The Company's executive offices are located in Hartford, Connecticut. The Company rents from an affiliate of Citigroup approximately 1,030,000 square feet of office space in Hartford, Connecticut, under a ten-year lease that expires on April 1, 2006 and, subject to certain conditions, is renewable by the Company for additional five-year terms. Under certain circumstances, the Company may be required to purchase the leased premises. In addition, the Company leases 175 field and claim offices totaling approximately 4,643,000 square feet throughout the United States under leases or subleases with third parties. The Company also rents from Aetna approximately 373,000 square feet of office space at CityPlace, located in Hartford, Connecticut, under an eight-year sublease that expires in 2004.
Management's narrative analysis of the results of operations is presented in lieu of Management's
Discussion and Analysis of Financial Condition and Results of Operations, pursuant to General Instruction I (2) (a) of Form 10-K.
During April 2000, TIGI completed a cash tender offer to purchase all of the outstanding shares of Class A Common Stock of TPC at a price of $41.95 per share. TIGI also established a wholly-owned subsidiary of TIGI which effected a merger pursuant to which TPC became a wholly-owned subsidiary of TIGI. Upon the merger of the new subsidiary into TPC, all previously outstanding shares of Class A Common Stock of TPC became authorized and unissued shares and the 1,000 shares of Common Stock of the new subsidiary (held by TIGI) were exchanged for 1,000 shares of Class A Common Stock of TPC. On June 29, 2000, the Company restated its certificate of incorporation and reclassified the Class A Common Stock to Common Stock, which had the effect of retiring all treasury stock. At December 31, 2000 TPC's common stock outstanding consists of 1,000 shares of Common Stock, which are 100% owned by TIGI. These transactions also generated goodwill of approximately $1.0 billion, which TIGI allocated to TPC. The goodwill is being amortized over 36 years.
On May 31, 2000, the Company completed its acquisition of the surety business of Reliance Group Holdings, Inc. (Reliance Surety) for $580 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 million. This transaction included the acquisition of an intangible asset of approximately $450 million, which is being amortized over 15 years. Accordingly, 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.
In the third quarter of 2000, the Company purchased the renewal rights to a portion of Reliance Group Holdings, Inc.'s commercial lines middle-market book of business (Reliance Middle Market). The Company also acquired the renewal rights to Frontier Insurance Group, Inc.'s (Frontier) environmental, excess and surplus lines casualty businesses and certain classes of surety business.
Excluding realized investment gains in all years and the cumulative effect of changes in accounting principles in 1999 described above, operating income was $1.449 billion in 2000, $1.337 billion in 1999 and $1.250 billion in 1998. The increase in operating income in 2000 from 1999 was due to Commercial Lines rate increases, lower catastrophe losses, higher net investment income, the 1999 charge related to curtailing the sale of TRAVELERS SECURE(R) auto and homeowners products marketed through the agents of Primerica Financial Services, a unit of Citigroup, higher fee income and lower operating expenses. These factors were partially offset by increased loss cost trends primarily due to inflationary pressures and lower favorable prior-year reserve development. Results for 2000 and 1999 reflected benefits resulting from legislative actions that changed the manner in which certain states finance their workers' compensation second injury funds, principally in the states of New York and Pennsylvania. The increase in operating income in 1999 from 1998 was primarily due to favorable prior-year reserve development and lower weather-related losses in Commercial Lines, the benefit of the legislative actions in the states of New York and Pennsylvania, an increase in income due to the growth in Personal Lines and lower operating expenses. These factors were partially offset by higher catastrophe losses principally due to Hurricane Floyd, higher loss ratios in the TRAVELERS SECURE(R) program, a charge related to curtailing the sale of TRAVELERS SECURE(R) auto and homeowners products, lower favorable prior-year reserve development in Personal Lines and lower Commercial Lines fee income.
Revenues of $11.068 billion in 2000 increased $496 million from 1999. Revenues of $10.572 billion in 1999 increased $121 million from 1998. The increase in revenue in 2000 from 1999 was due to higher earned premiums, higher net investment income and higher fee income, partially offset by lower realized gains. The increase in earned premiums in 2000 was primarily due to Commercial Lines rate increases and the impact of the ongoing business associated with the Reliance Surety acquisition and the new business associated with the acquisition of the renewal rights for the Reliance Middle Market and Frontier businesses. The 1999 increase was primarily attributable to growth in earned premiums in Personal Lines, partially offset by lower earned premiums in Commercial Lines, lower realized investment gains and lower fee income.
GAAP combined ratios differ from statutory combined ratios primarily due to the deferral and amortization of certain expenses for GAAP reporting purposes only.
The 2000 statutory combined ratio before policyholder dividends, excluding the Reliance Surety adjustment, was virtually the same as the 1999 statutory combined ratio before policyholder dividends, excluding the commutation and quota share reinsurance adjustments. The 2000 statutory loss and loss adjustment expense ratio component increased primarily due to increased loss cost trends and lower favorable prior-year reserve development, partially offset by lower catastrophe losses. The 2000 statutory underwriting expense ratio decreased primarily due to a disproportionately smaller increase in expenses associated with the growth in premiums.
