The main offices of General Re are located in a six-story building in Stamford, Connecticut. This building, consisting of approximately 560,000 square feet of office space and a multiple-level parking garage, on approximately eight acres of land, was originally owned by Elm Street Corporation, a wholly owned financial services subsidiary of General Re. In November 1984, the land was leased and the improvements were sold to Stamford Investment Partners. Subsequently, the land and improvements were leased back by General Re. Under the terms of the lease, General Re has the option to purchase the improvements upon expiration of the 25-year lease or at an earlier date upon the occurrence of certain events. General Re has guaranteed the rental obligations of Elm Street Corporation in connection with this transaction.
National Re leases approximately 107,500 square feet of office space in Stamford, Connecticut which was previously used as their principal offices. The lease is noncancellable and will expire in 2009. General Re has subleased this space until 2003 to a third party on approximately the same terms as the original lease.
Only continuing operations are presented. Balance sheet data are as of December 31st. The 1996 North American property/casualty operations include the balance sheet of National Re as of December 31, 1996 and income statement amounts since the October 3, 1996 acquisition. International property/casualty and life/health operations are reported on a one-quarter lag. The international property/casualty operations include Cologne Re for balance sheet amounts beginning at December 31, 1994 and income statement amounts beginning in 1995. Only nine months of Cologne Re's 1995 results are included in General Re's 1995 results due to the one-quarter reporting lag. Loss ratios, expense ratios and combined ratios shown in the table are computed in relation to net premiums earned (referred to as a "GAAP" combined ratio).
(4) Return on equity is computed based on income from continuing operations excluding after-tax realized gains and cumulative effects of accounting changes divided by average common stockholders' equity at the beginning and end of the year.
(8) The common share price information is based on General Re Corporation's daily closing price on the New York Stock Exchange.
Net income in 1995 was $825 million or $9.92 per share, an increase of 24.5 percent over $7.97 per share earned in 1994. These results include after-tax realized gains of $.45 per share in 1995 and $.54 per share in 1994. The improved results in 1995 were primarily attributable to increased underwriting profitability in the North American property/casualty operations, growth in after-tax investment income and increased income from General Re's international property/casualty operations. The 1995 results include three quarters of the year's results for Cologne Re and GR-CK, which are not reflected in the comparable 1994 amounts, since GR-CK was not formed until December 28, 1994.
Consolidated net premiums written in 1995 were $6,102 million, an increase of $3,101 million or 103.3 percent from $3,001 million in 1994. North American property/casualty premium volume was $2,964 million in 1995, compared with $2,581 million in 1994, an increase of 14.9 percent. Net premiums written in the international property/casualty reinsurance operations were $2,429 million in 1995, compared to $420 million in 1994, with most of the growth attributable to the inclusion of Cologne Re's premiums during the year. In addition, the underwriting results of General Re's wholly owned European operations, which were predominantly reported on
a full underwriting-year lag in prior years, are now reported on a one-quarter lag, beginning in 1995. The international wholly owned subsidiaries' net premiums written increased by $263 million during 1995 due to this change in reporting, although net income was not materially affected by the change. Net premiums written for the life/health segment, which consist of Cologne Re's North American and international life/health operations, were $709 million for 1995.
On October 3, 1996, General Re Corporation acquired all of the outstanding shares of National Re, a North American property/casualty reinsurance group, in exchange for 4,023,901 shares of General Re's common stock and $313 million in cash, including expenses, for a total cost of $900 million. National Re provides property and casualty reinsurance to insurers written on a direct basis. In 1996, National Re's full-year gross premiums written
[PIE CHART] Net premiums written in 1996 for the North American property/casualty GRC Treaty & Facultative 87.5% operations were $3,081 million, an increase of 3.9 percent from $2,964 General Star 8.3% million in 1995. The pie chart to the left depicts the relative share of Genesis 4.2% property/casualty premium by operating unit and the table below shows net premiums for the past three years by operating unit.
The Genesis operations provide direct excess insurance and reinsurance to companies with self-insurance programs. Net premiums written for Genesis increased during the year by 15.9 percent over 1995 levels, principally due to growth in directors' and officers' coverage. Property premiums grew by $8 million due to increased emphasis on multiple line programs with existing accounts.
