholders with potentially significant environmental and/or asbestos exposures, may often have other CIOTA exposures or CIOTA claims pending with the Company. Generally, the terms of a settlement agreement set forth the nature of the Company’s participation in resolving CIOTA claims and the scope of coverage to be
provided by the Company, and contain the appropriate indemnities and hold harmless provisions to protect the Company. These settlements generally eliminate uncertainties for the Company regarding the risks extinguished, including the risk that losses would be greater than anticipated due to evolving theories of tort liability or unfavorable coverage determinations. The Company’s approach also has the effect of determining losses at a date earlier than would have occurred in the absence of these settlement agreements. On the other hand, in cases where future developments are favorable to insurers, this approach could have the effect of resolving claims for amounts in excess of those that the Company ultimately would have paid had the claims not been settled in this manner. The Company decreased CIOTA reserves by $94.8 million in the fourth quarter of 2002 reflective of lower levels of paid activity during recent periods.
The following table displays activity for CIOTA losses and loss expenses and reserves:
Because the primary purpose of the investment portfolio is to fund future claims payments, the Company employs a conservative investment philosophy. The Company’s fixed maturity portfolio at December 31, 2002 totaled $30.003 billion, comprising $29.462 billion of publicly traded fixed maturities and $541.6 million of private fixed maturities. The weighted average quality ratings of the Company’s publicly traded fixed maturity portfolio and private fixed maturity portfolio at December 31, 2002 were Aa2 and Baa1, respectively. Included in the fixed maturity portfolio at that date was approximately $1.945 billion of below investment grade securities. The average duration of the fixed maturity portfolio, including short-term investments, was 5.0 years as of December 31, 2002, or 5.8 years excluding short-term investments.
The Company’s equity investments are primarily through private equity and arbitrage partnerships, which are subject to more volatility than the Company’s fixed income investments, but historically have provided a higher return. At December 31, 2002, the carrying value of the Company’s investments in private equity and arbitrage partnerships was $1.611 billion.
The Company’s strategic objective is to enhance the Company’s position as a consistently profitable market leader and a cost-effective provider of property and casualty insurance in the United States.
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 is 7% for 2003, 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 $570.0 million for 2003 subject to final rules to be established by the U.S. Treasury. Due to the high level of the deductible, the Company believes that the bill will have little impact on the price or availability of terrorism coverage in the marketplace.
In Select Accounts, the trend toward increased pricing on renewal business that started in late 1999 gained momentum in 2000 and 2001 and continued to improve during 2002. Prices generally rose during this time frame while customer retention remained consistent with prior periods. Price increases varied significantly by region, industry and product. However, the ability of Select Accounts to achieve future rate increases is subject to regulatory constraints in some jurisdictions. Select will continue to seek rate increases in 2003, however the rate of increase may decline modestly as compared to the past year. Loss cost trends in Select Accounts improved across major lines in 2002 due to the Company’s continued disciplined approach to underwriting and risk selection. The Company will continue to pursue business based on the Company’s ability to achieve acceptable returns.
Bond achieved significant growth in 2002 in both the surety and executive liability markets. A decrease in capacity in the surety industry, driven by an increase in claim frequency and severity in accident years 1999 through 2001 for the surety industry, enabled Bond to increase prices for all surety products. The decrease in capacity in the surety marketplace is expected to continue to create opportunities for further price increases for all surety products in 2003, although the increased cost of reinsurance will offset some of the positive impact. In the executive liability market for middle and small private accounts and not-for-profit accounts, Bond’s expanding array of products and recognized local expertise enabled it to further enhance its product and customer diversification, as well as profit opportunities, while realizing significant price increases. In addition, a decrease in reinsurance capacity will allow further price increases for all executive liability products in 2003. Bond’s focus remains on selective underwriting,
selling its products to customers that provide the greatest opportunities for profit. Bond is also focused on the Company’s efforts to cross-sell its expanding array of products to existing customers of Commercial Lines and Personal Lines.
In Gulf, rate increases began in most lines of business in 2001 and accelerated significantly in 2002. Although specific increases varied by region, industry and product, improvement was most evident in the directors’ and officers’, professional liability and umbrella lines of business, with lesser increases achieved in the excess and surplus lines of business. The favorable impact from rate improvement continues to be partially offset by rising loss cost trends. At the end of February 2003, Gulf resolved a claims coverage dispute with a policyholder relating to a run-off product line. The settlement will result in a charge by the Company of approximately $68.0 million after reinsurance, tax and minority interest.
There are currently various state and federal legislative and judicial proposals to require asbestos claimants to demonstrate an asbestos illness. At this time it is not possible to predict the likelihood or timing of such proposals being enacted or the effect if they are enacted. The Company’s asbestos study did not assume the adoption of any asbestos reforms.
During 2002, the personal auto market place experienced widespread rate increases, as companies attempted to restore profitability after years of unacceptable underwriting and investment yields. As a result, premium growth is expected to outpace growth in losses and expenses in 2003. Personal Lines will continue to maintain its underwriting discipline and will continue to increase auto rates as needed to achieve acceptable returns and to offset inflationary pressures.
Prior to the 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 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 $47.2 million for the period from April 1, 2002 through December 31, 2002. Either party may terminate the agreement effective on the end of a month upon 90 days prior notice. 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.
See note 16 to the Company’s consolidated financial statements for a description of these and other intercompany arrangements and transactions between the Company and Citigroup.