The improvement in the 1999 statutory and GAAP combined ratios before policyholder dividends, excluding the commutation adjustment and the effects of a quota share termination, compared to 1998 was due to favorable prior-year reserve development in Commercial Lines, continued productivity improvements and expense savings, partially offset by higher catastrophe losses, higher loss ratios in the TRAVELERS SECURE(R) program and the charge related to curtailing the sale of TRAVELERS SECURE(R) policies. In addition, the 1999 GAAP combined ratio before policyholder dividends benefited from legislative actions in the states of New York and Pennsylvania that changed the manner in which these states finance their workers' compensation second-injury funds.
Net income was $1.220 billion in 2000, $1.026 billion in 1999 and $1.018 billion in 1998. Net income in 1999 included a charge of $160 million related to the initial adoption of SOP 97-3 and a benefit of $27 million related to the initial adoption of SOP 98-7. The net charge of $133 million due to the initial adoption of these Statements of Position has been accounted for as a cumulative effect of a change in accounting principles.
Commercial Lines operating income, which excludes realized investment gains in all years and the cumulative effect of changes in accounting principles in 1999, was $1.189 billion, $1.077 billion and $942 million in 2000, 1999 and 1998, respectively. The improvement in operating income for 2000 over 1999 reflected rate increases, higher fee income, lower catastrophe losses and higher net investment income, partially offset by increased loss cost trends and lower favorable prior-year reserve development. Results for 2000 and 1999 reflected benefits resulting from legislative actions that changed the manner in which certain states finance their workers' compensation second injury funds, principally in the states of New York and Pennsylvania. The improvement in operating income for 1999 over 1998 included the benefit of the New York and Pennsylvania legislative actions, favorable prior-year reserve development, lower weather-related losses and lower operating expenses, partially offset by lower fee income.
Net written premiums by market for the three years ended December 31, 2000 were as follows:
Commercial Lines net written premiums were $5.031 billion in 2000 compared to $4.408 billion in 1999 and $4.614 billion in 1998. Included in Specialty Accounts net written premiums in 2000 is an adjustment of $131 million due to a reinsurance transaction associated with the acquisition of the Reliance Surety business. The 2000 increase reflected the impact of an improving rate environment as evidenced by the continued favorable pricing on new and renewal business. Also contributing to the increase in net written premiums in 2000 was the new business associated with the acquisition of the renewal rights for the Reliance Middle Market business in Commercial Accounts and the impact of the ongoing business associated with the Reliance Surety acquisition and the new business associated with the acquisition of the renewal rights for the Frontier business in Specialty Accounts. The decrease in National Accounts net written premiums is primarily due to the shift in business mix from premium-based products to fee-based products. The decrease in 1999 net written premiums reflected the highly competitive marketplace and the Company's continued disciplined approach to underwriting and risk management. Also contributing to the 1999 decrease in net written premiums in National Accounts and Specialty Accounts was the impact of additional reinsurance coverage. The slight increase in Commercial Accounts net written premiums in 1999 reflected growth in specific business segments and an improving rate environment.
New business in National Accounts for 2000 was marginally lower than 1999, reflecting the Company's continued disciplined approach to underwriting and risk management. For 1999, new business in National Accounts was significantly lower than 1998, reflecting the Company's continued disciplined approach to underwriting and risk management in the highly competitive marketplace. The business retention ratio for 2000 was moderately lower than 1999, reflecting an increase in lost business due to the renewal price increases in 2000. The business retention ratio for 1999 was moderately higher than 1998, primarily reflecting the loss of one large account in 1998.
Commercial Lines claims and expenses of $5.171 billion in 2000 increased $244 million from 1999 and decreased $400 million in 1999 compared to 1998. The 2000 increase was primarily due to increased loss cost trends, lower favorable prior-year reserve development and higher losses associated with the growth in premium and claims volume, partially offset by lower catastrophe losses. Results for 2000 and 1999 reflected benefits resulting from legislative actions that changed the manner in which certain states finance their workers' compensation second injury funds, principally in the states of New York and Pennsylvania. The 1999 decrease reflected the benefit resulting from the legislative actions in the states of New York and Pennsylvania, favorable prior-year reserve development, lower weather-related losses and lower operating expenses.
There were no catastrophe losses in 2000. Catastrophe losses, net of taxes and reinsurance, were $27 million and $25 million in 1999 and 1998, respectively. The 1999 catastrophe losses were primarily due to Hurricane Floyd in the third quarter and tornadoes in Oklahoma in the second quarter. The 1998 catastrophe losses were primarily due to Hurricane Georges in the third quarter and tornadoes in Nashville, Tennessee in the second quarter.
GAAP combined ratios for Commercial Lines differ from statutory combined ratios primarily due to the deferral and amortization of certain expenses for GAAP reporting purposes only.