Income before taxes and realized gains for the international property/casualty operations of $200 million in 1995 increased 334.4 percent over 1994 levels. The segment's results in 1995 were significantly affected by the inclusion of Cologne Re's results and, therefore, are not directly comparable to the results in 1994.
On December 28, 1994, General Re and Colonia Konzern AG ("Colonia") formed a new company that acquired 75 percent of the ordinary shares and approximately 30 percent of the preference shares of Cologne Re, which collectively represents a 66.3 percent economic interest in Cologne Re. In exchange for its Cologne Re shares, Colonia, for itself and as trustee for Nordstern Allgemeine Versicherungs AG (collectively, "CKAG"), received 100 percent of the Class A shares of the new company, GR-CK. General Re initially contributed $884 million (DM 1,377 million) to GR-CK in exchange for 100 percent of the Class B shares of GR-CK. On December 30, 1994, GR-CK paid $302 million (DM 475 million) to General Re in exchange for notes in the principal amount of DM 475 million. The notes pay interest of 8.0 percent annually to GR-CK and are due on December 30, 2004. The intercompany notes have been eliminated in consolidation. The funds invested in GR-CK are subject to certain investment restrictions according to the joint-venture agreement.
The life/health operations include a full year of results in 1996 as compared to only three quarters of life/health operations in 1995, due to General Re's reporting of its international operations on a quarter lag. This segment includes the North American and international life/health operations of Cologne Re. During 1996, the life/health operations' income before taxes and realized gains increased by 6.4 percent. Excluding the effect of the quarter lag, life/health income would have declined 17.4 percent in 1996 due to lower underwriting margins.
Net premiums written in 1996 were $1,075 million, an increase of 51.7 percent over 1995. Excluding the effect from the quarter lag, life/health premiums increased 16.4 percent in 1996. Approximately 43 percent of General Re's life/health net premiums was written in Europe, another 42 percent was written in North America and the remaining 15 percent was written throughout the rest of the world. The segment experienced strong premium growth in both North America and internationally. The North American operation's growth was primarily in the individual life, group life and individual health segments. The international operation's growth was spread throughout Europe, the United Kingdom and Australia. The 1996 underwriting income of $2 million decreased by $8 million from 1995 due to increased frequency in mortality experience and higher claims in the Medicare supplement and long-term care lines in the North American operations. Investment income increased by $19 million in 1996 as compared to 1995, in part due to the four quarters of investment income in 1996.
The financial services operations include General Re's derivative products, insurance brokerage and management, investment management, reinsurance brokerage and real estate management operations. Pretax income for the financial services operations was $100 million in each of 1996 and 1995. The overall unchanged result was due to lower 1996 income in General Re's derivative products operations, General Re Financial Products Corporation and affiliates ("GRFP"), and from U.S. Aviation Underwriters, Inc., an aviation pool manager, partially offset by increased income from General Re Underwriting Services Limited, which provided underwriting services for Tempest Reinsurance Company Limited ("Tempest"), an affiliated Bermuda-based company specializing in excess property catastrophe reinsurance. This underwriting services agreement was terminated on July 1, 1996 when General Re sold its 20.7 percent interest in Tempest; this termination eliminated a major portion of General Re Underwriting Services Limited's operations.
In August 1995, General Re acquired all of the outstanding stock of New England Asset Management in exchange for stock of General Re and combined it with General Re's own investment management subsidiary. The resulting company, General Re-New England Asset Management, Inc. ("GR-NEAM"), provides investment management services primarily for other insurance companies that seek General Re's expertise in managing insurance company investment portfolios. GR-NEAM has approximately 48 insurance company clients and approximately $10 billion of client assets under management or advisement at December 31, 1996.
General Re's North American property/casualty investment portfolios are managed for both after-tax total return and after-tax current income. These investment objectives take into consideration the duration of the operation's liabilities and investment parameters requiring high credit quality across the portfolios. At December 31, 1996, total invested assets of the North American property/casualty operations were $14,879 million, a 10.4 percent increase over 1995 invested assets.