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
The Company’s cash flow needs include shareholder dividends and debt service. TPC and TIGHI are holding companies and have no direct operations. Accordingly, TPC and TIGHI meet cash flow needs primarily through dividends from operating subsidiaries. In addition, TIGHI has available to it a $250.0 million revolving line of credit from Citigroup. TIGHI pays a commitment fee to Citigroup for that line of credit, which expires in 2006. Borrowings under this line of credit carry a variable interest rate based upon LIBOR plus 50 basis points. At December 31, 2002, borrowings under this revolving line of credit were $200.0 million. The Company expects to repay all of this debt by the end of the first quarter of 2003. TIGHI also has an additional $500.0 million revolving line of credit agreement from Citigroup, which expires in December 2006. At December 31, 2002, current borrowings under this line of credit, which mature on November 7, 2003 and carry a fixed interest rate of 3.60%, were $500.0 million.
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.
In February 2002, TPC also paid a 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 the normal course of business, the Company has unfunded commitments to partnerships in which it invests. These commitments were $864.3 million and $1.025 billion at December 31, 2002 and 2001, respectively.
On January 23, 2003, the Company’s board of directors declared a quarterly dividend of $0.06 per share on class A and class B common stock, payable on February 28, 2003, to shareholders of record on February 5, 2003. The declaration and payment of future dividends to holders of the Company’s common stock will be at the discretion of the Company’s board of directors and will depend upon many factors, including the Company’s financial condition, earnings, capital requirements of TPC’s operating subsidiaries, legal requirements, regulatory constraints and other factors as the board of directors deems relevant.
On September 25, 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 through September 2004 in the open market, and it is expected that funding for the program will principally come from operating cash flow. When shares are repurchased, such shares will be reported as authorized and unissued treasury stock in the consolidated balance sheet. There were no shares repurchased under this plan in 2002.
stock within two years of the Citigroup Distribution. On April 23, 2002, the Internal Revenue Service issued temporary regulations governing certain aspects of spin-off distributions occurring after April 26, 2002. In these temporary regulations, safe harbor rules are provided under which certain post spin-off transactions involving common stock do not adversely impact the tax status of the spin-off. In certain circumstances, these rules provide TPC with additional flexibility to issue additional common stock in corporate transactions as compared to the rules that were in place at the time of the TPC IPO.
In May 2002, the Company guaranteed certain debt obligations of TIGHI. If the Company or TIGHI defaults on certain of their obligations related to the TIGHI Securities, the Company may not declare or pay dividends on its capital stock or take certain other actions related to its capital stock.
In the opinion of Company’s management, realization of the recognized deferred tax asset of $1.447 billion is more likely than not based on expectations as to the Company’s future taxable income. Excluding the effect of the asbestos reserve increase in 2002 (see note 6 of notes to the Company’s consolidated financial statements for a further discussion), the Company has reported pretax financial statement income of $1.848 billion on average over the last three years and has generated federal taxable income exceeding $1.071 billion on average in each year during this same period. The Company has a net operating loss carryforward of $1.390 billion at December 31, 2002. Projections of taxable income for 2003 are in excess of the loss carryforward. See note 9 of notes to the Company’s consolidated financial statements for a further discussion.
The Company considers its most significant accounting policies to be those applied to unpaid claim and claim adjustment liabilities and related reinsurance recoverables.
During 2001, the Company recorded a charge of $489.5 million representing the estimated loss for both reported and unreported claims incurred and related claim adjustment expenses, net of reinsurance recoverables and taxes, related to the terrorist attack on September 11th. The associated reserves and related reinsurance recoverables represent the estimated ultimate net costs of all incurred claims and claim adjustment expenses related to the attack. Since the reserves and related reinsurance recoverables are based on estimates, the ultimate net liability may be more or less than such amounts.
Some of the Company’s loss reserves are for asbestos and environmental claims and related litigation. While the study of asbestos claims and associated liabilities and the analysis of environmental claims considered 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 in future periods it is possible that the outcome of the continued uncertainties regarding asbestos-related claims could result in liability 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 $10.978 billion at December 31, 2002. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability
associated with the reinsured business. The Company evaluates and monitors the financial condition of its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies. The Company reports its reinsurance recoverables net of an allowance for estimated uncollectible reinsurance recoverables. The allowance is based upon the Company’s ongoing review of amounts outstanding, length of collection periods, changes in reinsurer credit standing, and other relevant factors. Accordingly, the establishment of reinsurance recoverables and the related allowance for uncollectible reinsurance recoverables is also an inherently uncertain process involving estimates. Changes in these estimates could result in additional income statement charges.
During April 2000, the Company completed a cash tender offer and merger, as a result of which TIGHI became TPC’s wholly-owned subsidiary. In the tender offer and merger, TPC acquired all of TIGHI’s outstanding shares that were not already owned by TPC, representing approximately 14.8% of TIGHI’s outstanding common stock, for $2.413 billion in cash financed by a loan from Citigroup.
Prior to the IPO, the Company participated in Citigroup’s Capital Accumulation Plan (CAP) that provided for the issuance of shares of Citigroup common stock in the form of restricted stock awards to eligible officers and other key employees. On August 20, 2002, in connection with the Citigroup Distribution, the unvested outstanding awards of restricted stock and deferred shares held by 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. In addition, the Board of Directors plan allows deferred receipt of shares of class A common stock (deferred stock) to a future distribution date or upon termination of their service.