The 2000 statutory and GAAP combined ratios include an adjustment associated with the acquisition of the Reliance Surety business. Excluding this adjustment, the statutory and GAAP combined ratios before policyholder dividends for 2000 would have been 103.5% and 100.8%, respectively. The 1999 statutory combined ratio reflects the treatment, on a statutory basis only, of the commutation of an asbestos liability to an insured. Excluding the commutation, the statutory combined ratio before policyholder dividends for 1999 would have been 106.1%. The improvement in the 2000 statutory and GAAP combined ratios before policyholder dividends compared to 1999, excluding the related adjustments above, was primarily due to premium growth related to rate increases as well as the impact of the ongoing business associated with the Reliance Surety acquisition and the purchase of the renewal rights for the Reliance Middle Market and Frontier businesses, and lower catastrophe losses. This was partially offset by increased loss cost trends, lower favorable prior-year reserve development and a disproportionately smaller increase in expenses associated with the growth in premiums. The improvement in the 1999 statutory combined ratio before policyholder dividends, excluding the commutation, over 1998 was primarily due to favorable
(1) Personal Lines net income includes $10 million of realized investment losses in 1999 and $17 million of realized investment gains in 1998.
Personal Lines net written premiums in 2000 were $3.813 billion compared to $3.733 billion in 1999 (excluding an adjustment of $72 million due to an adjustment associated with the termination of a quota share reinsurance arrangement) and $3.490 billion in 1998. The increase in 2000 reflects growth in target markets served by independent agents and growth in affinity group marketing and joint marketing arrangements, partially offset by planned reductions in the TRAVELERS SECURE(R) auto and homeowners business, a mandated rate decrease in New Jersey, and continued emphasis on disciplined underwriting and risk management. The business retention ratio in 2000 was moderately lower compared to 1999, reflecting planned reductions in the TRAVELERS SECURE(R) auto and homeowners business. The net written premium increase in 1999 primarily reflected growth in independent agents business and
Personal Lines claims and expenses were $3.715 billion in 2000 compared to $3.561 billion in 1999 and $3.104 billion in 1998. The 2000 increase was primarily the result of increased loss cost trends, lower favorable prior-year reserve development and higher losses associated with the growth in premiums and related claim volume, partially offset by the 1999 charge related to curtailing the sale of TRAVELERS SECURE(R) products and lower catastrophe losses. The 1999 increase was primarily the result of higher losses associated with the growth in premiums and related claim volumes, higher catastrophe losses and lower favorable prior-year reserve development. In addition, 1999 included higher loss ratios in the TRAVELERS SECURE(R) program and the charge related to curtailing the sale of TRAVELERS SECURE(R) products.
Catastrophe losses, net of tax and reinsurance, were $54 million, $79 million and $44 million in 2000, 1999 and 1998, respectively. Catastrophe losses in 2000 were primarily due to Texas, Midwest and Northeast wind and hailstorms in the second quarter and hailstorms in Louisiana and Texas in the first quarter. Catastrophe losses in 1999 were primarily due to Hurricane Floyd in the third quarter, wind and hail storms on the East Coast and tornadoes in the Midwest in the second quarter and a wind and ice storm in the Midwest and Northeast in the first quarter. Catastrophe losses in 1998 were primarily due to Hurricanes Bonnie and Georges, severe first quarter winter storms and second and third quarter wind and hailstorms.
GAAP combined ratios for Personal Lines differ from statutory combined ratios primarily due to the deferral and amortization of certain expenses for GAAP reporting purposes only.
The 1999 statutory and GAAP combined ratios for Personal Lines include an adjustment associated with the termination of a quota share reinsurance arrangement. Excluding this adjustment, the statutory and GAAP combined ratios for 1999 would have been 96.5% and 97.3%, respectively. The increase in the 2000 statutory and GAAP combined ratios compared to 1999 statutory and GAAP combined ratios, excluding the reinsurance adjustment, was primarily due to increased loss cost trends and lower favorable prior-year reserve development, offset in part by the 1999 TRAVELERS SECURE(R) charge and lower catastrophe losses. The increase in the 1999 statutory and GAAP combined ratios excluding the reinsurance adjustment compared to 1998 was due to higher catastrophe losses due to Hurricane Floyd, higher loss ratios in the TRAVELERS SECURE(R) program, the TRAVELERS SECURE(R) charge and lower favorable prior-year development in the automobile bodily injury line.
The primary component of net loss for 2000, 1999 and 1998 was after-tax interest expense of $87 million, $99 million and $105 million, respectively.
The Company continues to receive claims from insureds 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 ("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 both the recovery of response costs from certain liable parties and may require liable parties to directly 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. An aggregate bulk reserve is carried for all of the Company's environmental claims that are in the dispute process, 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 such claims. At December 31, 2000, approximately 73% of the net aggregate reserve (approximately $405 million), is carried in a bulk reserve and includes unresolved as well as incurred but not reported environmental claims for which the Company has not received any specific claims. The balance, approximately 27% of the net environmental loss reserve (approximately $153 million) consists of case reserves for resolved claims.