The table below shows the average maturity and effective duration of the North American taxable and tax-exempt portfolios in years:
At December 31, 1996, the effective average maturity of the fixed-maturity portfolio was 10.3 years, compared to an estimated average life of 10.6 years for General Re's property/casualty claim liabilities. The duration of property/casualty assets was 5.1 years, compared with 4.5 years for the property/casualty claim liabilities. This compares with 1995 durations of 5.1 years and 4.9 years, respectively. The decrease in the duration of General Re's property/casualty claim liabilities at December 31, 1996 was principally due to the mix of premiums written.
At December 31, 1996, common equity investments in the North American portfolio totaled $2,925 million, representing 19.6 percent of the North American property/casualty investment portfolio. The North American equity portfolio is well diversified and primarily consists of holdings in companies with large market capitalizations which collectively have a calculated volatility approximating the Standard & Poor's 500 index. During 1996, General Re purchased futures contracts to hedge a portion of the common equity portfolio as a means to achieve target asset allocations within the North American portfolio. To the extent that General Re's portfolio held the same securities as the futures contracts, related gains and losses on the futures contracts were treated as basis adjustments to those securities held. Otherwise, gains and losses on the futures contracts were not deemed to qualify for such hedge accounting treatment. In 1996, realized gains included $72 million of losses from these futures contracts and $53 million of losses were recorded as basis adjustments for hedged equities.
A small portion of the North American investment portfolio was dedicated to nontraditional, private investments. These alternative investments, included in the balance sheet caption, "Other invested assets," were $435 million (1.6 percent of consolidated invested assets) and $344 million (1.5 percent of consolidated invested assets) at December 31, 1996 and 1995, respectively. Most of these investments are interests in limited partnerships managed by outside professional managers. Over time, these investments are expected to provide a higher return than the overall North American property/casualty investment portfolio. This segment, however, also may entail a greater amount of risk both in terms of limited liquidity and greater uncertainty of returns compared to the rest of General Re's portfolio. General Re evaluates the fair value of these alternative investments on a quarterly basis by reviewing available financial information of the investee and performing other financial analyses in consultation with external advisors. Any changes in the fair value of limited partnerships are included in unrealized appreciation or depreciation in common stockholders' equity, unless a decline in fair value is considered other than temporary, resulting in a charge to income.
The overall pretax yield on the North American property/casualty invested assets was 5.4 percent in 1996 and 5.9 percent in 1995. During 1996, the segment had approximately $494 million of calls and maturities on grandfathered tax-exempt bonds. These bonds had an average yield of approximately 7.9 percent and the proceeds from the calls were reinvested at an average yield of approximately 5.3 percent.
Pretax total return for North American investments was 7.1 percent in 1996, compared with a return of 18.9 percent in 1995 and (2.2) percent in 1994. Almost all investment sectors recorded lower returns in 1996 than in 1995, primarily due to higher interest rates in 1996 and a difficult comparison against the very favorable gains in U.S. equity markets during 1995. The total pretax returns on the North American investment portfolio by major asset class were as follows:
The total after-tax return for the North American investment portfolio was 6.0 percent in 1996.
General Re's international investment portfolios are managed for both after- tax total return and after-tax investment income, taking into consideration the duration and currency structure of the operations' reinsurance liabilities. The investment objectives of each individual subsidiary company within the segment are determined by specific investment guidelines which consider the different legal and tax requirements in their respective jurisdictions.
The gross liability and reinsurance recoverable for claims and claim expenses were based on General Re's analysis of reports and individual case estimates received from ceding companies. The liability and related recoverables, which include an amount estimated by General Re for claims and claim expenses incurred but not reported ("IBNR"), are evaluated continuously by management, annually by General Re's independent accountants in conjunction with their audit and periodically by independent consulting actuaries at the discretion of the Board of Directors. Any resulting adjustments are included in the current period's income.
General Re discounts certain liabilities associated with workers' compensation claims. Current statutory rules allow the discounting of "tabular reserves" as defined and allow discounting of nontabular reserves if permitted by the insurer's state of domicile. As of December 31, 1996, General Re recorded $1,662 million in claim liability discount, of which $970 million relates to tabular reserves and $692 million relates to nontabular reserves for medical costs associated with tabular reserve claims. The Delaware Insurance Department confirmed that General Re may discount both its tabular reserves and the medical expenses associated with such tabular reserves at 4.5 percent per year.