Prior to the Citigroup Distribution on August 20, 2002, unearned compensation expense associated with the Citigroup restricted common stock grants is included in other assets in the consolidated balance sheet. Following the Citigroup Distribution and the issuance of replacement stock awards in the Company’s class A and class B shares on August 20, 2002, the unamortized unearned compensation expense associated with these awards is included as unearned compensation in the consolidated balance sheet. Unearned compensation expense is recognized as a charge to income ratably over the vesting period. The after-tax compensation cost charged to earnings for these restricted stock and deferred stock awards was $17.0 million, $19.4 million and $16.3 million for the years ended December 31, 2002, 2001 and 2000, respectively. See note 11 of notes to the Company’s consolidated financial statements for a discussion of restricted common stock awards.
Accordingly, beginning August 20, 2002, TPC sponsors qualified and nonqualified non-contributory defined benefit
pension plans covering substantially all employees. These plans provide benefits under a cash balance formula, except that employees satisfying certain age and service requirements remain covered by a prior final pay formula. TPC also provides postretirement health and life insurance benefits for employees satisfying certain age and service requirements who retire after the Citigroup Distribution. The Company’s net expense related to these plans was $9.2 million for the period from August 20, 2002 through December 31, 2002. Prior to the Citigroup Distribution, substantially similar benefits were provided to TPC employees through plans 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, $11.7 million for 2001, and $14.5 million for 2000.
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; 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; 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 to, 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.
We have audited the accompanying consolidated balance sheets of Travelers Property Casualty Corp. and subsidiaries as of December 31, 2002 and 2001, and the related consolidated statements of income (loss), changes in shareholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2002. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America 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.
On March 21, 2002, TPC issued 231 million shares of its class A common stock in an IPO, representing approximately 23% of TPC’s common equity. After the IPO, Citigroup Inc. (together with its consolidated subsidiaries, Citigroup) beneficially owned all of the 500 million shares of TPC’s outstanding class B common stock, each share of which is entitled to seven votes, and 269 million shares of TPC’s class A common stock, each share of which is entitled to one vote, representing at the time 94% of the combined voting power of all classes of TPC’s voting securities and 77% of the equity interest in TPC. Concurrent with the IPO, TPC issued $892.5 million aggregate principal amount of 4.5% convertible junior subordinated notes, which mature on April 15, 2032. The IPO and the offering of the convertible notes are collectively referred to as the offerings. During the first quarter of 2002, TPC paid three dividends of $1.000 billion, $3.700 billion and $395.0 million, aggregating $5.095 billion, which were each in the form of notes payable to Citigroup. The proceeds of the offerings were used to prepay the $395.0 million note and substantially prepay the $3.700 billion note. On December 31, 2002, the $1.000 billion note payable was repaid in its entirety.
In conjunction with the corporate reorganization and the offerings described above, 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 has fully utilized the total benefit available under the agreement. For the year ended December 31, 2002, revenues include $520.0 million from Citigroup under this agreement. At December 31, 2002, other assets include a $360.6 million receivable 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. See note 6.
TPC’s consolidated financial statements include the accounts of its primary subsidiary, Travelers Insurance Group Holdings Inc. (TIGHI), a property casualty insurance holding company. Also included are the accounts of CitiInsurance International Holdings Inc. and its subsidiaries (CitiInsurance), the principal assets of which are investments in the property casualty and life operations of Fubon Insurance Co., Ltd. and Fubon Assurance Co., Ltd., with respect to results prior to March 1, 2002. On February 28, 2002, the Company sold CitiInsurance to other Citigroup affiliated companies for $402.6 million, its net book value. The Company has applied $137.8 million of the proceeds from this sale to repay intercompany indebtedness to Citigroup. In addition, the Company has purchased from Citigroup affiliated companies the premises located at One Tower Square, Hartford, Connecticut and other properties for $68.2 million. Additionally, certain liabilities relating to employee benefit plans and lease obligations were assigned and assumed by Citigroup affiliated companies. In connection with these assignments, the Company transferred $172.4 million and $87.8 million, respectively, to Citigroup affiliated companies.
Prior to the 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. See note 16.
Certain equity securities with readily determinable fair values in the amount of $361.2 million and owned directly by the Company were reported in trading securities at December 31, 2001. As part of the Citigroup Distribution, these investments have been restructured such that the Company no longer controls the investments. As a result, these investments are now equity securities accounted for under the equity method. There is no impact on earnings related to this change. These investments have been reclassified to other investments. In addition, similar investments included in equity securities at December 31, 2001, in the amount of $96.4 million and $98.3 million at December 31, 2002 and 2001, respectively, have been reclassified to other investments.
During April 2000, TPC completed a cash tender offer to purchase all of the outstanding shares of Class A Common Stock of TIGHI at a price of $41.95 per share. See note 2.
exclude goodwill amortization expense for the years ended December 31, 2001 and 2000 are as follows:
Accounting by Certain Entities (Including Entities With Trade Receivables) That Lend to or Finance the Activities of Others
Effective January 1, 2002, the Company adopted American Institute of Certified Public Accountants Accounting Standards Executive Committee Statement of Position 01-06, “Accounting by Certain Entities (Including Entities With Trade Receivables) That Lend to or Finance the Activities of Others” (SOP 01-06). This SOP applies to any entity that lends to or finances the activities of others. SOP 01-06 clarifies that accounting and financial reporting practices for lending and financing activities should be the same regardless of the type of entity engaging in those activities. SOP 01-06 provides certain presentation and disclosure changes for entities with trade receivables as part of the objective of requiring consistent accounting and reporting for like transactions. This SOP also provides specific guidance for other types of transactions specific to certain financial institutions. To the extent an entity is not considered such a financial institution, the other guidance provided is not applicable. The adoption of this SOP did not have a significant impact on the Company’s results of operations, financial condition or liquidity.