The Company's reserving methodology is preferable to one based on "identified claims" since the resolution of environmental exposures by the Company generally occurs by settlement on an insured-by-insured basis as opposed to a claim-by-claim basis. Generally, the settlement between the Company and the insured extinguishes any obligation the Company may have under any policy issued to the insured for past, present and future environmental liabilities as well as extinguishes any pending coverage litigation dispute with the insured. 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
The reserving methodology includes an analysis by the Company of the exposure presented by each insured and the anticipated cost of resolution, if any, for each insured. This analysis is completed by the Company on a quarterly basis. In the course of this analysis, an assessment of the probable liability, available coverage, judicial interpretations and historical value of similar exposures is considered by the Company. In addition, due consideration is given to the many variables presented, such as the nature of the alleged activities of the insured 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 a 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 insured, including the role of any umbrella or excess insurance issued by the Company to the insured; the identification 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. Analysis of these and other factors, including the potential for future claims, results in the establishment of the bulk reserve.
The duration of the Company's investigation and review of such claims and the extent of time necessary to determine an appropriate estimate, if any, of the value of the claim to the Company, vary significantly and are dependent upon a number of factors. These factors include, but are not limited to, the cooperation of the insured in providing claim information, the pace of underlying litigation or claim processes, the pace of coverage litigation between the insured and the Company and the willingness of the insured and the Company to negotiate, if appropriate, a resolution of any dispute between them pertaining to such claims. Since the foregoing factors vary from claim-to-claim and insured-by-insured, the Company cannot provide a meaningful average of the duration of an environmental claim. However, based upon the Company's experience in resolving such claims, the duration may vary from months to several years.
In addition, the Company establishes claim files for environmental claims brought by individual claimants who allege injury or damage as a result of the discharge of wastes or pollutants allegedly by the policyholder. As it pertains to such claims tendered on policies issued by Travelers P&C, the Company establishes a claim file on a per claimant, per insured, per site basis. For example, if one hundred claimants file a lawsuit against five policyholders alleging bodily injury and property damage as a result of the discharge of wastes or pollutants, one thousand claims (five hundred for the bodily injury claims and five hundred for the property damage claims) would be established.
As it pertains to environmental claims brought by individual claimants and tendered on Aetna P&C policies, the Company establishes claim files on a per insured, per site basis due to current claim system
As of December 31, 2000, calculated as described above, the Company had approximately 43,000 pending environmental-related claims tendered by 787 active policyholders. Of the total pending environmental-related claims, 34,000 claims would relate to Travelers P&C policies tendered by 385 policyholders and 9,000 claims relate to Aetna P&C policies tendered by 501 policyholders. Approximately 99 of these Aetna P&C policyholders are also included in the 385 Travelers P&C policyholders count. The pending environmental-related claims represent federal or state EPA-type claims as well as plaintiffs' claims alleging bodily injury and property damage due to the discharge of waste or pollutants allegedly by the policyholder.
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, 2000, the number of policyholders with pending coverage litigation disputes pertaining to environmental claims was 243, approximately 10% less than the number pending as of December 31, 1999, approximately 40% less than the number pending as of December 31, 1998, as well as approximately 54% less than the number pending as of December 31, 1997. Also, in 2000, there were 158 policyholders tendering for the first time an environmental remediation-type claim to the Company. This compares to 256 policyholders doing so in 1999 and 288 policyholders in 1998.
In the area of asbestos claims, the Company believes that the property and casualty insurance industry has suffered from judicial interpretations that have attempted to maximize insurance availability from both a coverage and liability standpoint far beyond the intent of the contracting parties. These policies generally were issued prior to 1980. The Company continues to receive asbestos claims alleging insureds' liability from claimants' asbestos-related injuries. In 2000, the Company experienced an increase over prior years in the number of asbestos claims being tendered to the Company. In addition, the Company is continuing to evaluate the impact of recent and well-publicized filings for bankruptcy protection by certain major asbestos producers. As in the past, asbestos claims, when submitted, rarely indicate the monetary amount being sought by the claimant from the insured and the Company does not keep track of the monetary amount being sought in those few claims that indicated such a monetary amount. Based upon the Company's experience with asbestos claims, the duration period of an asbestos claim from the date of submission to resolution is approximately two years.
For environmental claims, the Company estimates its financial exposure and establishes reserves based upon an analysis of its historical claim experience and the facts of the underlying environmental exposure of each policyholder. The unique facts are evaluated individually and collectively. Due consideration is given to the many variables presented by each policyholder, as discussed above.
Due to claimants' allegations of long-term bodily injury in CIOTA claims, numerous complex issues regarding such claims are presented. The claimants' theories of liability must be evaluated, evidence pertaining to a causal link between injury and exposure to a substance must be reviewed, the potential role of other causes of injury must be analyzed, the liability of other defendants must be explored, an assessment of a claimant's damages must be made and the law of the jurisdiction must be applied. In addition, the Company must review the number of policies issued by the Company to the insured and whether such policies are triggered by the allegations, the terms and limits of liability of such policies, the
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 settlements with the policyholder or through coverage litigation. Some agreements may extinguish any insurance obligation which the Company may have for other claims, including but not limited to asbestos and environmental claims. Generally, the terms of a settlement agreement set forth the nature of the Company's participation in resolving CIOTA claims, 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 such 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 would ultimately have been paid had the claims not been settled in this manner. No inference should be drawn that because of the Company's method of dealing with CIOTA claims, its reserves for such claims are more conservatively stated than those of other insurers.