Major catastrophe losses in recent years have had a significant effect on the insurance and reinsurance industry. General Re has exposure to windstorm, hail, earthquake and other catastrophic events, all of which are managed through several measures, including strong underwriting controls, occurrence caps on certain property treaties, modeling and monitoring its accumulations and imposing zonal limits. In addition, General Re uses its retrocessional programs to provide catastrophe protection.
The asset and liability positions of the financial services operations fluctuate based on ongoing derivatives transactions and related risk management activities. The purchase of U.S. and foreign government securities (fixed maturities at fair value), which are primarily financed through collateralized repurchase agreements (securities sold under agreements to repurchase), and the "short" sale of U.S. and foreign government securities (securities sold but not yet purchased), whose proceeds are invested in reverse repurchase agreements (securities purchased under agreements to resell), contribute to the short-term fluctuations in the operations' total assets and liabilities, while generally not having any material effect on common stockholders' equity. During 1996, invested assets of these operations increased $915 million to $3,393 million. Securities purchased under agreements to resell (an asset) declined $66 million in 1996. Securities sold under agreements to repurchase (a liability) increased $722 million in 1996 to $1,985 million. Securities sold but not yet purchased represent obligations of General Re to deliver the specified security at the contracted price, thereby creating a liability to repurchase the security in the market at prevailing prices. Accordingly, General Re's ultimate obligation to satisfy the sale of securities sold but not yet purchased may exceed the amount recognized in the balance sheet. The liability for securities sold but not yet purchased increased $255 million in 1996 to $869 million at December 31, 1996.
GRFP controls its market risk exposures through the use of cash instruments and derivative transactions. GRFP's components of market risk include foreign exchange, interest rate, equity, swap spread, volatility, correlation and yield curve risk. GRFP controls these risk exposures by taking offsetting positions in either cash instruments or other derivatives to reduce the overall exposure to loss due to movements in these variables. GRFP manages its exposures on a portfolio basis. Under this approach, GRFP monitors its market risk on a daily basis across all swap and option products by calculating the effect on operating results of potential changes in market variables over a one-week period, based on historical market volatility data and informed judgment. GRFP's 1996 aggregate weekly market risk limit across all trading books was $10 million.
The "value-at-risk" table below shows the aggregate risk management limit, as defined, and highest and lowest profits and losses recorded over one-week periods.
GRFP evaluates and records a fair-value adjustment against trading revenue to recognize counterparty credit exposure and future costs associated with administering each contract. The expected credit exposure for each trade is initially established on the trade date and is determined through the use of a proprietary credit exposure model that is based on historical default probabilities, market volatilities and, if applicable, the legal right of setoff. These exposures are continually monitored and adjusted due to changes in the credit quality of the counterparty, changes in interest and currency rates or changes in other factors affecting credit exposure. The fair value allowance for counterparty credit exposures and future administrative costs on existing contracts was $77 million and $67 million at December 31, 1996 and 1995, respectively. GRFP has not experienced any credit losses as a result of counterparty defaults.
Common stockholders' equity at December 31, 1996 was $7,326 million, or $89.82 per share, an increase of 12.0 percent over $80.22 per share at December 31, 1995. The increase was primarily due to net income of $894 million, the reissuance of treasury stock for the acquisition of National Re of $587 million, after-tax unrealized appreciation of $157 million, less stock repurchases of $735 million and dividends paid of $174 million. Common stockholders' equity at December 31, 1995 increased 35.6 percent over the $4,859 million at year end 1994.
has $1.2 billion of available lines of credit which provide financial flexibility to support General Re Corporation's commercial paper program. The credit lines consist of a 364-day facility of $400 million and a five-year credit facility of the remaining $800 million. The credit agreements with the banks require General Re to maintain a minimum consolidated tangible net worth, as defined, of $2.7 billion. All $1.2 billion of available lines of credit were unused at December 31, 1996 and 1995.
See Note 2 to the consolidated financial statements on page 40 for a discussion of new accounting standards.