As a result of adopting FAS 133, the Company recorded a benefit of $4.5 million after tax, reflected as a cumulative effect adjustment in the consolidated statement of income and a charge of $4.0 million after tax, reflected as a cumulative effect adjustment in the accumulated other changes in equity from nonowner sources section of shareholder’s equity. In addition, the Company redesignated certain investments as trading from available for sale in accordance with the transition provisions of FAS 133 resulting in a gross gain of $8.0 million after tax, reflected in realized investment gains (losses).
is taken if the carrying value of the property exceeds its current fair value less estimated costs to sell.
Other invested assets include certain private equity securities along with partnership investments and real estate joint ventures accounted for on the equity method of accounting. Undistributed income is reported in net investment income.
The Company adopted FAS 141 and FAS 142 effective January 1, 2002. See note 1, Summary of Significant Accounting Policies, Accounting Changes. Upon adoption of FAS 141 and FAS 142, the Company stopped amortizing goodwill. Instead, goodwill is tested for impairment at least annually using a two-step process. The first step is performed to identify potential impairment and, if necessary, the second step is performed for the purpose of measuring the amount of impairment, if any. Other intangible assets that are not deemed to have an indefinite useful life continue to be amortized over their useful lives. The Company does not have indefinite-lived intangible assets as of December 31, 2002.
Prior to the adoption of FAS 141 and FAS 142, goodwill was generally being amortized on a straight-line basis over a 40-year period. TPC’s purchase of the outstanding shares of Class A Common Stock of TIGHI (see note 2) generated goodwill of $984.5 million, which was amortized on a straight-line basis over a 36-year period. The
Receivables for investment sales represent amounts due the Company from investment brokers for securities sold, which are recorded as of trade date, for which the Company, in the normal course of securities settlement, has not yet received the proceeds.
Claims and claim adjustment expense reserves represent estimated provisions for both reported and unreported claims incurred and related expenses. The reserves are adjusted regularly based upon experience. Included in the claims and claim adjustment expense reserves in the consolidated balance sheet at December 31, 2002 and 2001 are $1.370 billion and $1.358 billion, respectively, of reserves related to workers’ compensation that have been discounted using an interest rate of 5%. Also included at December 31, 2002, are $456.1 million of reserves related to certain fixed and determinable asbestos-related settlements, where all payment amounts and their timing are known (see note 6), that have been discounted using a range of interest rates of 1.56% to 5.50%.
The Company engages in securities lending whereby certain securities from its portfolio are loaned to other institutions for short periods of time. The Company generally maintains cash collateral received from the borrower, equal to at least the market value of the loaned securities plus accrued interest, and reinvests it in a short-term investment pool. The loaned securities remain a recorded asset of the Company; however, the Company records a liability for the amount of the collateral held, representing its obligation to return the collateral related to these loaned securities.
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, 2002 and 2001, the Company had a liability of $171.1 million and $200.3 million, respectively, for guaranty-fund and other assessments and related recoveries of $14.3 million and $23.4 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 Company’s insurance subsidiaries, domiciled principally in the State of Connecticut, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices are those practices that are incorporated directly or by reference in state laws, regulations, and general
FAS 123 provides an alternative to APB 25 whereby fair values may be ascribed to options using a valuation model and amortized to compensation cost over the vesting period of the options. In 2002, in conjunction with the IPO in March and the Citigroup Distribution in August, the Company’s stock option awards provide for the purchase of the Company’s class A common shares. Prior to 2002 the stock option awards provided for the purchase of Citigroup common stock. The following tables illustrate the pro forma effect on net income (loss) and earnings per share for each period indicated as if the Company applied the fair value recognition provisions of FAS 123 to its employee stock option incentive compensation programs. See note 11 for a description of the method and fair value assumptions used in estimating the fair value of options.
The 2001 and 2000 pro forma fair value of stock-based employee compensation 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. Beginning January 1, 2001, the Company adopted FAS 133 which establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, 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. 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.
Interest rate swaps, equity swaps, credit derivatives, options, forward contracts and financial futures were not significant at December 31, 2002 and 2001. See note 14.
At December 31, 2002, the Company held the following investments that, for purposes of FIN 46, will need to be evaluated to determine whether such investments should be consolidated or disclosed as a variable interest entity in the Company’s future financial statements:
Real estate partnerships and joint ventures that are accounted for under the equity method of accounting and have a total carrying value of $250.8 million on the consolidated balance sheet; the Company’s unfunded commitments associated with real estate partnerships and joint ventures were $192.2 million.
Investment partnerships that are accounted for under the equity method of accounting and have a carrying value of $1.022 billion on the consolidated balance sheet; the Company’s unfunded commitments associated with investment partnerships were $662.4 million.
Below investment grade asset-backed securities and commercial mortgage-backed securities that are reported at fair value and have a carrying value of $128.1 million on the consolidated balance sheet.