The Company continues to receive asbestos claims alleging insureds' liability from claimants' asbestos-related injuries. In 2000, the Company experienced an increase over prior years in the number of asbestos claims being tendered to the Company. However, the uncertainties surrounding the final resolution of these claims continue. See the preceding discussions of Asbestos Claims and Uncertainty Regarding Adequacy of Environmental and Asbestos Reserves.
Personal Lines strategy includes control of operating expenses to improve competitiveness and profitability, growth in sales primarily through independent agents and selective expansion of alternative marketing channels to broaden distribution to a wider customer base. Personal Lines is continuing to grow its nonstandard auto insurance to broaden its product capabilities. These growth strategies also provide opportunities to leverage the existing cost structure and achieve economies of scale. In addition, Personal Lines continues to take action to control its exposure to catastrophe losses, including limiting the writing of new homeowners business in certain markets and implementing price increases in certain hurricane-prone areas, subject to restrictions imposed by insurance regulatory authorities.
The property and casualty insurance industry continues to be reshaped by consolidation and globalization. The Company's strategic objectives are to enhance its position as a consistently profitable market leader and to become a low-cost provider of property and casualty insurance in the United States, as the industry consolidates. While some of the insurance industry's cost control methods have been challenged in litigation, it continues to be the Company's objective to be a low-cost provider of property and casualty insurance, with an emphasis on claim payout and performance and enhanced productivity.
Changes in the general interest rate environment affect the return received on newly invested and reinvested funds. While a rising interest rate environment enhances the returns available, it reduces the market value of existing fixed maturity investments and the availability of gains on disposition. A decline in interest rates reduces the return available on investment of funds but creates the opportunity for realized investment gains on disposition of fixed maturity investments.
Certain of the statements contained herein that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. The Company's actual results may differ materially from those included in the forward-looking statements. Forward-looking statements are typically identified by the words or phrases such as "believe," "expect," "anticipate," "intend," "estimate," "may affect," and similar expressions or future or conditional verbs such as "will," "should," "would," and "could." In particular, the information appearing in the section under the heading "Outlook" is forward-looking. These forward-looking statements involve risks and uncertainties including, but not limited to, the following: the resolution of legal proceedings and related matters; the conduct of the Company's businesses following the Travelers Group merger with Citicorp; customer responsiveness to both new products and distribution channels; and the actual amount of liabilities associated with certain environmental and asbestos-related insurance claims. Readers are also directed to other risks and uncertainties discussed in documents filed by the Company with the Securities and Exchange Commission.
We have audited the accompanying consolidated balance sheets of Travelers Property Casualty Corp. and subsidiaries as of December 31, 2000 and 1999, and the related consolidated statements of income, changes in stockholder's equity and cash flows for each of the years in the three-year period ended December 31, 2000. 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.
As discussed in Note 1 to the consolidated financial statements, in 1999 the Company changed its methods of accounting for insurance and reinsurance contracts that do not transfer insurance risk and its accounting for insurance-related assessments.
TRAVELERS PROPERTY CASUALTY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF INCOME (In millions)
TRAVELERS PROPERTY CASUALTY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY (In millions, except shares)
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and claims and expenses during the reporting period. Actual results could differ from those estimates.
ACCOUNTING FOR TRANSFERS AND SERVICING OF FINANCIAL ASSETS AND EXTINGUISHMENTS OF LIABILITIES
In September 2000, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125" (FAS 140). Provisions of FAS 140 primarily relating to transfers of financial assets and securitizations that differ from provisions of "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities" (FAS 125) are effective for transfers taking place after March 31, 2001. Special purpose entities (SPEs) used in securitizations that are currently qualifying SPEs under FAS 125 will continue to be treated as qualifying SPEs as long as they issue no new beneficial interests and accept no new asset transfers after March 31, 2001, other than transfers committed to prior to that date. Under FAS 140, qualifying SPEs are not consolidated by the transferor. It is not expected that there will be a significant effect on results of operations, financial condition or liquidity relating to a change in consolidation status for existing qualifying SPEs under FAS 140. FAS 140 also amends the accounting for collateral and requires new disclosures for collateral, securitizations and retained interests in securitizations. These provisions are effective for financial statements for fiscal years ending after December 15, 2000. The accounting for collateral, as amended, requires (a) certain assets pledged as collateral to be separately reported in the consolidated balance sheet from assets not so encumbered and (b) disclosure of assets pledged as collateral that have not been reclassified and separately reported. The change in accounting for collateral did not have a significant effect on results of operations, financial condition or liquidity. See note 4.