1) Changes in the level of competition in the North American and international reinsurance or primary insurance markets that adversely affect the volume or profitability of General Re's property/casualty or life/health businesses. These changes include, but are not limited to, the intensification of price competition, the entry of new competitors, existing competitors exiting the market, and the development of new products by new and existing competitors;
2) Changes in the demand for reinsurance, including changes in ceding companies' retentions, and changes in the demand for excess and surplus lines insurance coverages in North America;
8) Changes in General Re's property/casualty and life/health businesses retrocessional arrangements;
9) Lower than estimated retrocessional or reinsurance recoveries on unpaid losses, including, but not limited to, losses due to a decline in the creditworthiness of General Re's retrocessionaires or reinsurers;
13) Changes in mortality or morbidity levels that affect General Re's life/health business;
16) Adverse results in litigation matters, including, but not limited to, litigation related to environmental, asbestos and other potential mass tort claims; and
In addition to the factors outlined above that are directly related to General Re's businesses, General Re is also subject to general business risks, including, but not limited to, adverse state, federal or foreign legislation and regulation, adverse publicity or news coverage, changes in general economic factors, and the loss of key employees.
The upper "triangle" of data shows the reestimated amount of the previously recorded net liability based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the frequency and severity of claims for individual years.
The "cumulative (deficiency) redundancy" represents the aggregate change in the initial estimates from the original balance sheet date through December 31, 1996. Annual changes in the estimates are included in current operating results each year as the liabilities are reevaluated. The deficiencies shown in the tables represent cumulative differences between the original estimate and the current balance sheet liabilities and therefore they should not be summed. The lower "triangle" of data shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year.
General Re purchases reinsurance, in both the North American and international markets, which provides protection from large property, liability or workers' compensation claims and allows General Re to offer greater capacity to clients for certain lines of business. General Re increased its capacity over time by retaining more risk and by purchasing additional reinsurance protection above its retentions. General Re believes it has selected financially sound reinsurers and anticipates receiving the full amounts recoverable, net of allowances provided for uncollectible reinsurance recoverables.
Table 3 and Table 4 present the development of net and gross balance sheet liabilities for General Re's international property/casualty operations beginning in 1994. The accident-year information required to complete Table 3 and Table 4 for General Re's wholly owned international subsidiaries was not available in prior years. These liabilities, however, were not significant to the consolidated total liabilities in prior periods. Due to lags in receiving underwriting activity reports from ceding companies in Europe, there may be correlated development of both premium and claims in the international operations and fluctuations due to currency movement. The effect of currency movements on these liabilities has been separately reported in these two tables.
- -------- * The liability for workers' compensation tabular reserves for claims and claim expenses is discounted as discussed herein. Therefore, the liability reestimated for each year includes the effect of the discount and its amortization.
ANALYSIS OF INTERNATIONAL GROSS CLAIMS AND CLAIM EXPENSE DEVELOPMENT (IN MILLIONS)
To the Board of Directors and Stockholders of General Re Corporation Stamford, Connecticut
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (IN MILLIONS, EXCEPT SHARE DATA)
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (IN MILLIONS)
General Re's North American property/casualty operations produced revenues of $3,887 million, or 47 percent, of consolidated revenues in 1996. The principal business of these subsidiaries is treaty and facultative reinsurance underwritten on a direct basis throughout North America. General Re predominately writes excess-of-loss reinsurance across various lines of business.
General Re's life/health reinsurance operations produced revenues of $1,134 million, or 14 percent, of the consolidated total in 1996. These operations include the North American and international life/health reinsurance operations of Cologne Re.
BASIS OF PRESENTATION: General Re's consolidated financial statements have been prepared on the basis of generally accepted accounting principles in the United States. The consolidated financial statements include General Re Corporation and its subsidiaries. All significant intercompany transactions have been eliminated. The North American property/casualty results include the results of National Re Corporation and its subsidiaries ("National Re") since the date of acquisition on October 3, 1996. International property/casualty and life/health subsidiaries report their results on a quarter lag. Certain other reclassifications have been made to 1995 and 1994 balances to conform to the 1996 presentation.