Effective January 1, 2003, the Company adopted the fair value method of accounting for its employee stock-based compensation plans as defined in Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation” (FAS 123). FAS 123 indicates that the fair value method is the preferable method of accounting. The Company adopted the fair value method prospectively to awards granted or modified after January 1, 2003 as currently required by FAS 123. The Company does not expect the impact of adopting FAS 123 to be significant in 2003.
provide for the recognition of such costs at the date of management’s commitment to an exit plan. In addition, FAS 146 requires that the liability be measured at fair value and be adjusted for changes in estimated cash flows. The provisions of the new standard are effective for exit or disposal activities initiated after December 31, 2002. The Company does not expect the impact of this new standard to be significant.
Bond markets its products to national, mid-sized and small customers as well as individuals, and distributes them through both national and wholesale brokers, and retail agents and regional brokers. Bond’s range of products includes fidelity and surety bonds, excess SIPC, directors’ and officers’ liability insurance, errors and omissions insurance, professional liability insurance, employment practices liability insurance, fiduciary liability insurance, and other related coverages.
organizations such as employee and affinity groups, and joint marketing arrangements with other insurers.
The Company also has exposure to significant losses from terrorism, primarily in the commercial property and workers’ compensation lines of business. 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 is 7% for 2003, 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 per 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 $570.0 million for 2003 subject to final rules to be established by the U.S. Treasury.
On May 31, 2000, the Company completed the acquisition of the surety business of Reliance Group Holdings, Inc. (Reliance Surety) for $580.0 million. In connection with the acquisition, the Company entered into a reinsurance arrangement for pre-existing business, and the resulting net cash outlay for this transaction was approximately $278.4 million. This transaction included the acquisition of an intangible asset of approximately $450.0 million, which is being amortized over 15 years. The results of operations and the assets and liabilities acquired from Reliance Surety are included in the financial statements beginning June 1, 2000. This acquisition was accounted for as a purchase.
During April 2000, TPC completed a cash tender offer to purchase all of the outstanding shares of TIGHI that it did not already own at a price of $41.95 per share. The total cost of the shares acquired was approximately $2.413 billion and generated goodwill of approximately $1.006 billion. The goodwill represents the excess of the cost of the acquired shares over the minority interest liability recorded by TPC. In conjunction with the purchase of TIGHI’s outstanding shares, TPC entered into a note agreement with Citigroup to borrow up to a maximum of $2.600 billion.
Operating income is reflected net of tax and excludes realized investment gains (losses), restructuring charges, the cumulative effect of changes in accounting principles and TPC minority interest in 2000.
The primary component of the other operating loss is after-tax interest expense of $99.6 million, $133.2 million and $192.1 million in 2002, 2001 and 2000, respectively.
Other assets consists primarily of a receivable under the Citigroup indemnification agreement in 2002, goodwill in 2002, 2001 and 2000 and the investment in CitiInsurance in 2001 and 2000.
At December 31, 2002 and 2001, the Company held CMOs classified as available for sale with a fair value of $4.120 billion and $3.345 billion, respectively. Approximately 58% and 54% of the Company’s CMO holdings are fully collateralized by GNMA, FNMA or FHLMC securities at December 31, 2002 and 2001, respectively. In addition, the Company held $4.815 billion and $2.273 billion of GNMA, FNMA, FHLMC or FHA mortgage-backed pass-through securities classified as available for sale at December 31, 2002 and 2001, respectively. Virtually all of these securities are rated Aaa.
The Company engages in securities lending agreements whereby certain securities from its portfolio are loaned to other institutions for short periods of time. The Company generally receives cash collateral from the borrower, equal to at least the market value of the loaned securities plus accrued interest, and reinvests it in a short-term investment pool. See note 16. The loaned securities remain a recorded asset of the Company, however, the Company records a liability for the amount of the collateral held, representing its obligation to return the collateral related to these loaned securities, and reports that liability as part of other liabilities in the consolidated balance sheet. At December 31, 2002 and 2001, the Company held collateral of $597.9 million and $1.002 billion, respectively.
The Company monitors creditworthiness of counterparties to all financial instruments by using controls that include credit approvals, limits and other monitoring procedures. Collateral for fixed maturities often includes pledges of assets, including stock and other assets, guarantees and letters of credit.
The increase in the claims and claim adjustment expense reserves in 2002 from 2001 was primarily due to the strengthening of the Company’s asbestos reserves, principally in connection with the Company’s asbestos reserve study completed in fourth quarter 2002. Partially offsetting the above were net payments of $578.0 million in 2002 for asbestos, environmental and cumulative injury claims.
The increase in the claims and claim adjustment expense reserves in 2001 from 2000 was primarily due to the additional reserves recorded as part of the acquisition and contribution of certain affiliates (see note 2), and the impact of the terrorist attack on September 11th, 2001. Partially offsetting the above were net payments of $426.6 million in 2001 for asbestos, environmental and cumulative injury claims.