Effective January 1, 1999, the Company adopted the AcSEC Statement of Position 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments" (SOP 97-3). SOP 97-3 provides guidance for determining when an entity should recognize a liability for guaranty-fund and other insurance-related assessments, how to measure that liability, and when an asset may be recognized for the recovery of such assessments through premium tax offsets or policy surcharges. The effect of the initial adoption of this SOP is to be reported as a cumulative catch-up adjustment. Restatement of previously issued financial statements is not permitted. As a result of adopting SOP 97-3, the Company recorded a charge of $160 million after tax, reflected as a cumulative catch-up adjustment. Aside from the initial impact at adoption, this SOP is not expected to have a significant impact on results of operations, financial condition or liquidity.
During the third quarter of 1998, the Company adopted the AcSEC Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1 provides guidance on accounting for the costs of computer software developed or obtained for internal use and for determining when specific costs should be capitalized and when they should be expensed. The adoption of SOP 98-1 did not have a significant impact on results of operations, financial condition or liquidity.
Equity securities, which include common and nonredeemable preferred stocks, are classified as available for sale and carried at fair value based primarily on quoted market prices. Changes in fair values of equity securities are charged or credited directly to stockholder's equity, net of income taxes.
Realized investment gains and losses are included as a component of pretax revenues based upon specific identification of the investments sold on the trade date. Other-than-temporary declines in market value of investments are included in realized investment gains and losses.
Amounts which vary with and are primarily related to the production of new business, primarily commissions and premium taxes, are deferred and amortized pro rata over the contract periods in which the related premiums are earned. Future investment income attributable to related premiums is taken into account in measuring the recoverability of the carrying value of this asset. Deferred acquisition costs are reviewed to determine if they are recoverable from future income, and if not, are charged to expense. All other acquisition expenses are charged to operations as incurred.
CLAIMS AND CLAIM ADJUSTMENT EXPENSE RESERVES 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, 2000 and 1999 are $1.4 billion and $1.5 billion, respectively, of reserves related to workers' compensation that have been discounted using an interest rate of 5%.
OTHER LIABILITIES 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, 2000 and 1999, the Company had a liability of $223 million and $308 million, respectively, for guaranty-fund and other assessments and related recoveries of $28 million and $41 million, respectively. 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.
FEDERAL INCOME TAXES The provision for federal income taxes is comprised of two components, current income taxes and deferred income taxes. Deferred federal income taxes arise from changes during the year in cumulative temporary differences between the tax basis and book basis of assets and liabilities.
STOCK-BASED COMPENSATION The Company accounts for the stock-based compensation plans using the accounting method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and has included in the notes to consolidated financial statements the pro forma disclosures required by Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123). See note 14. The Company accounts for its stock-based non-employee compensation plans at fair value.
COMMERCIAL LINES Commercial Lines offers a broad array of property and casualty insurance and insurance-related services. Protection is afforded to customers of Commercial Lines for the risks of property loss such as fire and windstorm, financial loss such as business interruption from property damage, liability claims arising from operations and workers' compensation benefits through insurance products where risk is transferred from the customer to Commercial Lines. Coverages include workers' compensation, general liability, commercial multi-peril, commercial automobile, property, fidelity and surety, professional liability, and several miscellaneous coverages.
National Accounts provides a variety of casualty products to large companies. Products are marketed through national and regional brokers. Programs offered by National Accounts include risk management services, such as claims settlement, loss control and risk management information services, which are generally offered in connection with a large deductible or self-insured program, and risk transfer, which is typically provided through a guaranteed cost or retrospectively rated insurance policy. National Accounts also includes the Company's alternative market business, which primarily offers workers' compensation products and services to the involuntary market.
Select Accounts serves small businesses. Select Accounts' products are generally guaranteed cost policies, often a packaged product covering property and liability exposures. The products are sold through independent agents.
CATASTROPHE EXPOSURE The Company has a geographic exposure to catastrophe losses in certain areas of the country. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, severe winter weather, explosions and fires. The incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Company generally seeks to reduce its exposure to catastrophes through individual risk selection and the purchase of catastrophe reinsurance.
The Commercial Lines business segment serves businesses of all sizes, providing a full range of primary and excess insurance and risk management and insurance-related services. The Commercial Lines segment offers workers' compensation, general liability, commercial multi-peril, commercial automobile, property, fidelity and surety, professional liability, and several miscellaneous coverages.
The Personal Lines business segment serves consumers and writes virtually all types of property and casualty insurance covering personal risks. The primary coverages in Personal Lines are personal automobile and homeowners insurance.
The accounting policies used to generate the following segment data are the same as those described in the summary of significant accounting policies in note 1. The amount of investments in equity method investees and total expenditures for additions to long-lived assets other than financial instruments were not significant.
Operating income excludes realized investment gains (losses) and the cumulative effect of changes in accounting principles, and is reflected net of tax.
(1) The source of other revenues is businesses that are in run-off and are not significant.
The Company makes investments in collateralized mortgage obligations (CMOs). CMOs typically have high credit quality, offer good liquidity, and provide a significant advantage in yield and total return compared to U.S. Treasury securities. The Company's investment strategy is to purchase CMO tranches which are protected against prepayment risk, including planned amortization class tranches. Prepayment protected tranches are preferred because they provide stable cash flows in a variety of scenarios. The Company does invest in other types of CMO tranches if a careful assessment indicates a favorable risk/return tradeoff. The Company does not purchase residual interests in CMOs.