INVESTMENTS: Fixed maturity securities that General Re may sell prior to maturity in response to changes in market interest rates, changes in liquidity needs, or other factors and equity securities are classified as available-for- sale and carried at fair value, with unrealized gains and losses, net of deferred income taxes, excluded from income and reported in a separate component of common stockholders' equity. Fixed maturity securities that are held for resale are classified as trading and carried at fair value, with unrealized gains and losses included in income.
Realized gains or losses on sales of investments are primarily determined on the basis of identified cost and include adjustments to the net realizable value of investments for declines in value that are considered to be other
Included in other invested assets are investments in reinsurance joint ventures, limited partnerships and real estate. Reinsurance ventures reported under the equity method are carried at initial cost with adjustment after acquisition for General Re's proportionate share of the venture's earnings. The amount of the adjustment is included in "Other revenues." Limited partnership investments are carried at estimated fair value. Real estate is valued at cost and depreciated over its estimated useful life.
CLAIMS AND CLAIM EXPENSES: The liability for claims and claim expenses is based on reports and individual case estimates received from ceding companies. The liability also includes incurred but not reported claims and claim expenses, which are actuarially estimated based on past experience and are reduced by anticipated salvage and subrogation recoverable. The methods of determining such estimates and establishing the related liabilities are regularly reviewed and updated, and any resulting adjustments are included in income currently. Reinsurance recoveries on unpaid claims and claim expenses, net of uncollectible amounts, are recognized as assets at the same time and in a manner consistent with General Re's method for establishing the related liability. Workers' compensation liabilities, after deduction of reinsurance recoverable for unpaid losses, were $1,490 million and $1,244 million at December 31, 1996 and 1995, respectively, after being discounted at an interest rate of 4.5 percent.
FUNDS HELD BY REINSURED COMPANIES: Funds held by reinsured companies represent ceded premium retained by the ceding company for a period according to contractual terms. General Re generally earns investment income on these balances during the period funds are held.
On October 3, 1996, General Re acquired all of the outstanding shares of National Re, a North American property/casualty reinsurance group, in exchange for 4,023,901 shares of General Re Corporation's common stock and $313 million in cash, including expenses, for a total cost of $900 million. The acquisition of the shares of National Re has been accounted for as a purchase. The results of operations subsequent to the date of acquisition are included in General Re's consolidated operating results. At December 31, 1996, National Re's assets and liabilities at acquisition were included in General Re's consolidated balance sheet. Pro forma figures showing the effect of this acquisition on General Re's 1995 and 1996 net income and stockholders' equity have not been presented due to immateriality.
On December 28, 1994, General Re and Colonia Konzern AG ("Colonia") formed a new company that acquired 75 percent of the ordinary shares and approximately 30 percent of the preference shares of Cologne Re, which collectively represents a 66.3 percent economic interest in Cologne Re. In exchange for its Cologne Re shares, Colonia, for itself and as trustee for Nordstern Allgemeine Versicherungs AG (collectively, "CKAG"), received 100 percent of the Class A shares of the new company, General Re-CKAG Reinsurance and Investment S.a r.1. ("GR-CK"). General Re initially contributed $884 million (DM 1,377 million) to GR-CK in exchange for 100 percent of the Class B shares of GR-CK. On December 30, 1994, GR-CK paid $302 million (DM 475 million) to General Re in exchange for notes in the principal amount of DM 475 million. The notes pay interest of 8.0 percent annually to GR-CK and are due on December 30, 2004. The intercompany notes have been eliminated in consolidation. The funds invested in GR-CK are subject to certain restrictions according to the joint venture agreement.
The acquisition of the shares of Cologne Re through GR-CK has been accounted for as a purchase. General Re has consolidated GR-CK and Cologne Re in its financial statements and recorded as minority interests the share of CKAG in GR-CK and of the other stockholders in Cologne Re.