In 2002, estimated claims and claim adjustment expenses for claims arising in prior years was a net unfavorable development of $3.031 billion. This included $3.132 billion of net unfavorable development which impacted results of operations primarily due to unfavorable development of $2.945 billion related to asbestos. Claims arising in prior years for 2002 also included unfavorable development of $150.1 million related to environmental claims and favorable development of $100.1 million related to CIOTA claims. In addition, estimated claims and claim adjustment expenses for claims arising in prior years included net unfavorable development, primarily related to certain Commercial Lines coverages, predominantly in assumed reinsurance specialty businesses, partially offset by favorable development in Commercial Lines workers’ compensation and Personal Lines automobile. In 2002, estimated claims and claim adjustment expenses for claims arising in prior years included $71.2 million of net favorable loss development on Commercial Lines loss sensitive policies in various lines; however, since the business to which it relates is subject to premium adjustments, there is no impact on results of operations. For each of the years ended December 31, 2002, 2001 and 2000, changes in allocations between policy years of unallocated loss adjustment expenses, pursuant to regulatory reporting requirements, are included in claims and claim adjustment expenses for claims arising in prior years and did not impact results of operations.
With respect to its asbestos exposures, 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. Losses paid have increased in 2002 compared to prior years. There has been an acceleration in recent quarters in the amount of payments, including those from prior settlements of coverage disputes entered into between the Company and certain of its policyholders. For 2002, approximately 54% of total paid losses relate to policyholders with whom the Company previously entered into settlement agreements that limit the Company’s liability. Net losses paid were $361.1 million for 2002 compared to $174.8 million for 2001 reflective of the items described above.
As a result of the processes and procedures described above, management believes that the reserves carried for asbestos and environmental claims at December 31, 2002 are appropriately established based upon known facts, current law and management’s judgment. However, the uncertainties surrounding the final resolution of these claims
continue, which may result in the estimates being subject to revision as new information becomes available. These 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 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.
In March 2002, Citigroup entered into an agreement under which it provided the Company with financial support for asbestos claims and related litigation, in any year that the Company’s insurance subsidiaries record asbestos-related income statement charges in excess of $150.0 million, net of any reinsurance, 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 has fully utilized the total benefit available under the agreement.
Because of the uncertainties set forth above, additional liabilities may arise for amounts in excess of the current related reserves. In addition, the Company’s estimate of ultimate claims and claim adjustment expenses may change. These additional liabilities or increases in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to the Company’s results of operations and financial condition in future periods.
In August 2002, the Company entered into a settlement agreement with Shook & Fletcher Insulation Co. (Shook) settling coverage litigation under insurance policies, which the Company issued to Shook. After payments made in the fourth quarter of 2002 under this settlement, the remaining obligations are valued at approximately $99.2 million (after reinsurance and discounting).
On April 13, 2001, TIGHI entered into a $500.0 million revolving line of credit agreement (the line of credit) with Citigroup, which expires in December 2006. On April 16, 2001, TIGHI borrowed $275.0 million on the line of credit. Proceeds from this borrowing together with $225.0 million of commercial paper proceeds were used to pay the $500.0 million 6.75% long-term note payable, which was due on April 16, 2001. On November 8, 2001, TIGHI borrowed another $225.0 million under the line of credit. The proceeds were used to pay off maturing commercial paper. The maturity for all $500.0 million borrowed under this line was extended to November 7, 2003, and the interest rate was fixed at 3.60%. The weighted average interest rate for the line of credit was 3.60% and 3.82% for 2002 and 2001, respectively.
TIGHI has an additional $250.0 million revolving line of credit from Citigroup. TIGHI pays a commitment fee to Citigroup for this line of credit, which expires in 2006. This agreement became effective on December 19, 2001 and replaced a previous facility with a syndicate of banks. Borrowings under this line of credit carry a variable interest rate based upon LIBOR plus 50 basis points. During December 2002, the Company borrowed $250.0 million and subsequently repaid $50.0 million under this line of credit. At December 31, 2002, borrowings outstanding under this line of credit were $200.0 million, and the weighted average interest rate for these borrowings was 1.92% for 2002.
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. This note would have begun to accrue interest from December 31, 2002 on any outstanding balance at the floating rate of the base rate of Citibank, N.A., New York City plus 2.0%. On December 31, 2002, this note was repaid in its entirety.
In March 2002, TPC paid a dividend of $395.0 million to Citigroup in the form of a note payable, which would have begun to bear interest after May 9, 2002 at a rate of 6.0% per annum. This note was prepaid following the offerings.
In March 2002, TPC issued $892.5 million aggregate principal amount of 4.5% convertible junior subordinated notes, which will mature on April 15, 2032, unless earlier redeemed, repurchased or converted. Interest is payable quarterly in arrears. TPC has the option to defer interest payments on the notes for a period not exceeding 20 consecutive interest periods nor beyond the maturity of the notes. During a deferral period, the amount of interest due to holders of the notes will continue to accumulate, and such deferred interest payments will themselves accrue interest. Deferral of any interest can create certain restrictions for TPC.
Unless previously redeemed or repurchased, the notes are convertible into shares of class A common stock at the option of the holders at any time after March 27, 2003 and prior to April 15, 2032 if at any time (1) the average of the daily closing prices of class A common stock for the 20 consecutive trading days immediately prior to the conversion date is at least 20% above the then applicable conversion price on the conversion date, (2) the notes have been called for redemption, (3) specified corporate transactions have occurred, or (4) specified credit rating events with respect to the notes have occurred. The notes will be convertible into shares of class A common stock at a conversion rate of 1.0808 shares of class A common stock for each $25 principal amount of notes (equivalent to an initial conversion price of $23.13 per share of class A common stock), subject to adjustment in certain events.