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 14. 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, 2000 and 1999, the Company held collateral of $1.1 billion and $563 million, respectively.
Proceeds from sales of fixed maturities classified as available for sale were $12.5 billion, $10.0 billion and $8.5 billion in 2000, 1999 and 1998, respectively. Gross gains of $267 million, $193 million and $210 million and gross losses of $284 million, $182 million and $93 million, respectively, were realized on those sales.
Underperforming mortgage loans include delinquent loans, loans in the process of foreclosure and loans modified at interest rates below market and were not significant at December 31, 2000 and 1999.
Aggregate annual maturities on mortgage loans are $3 million, $4 million, $30 million, $23 million, $1 million and $225 million for 2001, 2002, 2003, 2004, 2005 and 2006 and thereafter, respectively. There are no mortgage loans which are past due.
Included in fixed maturities are below investment grade assets totaling $1.6 billion and $1.5 billion at December 31, 2000 and 1999, respectively. The Company defines its below investment grade assets as those securities rated "Ba1" or lower by external rating agencies, or the equivalent by internal analysts when a public rating does not exist. Such assets include publicly traded below investment grade bonds and certain other privately issued bonds that are classified as below investment grade loans.
The Company participates in reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and to effect business-sharing arrangements. In addition, the Company assumes 100% of the workers' compensation premiums written by the Accident Department of its affiliate, The Travelers Insurance Company (TIC). The Company is also a member of and participates as a servicing carrier for several pools and associations.
Reinsurance is placed on both a quota-share and excess of loss basis. Reinsurance ceded arrangements do not discharge the Company as the primary insurer, except for cases involving a novation.
In connection with the 1992 sale of American Re-Insurance Company (Am Re), a reinsurance agreement was entered into that provides that to the extent Am Re incurred losses in 1991 and prior that were still outstanding at January 1, 1992 in excess of $2.7 billion, the Company has an 80% participation in payments on those losses up to a maximum payment of $500 million. This agreement has been accounted for as a deposit and a liability has been established for the expected payout under the agreement.
The table below is a reconciliation of beginning and ending property-casualty reserve balances for claims and claim adjustment expenses.
The decreases in the claims and claim adjustment expense reserves in 2000 and 1999, from 1999 and 1998, respectively, were primarily attributable to net payments of $341 million and $504 million, respectively, for environmental and cumulative injury claims.
It is difficult to estimate the reserves for environmental and asbestos-related claims due to the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties, including without limitation, those which are set forth below. Conventional actuarial techniques are not used to estimate such reserves.
The Company also compares its historical direct and net loss and expense paid experience in environmental and asbestos, year-by-year, to assess any emerging trends, fluctuations or characteristics suggested by the aggregate paid activity. The comparison includes a review of the result derived from the division of the ending direct and net reserves by last year's direct and net paid activity, also known as the survival ratio.
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. Such development will be affected by future court decisions and interpretations, as well as changes in legislation applicable to such claims. Because of these future unknowns, and the uncertainties set forth above, additional liabilities may arise for amounts in excess of the current reserves. These additional amounts, or a range of these additional amounts, cannot now be reasonably estimated, and could result in a liability exceeding reserves by an amount that would be material to the Company's operating results in a future period. However, in the opinion of the Company's management, it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity.
On each of September 1, 1999 and October 1, 1999, TPC repaid $200 million for its 6-3/4% note and 6-1/4% note, respectively, which matured on those dates. Long-term debt outstanding at December 31, 2000 and 1999 was as follows:
The net deferred tax assets were comprised of the tax effects of temporary differences related to the following assets and liabilities:
The Company is a member of a subgroup of companies comprised of TIGI and its non-life insurance subsidiaries. This subgroup is included in the consolidated federal income tax return filed by Citigroup. TIGI allocates federal income taxes to its subsidiaries on a separate return basis adjusted for credits and other amounts required by the consolidation process. Any resulting liability is paid currently to TIGI. Any credits for losses will be paid by TIGI currently to the extent that such credits are for tax benefits that have been utilized in the consolidated federal income tax return. TIGI will reimburse the Company for any remaining receivable at the end of the federal statutory carryforward period.
Travelers P&C Capital I and Travelers P&C Capital II will use the proceeds from any redemption of TPC Securities to redeem a like amount of TPC Debentures.
The obligations of TPC with respect to the TPC Debentures, when considered together with certain undertakings of TPC with respect to Travelers P&C Capital I and Travelers P&C Capital II, constitute full and unconditional guarantees by TPC of Travelers P&C Capital I's and Travelers P&C Capital II's obligations under the respective TPC Securities. The TPC Securities are classified in the consolidated balance sheet as "TPC-obligated mandatorily redeemable securities of subsidiary trusts holding solely junior subordinated debt securities of TPC" at their liquidation value of $900 million. TPC has the right, at any time, to defer payments of interest on the TPC Debentures and consequently the distributions on the TPC Securities and common securities would be deferred (though such distributions would continue to accrue with interest thereon since interest would accrue on the TPC Debentures during any such extended interest payment period). TPC cannot pay dividends on its common stock during such deferments. Distributions on the TPC Securities have been classified as interest expense in the consolidated statement of income.