During the second quarter of 1995, Cologne Re completed a rights offering that raised DM 437 million ($317 million at the June 30, 1995 exchange rate), which increased its capital under U.S. generally accepted accounting principles by 62.9 percent over the amount at December 31, 1994. In connection with Cologne Re's rights offering, GR-CK subscribed for its pro rata share, approximately DM 297 million ($215 million at the June 30, 1995 exchange rate), of the offering. In addition to its ownership in Cologne Re through GR-CK, General Re purchased for its own account an additional 8.4 percent of the ordinary and preference shares of Cologne Re through December 31, 1996 for aggregate consideration of $85 million, which increased General Re's
consolidated economic interest in Cologne Re to 74.7 percent. The purchases of additional Cologne Re shares are accounted for as a step acquisition. Under the step acquisition method of accounting, the fair value of assets and liabilities are recorded at each acquisition date with the excess of cost over fair value recorded as incremental goodwill.
In September 1993, General Re acted as sponsor in the formation of Tempest Reinsurance Company Limited ("Tempest"), a Bermuda-based reinsurance company specializing in excess property catastrophe reinsurance. On July 1, 1996, General Re sold its 20.7 percent interest in Tempest and its stock options, and terminated its underwriting services agreement with Tempest for $216 million in total consideration.
General Re's North American reinsurance and insurance subsidiaries file financial statements prepared in accordance with statutory accounting practices prescribed or permitted by insurance regulators. Statutory accounting differs from generally accepted accounting principles in the reporting of certain reinsurance contracts, investments, subsidiaries, acquisition expenses, fixed assets, deferred income taxes and certain other items. Combined statutory surplus at December 31, 1996 and 1995 was $5,326 million and $4,607 million, respectively, and combined statutory net income for the years ended December 31, 1996, 1995 and 1994 was $777 million, $621 million and $511 million, respectively.
General Re prepares statutory financial statements in accordance with accounting practices prescribed or permitted by their domiciliary state's insurance department. Prescribed accounting practices include a variety of publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed that have been permitted by the insurance department of the insurer's domiciliary state. As discussed in Note 1, General Re discounts certain workers' compensation liabilities at an annual rate of 4.5 percent. Included in the discount recognized for statutory purposes at December 31, 1996 was $692 million resulting from discounting permitted by the domiciliary insurance department.
Gross gains of $148 million, $117 million and $57 million and gross losses of $93 million, $73 million and $120 million were realized on sales of available- for-sale fixed maturities in 1996, 1995 and 1994, respectively. The contractual maturities of fixed maturity investments--available-for-sale are shown in the following table. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay certain obligations.
Realized gains or losses recognized in income for fixed maturities and equity securities were as follows:
The 9.00 percent note issued by General Re Corporation in conjunction with the Employee Savings and Stock Ownership Plan has a covenant requiring General Re not to encumber its common stock holding in GRC, the largest subsidiary of General Re. The 8.85 percent and 7.50 percent notes were issued by National Re on January 19, 1995 and July 31, 1995, respectively. These notes have a par value of $100 million and $25 million, respectively, and have been recorded on the balance sheet at their fair value at the acquisition date of National Re. The difference between their fair value and par value is recognized as an adjustment to interest expense over the life of the notes. The 7.70 percent mortgage payable is collateralized by General Re's prior home office.
Substantially all of General Re's employees in the United States will become eligible for certain health care and group life insurance benefits upon retirement from General Re. General Re has funded the benefit cost of current retirees, with the retiree paying a portion of the costs. The retiree's portion of the costs varies depending upon the individual's length of service with General Re upon retirement. General Re funded $3 million for postretirement health care benefits for current retirees in both 1996 and 1995 and had an accrued liability of $30 million and $27 million, respectively, for current employees.
The Plan also permits the granting of restricted stock awards as compensation to officers of General Re. Shares of restricted stock become outstanding upon grant, receive dividends and have voting rights identical to other outstanding shares of common stock. Restrictions lapse upon termination of the restriction period or upon death, disability or normal retirement. During 1996, 1995 and 1994, General Re made aggregate compensatory restricted stock awards of 96,153, 31,900 and 17,250 shares, respectively. The cost of restricted stock awards is based on the market value of the common stock at the date of grant and is recognized as expense over the restriction period.
General Re leases office space and computer equipment under noncancelable leases expiring in various years through 2010. Several of the leases have renewal options with various terms and rental rate adjustments. Rental expense was $32 million in 1996, $31 million in 1995 and $32 million in 1994. At December 31, 1996, the future minimum annual rental commitments under noncancelable leases were as follows:
Future minimum rental payments above have not been reduced by $48 million of anticipated sublease rental income on noncancelable leases.