On or after April 18, 2007, the notes may be redeemed at TPC’s option. TPC is not required to make mandatory redemption or sinking fund payments with respect to the notes.
The notes are general unsecured obligations and are subordinated in right of payment to all existing and future Senior Indebtedness. The notes are also effectively subordinated to all existing and future indebtedness and other liabilities of any of TPC’s current or future subsidiaries.
In August 2002, Commercial Insurance Resources, Inc. (CIRI), a subsidiary of the Company, issued $49.7 million aggregate principal amount of 6.0% convertible notes (the CIRI Notes) which will mature on December 31, 2032 unless earlier redeemed or repurchased (see note 2). Interest on the CIRI Notes is payable quarterly in arrears. The CIRI Notes are convertible as a whole and not in part into shares of CIRI common stock at the option of the holders of 66 2/3% of the aggregate principal amount of the notes, in the event of an Initial Public Offering (IPO) or change of control of CIRI. At any time after the earlier of (a) December 31, 2010 or (b) an IPO by CIRI, the notes may be redeemed by CIRI.
CIRI also issued $85.9 million of mandatory convertible preferred stock during August 2002 (see note 2). 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 $2.2 million were declared and paid during 2002.
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 Promissory Note. The Floating Rate Notes also carry a variable interest rate of LIBOR plus 25 basis points per annum and are callable by the Company after August 5, 2003.
TPC’s primary source of funds for debt service is dividends from subsidiaries, which are subject to various restrictions. See note 10.
The Company has a net operating loss carryforward of $1.390 billion as of December 31, 2002, which expires December 31, 2022. Under terms of the tax sharing agreement with Citigroup, the Company is entitled to carry operating losses back to prior years upon receiving Citigroup’s consent. These years have sufficient taxable income to utilize the entire operating loss carryback. If the carryback is approved, the Company’s deferred tax asset would be reduced by $486.5 million with an offset to the current federal income tax payable.
In the opinion of the Company’s management, realization of the recognized deferred tax asset of $1.447 billion is more likely than not based on expectations as to the Company’s future taxable income. Excluding the effect of the asbestos reserve increase in 2002 (see note 6), the Company has reported pretax financial statement income of $1.848 billion on average over the last three years and has generated federal taxable income exceeding $1.071 billion on average in each year during the same period. Projections of taxable income for 2003 are in excess of the December 31, 2002 net operating loss carryforward of $1.390 billion.
Under the arrangements, taken as a whole, payments due are fully and unconditionally guaranteed on a subordinated basis.
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. TIGHI has the right, at any time, to defer payments of interest on the TIGHI Debentures and consequently the distributions on the TIGHI Securities and common securities would be deferred (though such distributions would continue to accrue with interest thereon since interest would accrue on the TIGHI Debentures during any such extended interest payment period). TIGHI cannot pay dividends on its common stock during such deferments. Distributions on the TIGHI Securities have been classified as interest expense in the consolidated statement of income.
On March 21, 2002, TPC sold approximately 231.0 million shares of its class A common stock in a public offering for net proceeds of $4.090 billion. See note 1.
In 2002, prior to the Company’s IPO, the Company’s Board of Directors adopted a shareholder rights plan as a result of which each outstanding share of the Company’s class A common stock and class B common stock carries with it the right to acquire one-thousandth of a share in a new series of the Company’s preferred stock designated as series A junior participating 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 power.
The Company’s stock incentive plan provides settlement alternatives to employees in which the Company repurchases shares to cover tax withholding costs and exercise costs. At December 31, 2002, TPC had purchased $3.7 million of its common stock under this plan.
TPC’s insurance subsidiaries are subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of insurance regulatory authorities. A maximum of $727.7 million will be available by the end of 2003 for such dividends without prior approval of the Connecticut Insurance Department. However, the payment of a portion of this amount is likely to be subject to approval by the Connecticut Insurance Department, depending upon the amount and timing of the payments. See note 1.
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 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 interest 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 has established stock option programs pursuant to the 2002 Incentive Plan: the Management stock option program and the Wealthbuilder stock option program (see also Restricted Stock Program below). The Management stock option program provides for the granting of stock options to officers and key employees of the Company and its participating subsidiaries. The Wealthbuilder stock option program provides for the granting of stock options to all employees meeting certain requirements. The exercise price of options is equal to the fair market value of the Company’s class A common stock at the time of grant. Generally, options may be exercised for a period of ten years from the date of grant, vest 20% each year over a five-year period and are exercisable only if the optionee is employed by the Company, and for certain periods after employment termination, depending on the cause of termination. The Management stock option program also permits an employee exercising an option to be granted a new option (a reload option) in an amount equal to the number of shares of class A common stock used to satisfy both the exercise price and withholding taxes due upon exercise of an option. The reload options are granted at an exercise price equal to the fair market value of the class A common stock on the date of grant, are exercisable for the remaining term of the related original option, and vest six months after the grant date. The reload feature is not available for initial option grants after January 23, 2003. The Wealthbuilder stock option program does not contain a reload feature.
Prior to the IPO, the Company participated in various stock option plans sponsored by its former affiliate, Citigroup, that provided for the granting of stock options in Citigroup common stock to officers and key employees, and, in the case of certain stock option programs, to all employees meeting specific requirements.