CLASS A On April 2, 1996, TPC sold approximately 33 million shares of its Class A Common Stock to four private investors, Aetna Services, Inc., J.P. Morgan Capital Corporation, Fund American Enterprise Holdings, Inc. and The Trident Partnership, L.P. (collectively, the Private Investors), for an aggregate of $525 million. On April 23, 1996, TPC sold in a public offering approximately 39 million shares of its Class A Common Stock, for net proceeds of $928 million. On all matters submitted to vote of the TPC stockholders, holders of Class A Common Stock were entitled to one vote per share.
In connection with the cash tender offer completed by TIGI in 2000, all previously outstanding shares of Class A Common Stock became authorized and unissued shares.
CLASS B TIGI owned all of the outstanding shares of Class B Common Stock representing 85.2% of the economic interest in TPC at April 19, 2000. Class B holders were entitled to 10 votes per share on any matter submitted to vote of the TPC stockholders. In connection with the cash tender offer by TIGI in 2000, all of the outstanding shares of Class B Common Stock were converted to shares of Class A Common Stock.
The Company participates in a qualified, noncontributory defined benefit pension plan sponsored by an affiliate. In addition, the Company provides certain other postretirement benefits to retired employees through a plan sponsored by TIGI. The Company's share of net expense for the qualified pension and other postretirement benefit plans was $5 million, $30 million and $31 million for 2000, 1999 and 1998, respectively.
Most leasing functions for TIGI and its subsidiaries are administered by the Company. See note 14. Rent expense related to these leases is shared by the companies on a cost allocation method based generally on estimated usage by department. Rent expense was $113 million, $112 million and $106 million in 2000, 1999 and 1998, respectively.
Future minimum annual rentals under noncancellable operating leases are $97 million, $72 million, $49 million, $24 million, $17 million and $97 million for 2001, 2002, 2003, 2004, 2005 and 2006 and thereafter, respectively. Future sublease rental income of approximately $37 million will partially offset these commitments.
The Company uses derivative financial instruments, including interest rate swaps, currency swaps, options, forward contracts and financial futures, as a means of hedging exposure to foreign currency, equity price changes and/or interest rate risk on anticipated transactions or existing assets and liabilities. The Company's insurance subsidiaries do not hold or issue derivative instruments for trading purposes.
These derivative financial instruments have off-balance-sheet risk. Financial instruments with off-balance-sheet risk involve, to varying degrees, elements of credit and market risk in excess of the amount recognized on the consolidated balance sheet. The contract or notional amounts of these instruments reflect the extent of involvement the Company has in a particular class of financial instrument. However, the maximum loss of cash flow associated with these instruments can be less than these amounts. For interest rate swaps, currency swaps, currency options, forward contracts and financial futures, credit risk is limited to the amount that it would cost the Company to replace the contract. The Company is a writer of option contracts and as such has no credit risk since the counterparty has no performance obligation after it has paid a premium.
TRAVELERS PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
At December 31, 2000 and 1999, investments in fixed maturities had a fair value, which equaled carrying value, of $25.0 billion and $25.3 billion, respectively. The fair value of investments in fixed maturities for which a quoted market price or dealer quote are not available was $874 million and $949 million at December 31, 2000 and 1999, respectively. The carrying values of cash, short-term securities, mortgage loans and investment income accrued approximated their fair values. See notes 1 and 4.
See note 12 for a discussion of financial instruments with off-balance-sheet risk.
In the normal course of business, the Company issues fixed and variable rate loan commitments and has unfunded commitments to partnerships and limited liability corporations. The off-balance-sheet risks of these financial instruments were not significant at December 31, 2000 and 1999.
In the ordinary course of business, the Company is a defendant or codefendant in various litigation matters other than environmental and asbestos claims. Although there can be no assurances, as of December 31, 2000, in the opinion of the Company's management, based on information currently available, the ultimate resolution of these other legal proceedings would not be likely to have a material adverse effect on its results of operations, financial condition or liquidity.
An affiliate maintains a short-term investment pool in which the Company participates. The positions of each company participating in the pool are calculated and adjusted daily. At December 31, 2000 and 1999, the pool totaled approximately $4.4 billion and $2.6 billion, respectively. The Company's share of the pool amounted to $2.2 billion and $1.3 billion at December 31, 2000 and 1999, respectively, and is included in short-term securities in the consolidated balance sheet.
The assumptions used in applying FAS 123 to account for Citigroup stock options were as follows:
At December 31, 2000 and 1999, the Company had $102 million of securities pledged as collateral to Citibank N.A. to support a letter of credit facility for certain of the Company's surety customers.
The Company participates in reinsurance agreements with TIC. See note 5.
The Company purchases annuities from affiliates to settle certain claims. Reinsurance recoverables at December 31, 2000 and 1999 included $811 million and $799 million, respectively, related to these annuities.
There were no significant noncash financing or investing activities for the years ended December 31, 2000, 1999 or 1998.