General Re utilizes reinsurance to reduce its exposure to large claims. These agreements provide for recovery of a portion of certain claims and claim expenses from reinsurers. If the reinsurers are unable to meet their obligations under the agreements, General Re would be liable for such defaulted amounts. General Re holds partial collateral under these agreements and has never suffered a significant loss because of defaults. General Re utilizes various North American and international reinsurers as part of its retrocessional program. Prior to
being included in General Re's retrocessional program, reinsurers are reviewed for their anticipated long-term creditworthiness by General Re's Retrocessional Market Committee. At December 31, 1996, the largest reinsurance recoverable on unpaid claims and claim expenses from any single reinsurer was $382 million. The reinsurer is rated A++ by A.M. Best and has a Standard & Poor's claims-paying ability rating of AAA.
The laws also subject extraordinary dividends and other extraordinary distributions to insurance company stockholders to regulatory approval. Under the insurance laws of the State of Delaware, GRC's state of domicile, dividends or distributions in a twelve-month period exceeding the greater of 10 percent of an insurance company's surplus or 100 percent of net income, excluding realized gains, for the previous calendar year are generally considered extraordinary and require such approval.
GRFP's products include interest rate, currency and equity swaps and options, as well as structured finance products. These instruments are carried at their current estimates of fair value, which is a function of underlying interest rates, currency rates, security values, volatilities and the creditworthiness of counterparties. Future changes in these factors or a combination thereof may affect the fair value of these instruments with any resulting adjustment, including amounts in excess of those previously recognized in the financial statements, being included currently in the income statement.
The results of GRFP's trading activities are summarized by profit centers in the following table. Trading revenues include any associated gains and losses on hedging instruments. Trading revenue is included in "Other revenues" in the income statement.
The table below discloses the net fair value or carrying amount at the reporting date for each class of derivative financial contract held or issued by GRFP for trading purposes, as well as the average fair value during the year, based on monthly observations. The net fair values reflect rights of setoff and qualifying master netting arrangements with various counterparties in accordance with Financial Accounting Standards Board Interpretation 39, Offsetting Amounts Related to Certain Contracts. Interest rate and foreign currency swaps shown in the table below include forward rate agreements and foreign exchange spot and forward contracts.
Credit risk arises from the possible inability of counterparties to meet the terms of their contracts. GRFP evaluates and records a fair value adjustment against trading revenue to recognize counterparty credit exposure and future costs associated with administering each contract. The expected credit exposure for each trade is initially established on the trade date and is determined through the use of a proprietary credit exposure model that is based on historical default probabilities, market volatilities and, if applicable, the legal right of setoff. These exposures are continually monitored and the fair value adjustment is adjusted to reflect the changes in the credit quality of the counterparty, changes in interest and currency rates or changes in other factors affecting credit exposures. The fair value allowance for counterparty credit exposures and future administrative costs on existing contracts was $77 million at December 31, 1996. GRFP has not experienced any write-offs on such contracts. In the event counterparties are unable to fulfill their contractual obligations, future losses due to defaults may exceed amounts currently recognized in the balance sheet.
GRFP enters into exchange traded futures contracts for delayed delivery of foreign currencies or securities in which the seller/purchaser agrees to make/take delivery at a specified future date of a specified instrument, at a specified price or yield. Risks arise from the inability of the futures exchange to meet the terms of the contracts and from counterparties' inability to meet their margin requirements.
Investments--Fair values for fixed maturities and equity securities were generally based on quoted market prices or dealer quotes. The fair value of investments in limited partnerships, which were included in other invested assets on the balance sheet, was determined by reviewing available financial information of the investee and by performing other financial analyses in consultation with external advisors. Fair values for investments in real estate were determined using discounted cash flow analyses for each property. Fair values for reinsurance ventures were based on General Re's proportionate share in the entity's stockholders' equity, since the cost of determining fair value exceeds the benefits derived. The carrying amounts for short-term investments approximate their fair values.
Securities purchased under agreements to resell, securities sold under agreements to repurchase--The carrying value for these financial instruments approximates their fair value.