Information with respect to stock option activity under the Company’s stock option plans for the year ended December 31, 2002 is as follows:
The following table summarizes the information about stock options outstanding under the Company’s stock option plans at December 31, 2002:
Prior to the Citigroup Distribution on August 20, 2002, unearned compensation expense associated with the Citigroup restricted common stock grants was included in other assets in the consolidated balance sheet. Following the Citigroup Distribution and the issuance of replacement stock awards in the Company’s class A and class B shares on August 20, 2002, the unamortized unearned compensation expense associated with these awards is included as unearned compensation as a separate component of equity in the consolidated balance sheet. Unearned compensation expense is recognized as a charge to income ratably over the vesting period.
The significant assumptions used during the year in estimating the fair value on the date of the grant for original options and reload options granted in 2002 and for replacement awards issued August 20, 2002 to Company employees who held Citigroup stock option awards on that date were as follows:
Also under FAS 123 reload options are treated as separate grants from the original grants and as a result are separately valued when granted. Reload options are exercisable for the remaining term of the related original option and therefore would generally have a shorter estimated life. Shares received through option exercises under the reload program are subject to restriction on sale. Discounts (as measured by the estimated cost of protection) have been applied to the fair value of reload options granted to reflect these sales restrictions.
For the pension plans, the aggregate projected benefit obligation and the aggregate accumulated benefit obligation were $502.6 million and $482.2 million, respectively, at December 31, 2002.
The principal assumptions used in determining pension and postretirement benefit obligation are shown in the following table:
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. See note 16. In conjunction with the Citigroup Distribution, the Company purchased certain properties from Citigroup. See note 1. Rent expense was $123.3 million, $121.0 million and $113.3 million in 2002, 2001 and 2000, respectively.
Future minimum annual rentals under noncancellable operating leases are $84.5 million, $64.7 million, $49.3 million, $36.5 million, $25.7 million and $40.7 million for 2003, 2004, 2005, 2006, 2007 and 2008 and thereafter, respectively. Future sublease rental income of approximately $4.9 million will partially offset these commitments.
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, 2002, the Company expects to include realized investment losses of approximately $.1 million in earnings over the next twelve months for these cash flow hedges. To the extent these derivatives are not effective, changes in their fair value are immediately included in 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 are 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, 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, 2002 and 2001, the amount included in the foreign currency translation adjustment in equity from nonowner sources was an $8.5 million gain and $3.2 million loss. The ineffective portion is reflected in realized investment gains (losses).
For those hedge relationships that are terminated, hedge designations removed, or forecasted transactions that are no longer expected to occur, the hedge accounting treatment described in the paragraphs above will no longer apply. For fair value hedges, any changes to the hedged item remain as part of the basis of the asset and are ultimately reflected as an element of the yield. For cash flow hedges, any changes in fair value of the end-user derivative remain in accumulated other changes in equity from nonowner sources, and are included in earnings of future periods when earnings are also affected by the variability of the hedged cash flow. If the hedged relationship was discontinued or a forecasted transaction is not expected to occur when scheduled, any changes in fair value of the end-user derivative are immediately reflected in realized investment gains (losses). During the year ended December 31, 2002, the Company recognized a $4.9 million gain from discontinued forecasted transactions. During the year ended December 31, 2001, there were no such discontinued forecasted transactions.
$892.5 million and $789.9 million at December 31, 2002 and 2001, respectively. See note 1.
The carrying values of $607.5 million and $392.7 million of financial instruments classified as other assets approximated their fair values at December 31, 2002 and 2001, respectively. The carrying values of $2.272 billion and $2.556 billion of financial instruments classified as other liabilities at December 31, 2002 and 2001, respectively, also approximated their fair values. Fair value is determined using various methods including discounted cash flows, as appropriate for the various financial instruments.
Prior to the 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 $47.2 million for the period from April 1, 2002 through December 31, 2002. Either party may terminate the agreement effective on the end of a month upon 90 days prior notice. 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.
In conjunction with the purchase of TIGHI’s outstanding shares in April 2000, TPC borrowed $2.2 billion pursuant to a note agreement with Citigroup. At December 31, 2001 the outstanding balance of the note payable to Citigroup was $1.198 billion. This note was prepaid following the offerings. Interest expense included in the consolidated statement of income was $5.5 million, $79.2 million and $112.7 million in 2002, 2001 and 2000, respectively. See notes 2 and 8.
The Company had notes payable to Citigroup of $700.0 million and $500.0 million at December 31, 2002 and 2001, respectively. Interest expense included in the consolidated statement of income was $18.1 million and $8.7 million in 2002 and 2001, respectively. See note 8.
In the ordinary course of business, the Company purchases and sells securities through formerly affiliated broker-dealers. These transactions are conducted on an arm’s-length basis. Commissions are not paid for the purchase and sale of debt securities. In addition, Citigroup performs investment banking and advisory services for the Company. Citigroup was the underwriter of the offerings and received underwriting discounts and commissions of approximately $90.0 million.
The Company purchases annuities from former affiliates to settle certain claims. Through 2004, the Company has agreed to use TIC as the most preferred provider of annuities, as long as Citigroup maintains competitive ratings and its products are competitively priced. Reinsurance recoverables at December 31, 2002 and 2001 included $810.4 million and $824.7 million, respectively, related to these annuities.
In 2002, TPC paid dividends of $5.095 billion to Citigroup in the form of notes payable. These notes were all repaid during 2002. See notes 1 and 8. 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. There were no significant noncash financing or investing activities for the year ended December 31, 2000.