The main offices of the Corporation and most of its United States subsidiaries 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 subsidiary of the Corporation. 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 the Corporation. Under the terms of the lease, the Corporation 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. The Corporation has guaranteed the rental obligations of Elm Street Corporation in connection with this transaction.
In addition, the Corporation's United States and international operations have branch and affiliate operations conducted from leased premises in various cities in the United States and foreign countries. At this time, the Corporation believes its facilities are suitable for its purpose and provide adequate capacity for the Corporation's present and anticipated needs.
Only continuing operations are presented. Balance sheet data are as of December 31st. 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 in 1995 and 1994 and income statement amounts in 1995. Only nine months of Cologne Re's 1995 results are included in the Corporation's 1995 results due to the one-quarter reporting lag.
(5) In 1994 the Corporation adopted FASB Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts and FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements. The combined effect of adopting the Interpretations increased reported assets and liabilities at December 31, 1994 and 1993 by $950 million and $1,747 million, respectively, and had no effect on results from operations or common stockholders' equity.
Consolidated investment income was $749 million in 1994, compared with $755 million in 1993. The level of investment income was adversely affected by the shift in assets from taxable to tax-advantaged securities in response to the Corporation's tax planning strategies, the use of the Corporation's cash flow from operations for stock repurchases, and an increase in lower yielding, short-term securities during the year to fund the investment in Cologne Re. Investment income for the United States property/casualty operations was $686 million in 1994, a decrease of 2.7 percent over $705 million earned in 1993. Investment income for the international property/casualty operations increased 20.9 percent to $52 million in 1994, compared with $43 million in 1993. The financial services operations had investment income of $11 million in 1994, compared with $7 million in 1993.
Net premiums written in 1995 for the United States property/casualty operations were $2,964 million, an increase of 14.9 percent from $2,581 million in 1994. Net premiums written by operating unit expressed as a percentage of total United States property/casualty premiums were as follows:
International net premiums written were $2,429 million in 1995, compared with $420 million in 1994. The premium growth is principally attributable to the inclusion of $1,651 million of Cologne Re's property/casualty premiums beginning in the second quarter of 1995. In addition, the international property/casualty growth reflects the continued expansion of existing and new client relationships. In the second quarter of 1995, the Corporation's wholly owned European operations began to include estimated premiums and losses for the current underwriting year in its financial results. This change increased net premiums written by approximately $263 million and added approximately $1 million to net income in 1995.
On December 28, 1994, the Corporation 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 Kolnische Ruckversicherungs-Gesellschaft AG ("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. The Corporation 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 the Corporation 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 Class A shares have 49.9 percent of the votes of GR-CK and are entitled to an annual Class A dividend, which is based on a formula and is subject to a minimum of approximately DM 36 million, while the Class B shares have 50.1 percent of the votes of GR-CK and are entitled to the earnings of GR-CK in excess of the Class A dividend. The Corporation will also receive an annual Class B cash dividend of 50.1 percent of GR-CK's distributable income, as defined in the joint-venture agreement. The dividend related to 1995 on the Class A and B shares will be paid in 1996.
The Corporation has an option after seven years to purchase the Class A shares of GR-CK owned by the CKAG at a formula price. The option has a minimum exercise price of DM 1,306 million and a maximum of DM 1,509 million, subject to certain warranty and other adjustments that may affect the exercise price. If the Corporation does not exercise its option to purchase the Class A shares of GR-CK from CKAG, CKAG has
Tempest is negotiating an exchange of shares of Tempest for shares in ACE Limited, a Bermuda insurer. The transaction would be subject to approval by both companies' Boards of Directors and shareholders. If the transaction is consummated, the Corporation would sell back to Tempest its 20.7 percent interest in Tempest for cash consideration. In addition, the underwriting services provided to Tempest by GRUS would be terminated. The financial effect of this transaction would be recorded in 1996.
GRFP is a dealer in derivative products and offers a full line of interest rate and cross-currency swaps, options, and other derivative products. GRFP's gross trading revenue was $142 million in 1995, compared with $135 million in 1994 and $142 million in 1993. The growth in GRFP's trading revenue for the year compared to 1994 was due to specialty products and growth in swap transactions outside of North America. The overall growth in the derivatives market in the United States was slower than outside of the United States due to continuing concerns about controls over the inappropriate use of derivative products by certain end users.
GRFP closely monitors its derivatives operations and actively manages its open positions to control its exposures. GRFP hedges its exposure to market risk (which includes foreign exchange, interest rate, swap spread, volatility, correlation, and yield curve risks) in connection with its dealer activities by purchasing or selling futures contracts, entering into forward foreign exchange contracts, purchasing or selling United States and foreign government securities or entering into offsetting transactions.
The Corporation's insurance and reinsurance brokerage operations also contributed to the increased profitability of the financial services segment in 1995. In addition, the Corporation has expanded its investment
The Corporation's investment portfolios are managed for after-tax total return while maintaining high credit quality across the portfolios. At December 31, 1995, total invested assets of the United States property/casualty operations were $13,481 million, a 20.6 percent increase over 1994 invested assets.
The composition of the United States property/casualty invested assets was as follows:
Throughout 1995, the Corporation continued to shift assets toward tax-advantaged securities due to improved underwriting profitability and increased international profits. Furthermore, municipal bonds became attractive relative to taxable bonds for all but the shortest maturities as the spread between taxable and tax-exempt bonds became historically narrow due to concerns about tax reform which could adversely affect tax-exempt bonds. The Corporation also added to its preferred stock holdings in 1995, since these securities were an attractive after-tax alternative to municipal bonds.
Credit considerations are an important part of the Corporation's fixed maturity investment strategy. The overall fixed-maturity portfolio continued to average a credit rating of AA. The distribution of the Corporation's United States property/casualty fixed-maturity portfolio by credit quality was as follows:
The overall pretax yield on the United States property/casualty invested assets was 5.9 percent in 1995 and 1994. During 1995, the segment had approximately $486 million of calls and maturities on grandfathered tax-exempt bonds. These bonds had an average yield of approximately 8.9 percent and the proceeds from the calls were reinvested at an average yield of approximately 5.3 percent. In addition, based on its current investment
portfolio and the current yield curve, the Corporation presently anticipates additional calls and maturities of approximately $404 million on grandfathered tax-exempt bonds with an average yield of approximately 7.8 percent through the end of 1996. Reinvestment of these funds may adversely affect average portfolio yields and investment income.
The primary goal of Cologne Re's investment policy is the optimization of after-tax investment income taking into consideration the duration and currency structure of Cologne Re's reinsurance liabilities. The investment objectives of Cologne Re's subsidiary companies are determined by specific investment guidelines which take into consideration the different legal requirements in their respective jurisdictions. The investments of the subsidiaries are monitored and reviewed by Cologne Re's Finance Department.
The composition of Cologne Re's invested assets by currency was as follows:
The invested assets of the Corporation's wholly owned international subsidiaries of $1,050 million at December 31, 1995 consist of 77.4 percent in fixed maturities, 14.7 percent in equities and 7.9 percent in short-term investments. The overall pretax yield on these operations was 7.6 percent in 1995 and 1994. The portfolio of each subsidiary is managed by local professional asset managers who are overseen by a local Board of Directors and the Corporation's Investment Department. The portfolio is diversified by country of issuer and duration to match the currency and duration structure of the reinsurance operations.
The composition of the Corporation's wholly owned international subsidiaries' investment portfolio by currency was as follows:
ants 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.
The liability for claims and claim expenses for 1994 and prior accident years for the United States operations, net of related reinsurance recoveries, increased by $13 million in 1995. The increase was principally the result of the net effect of reserve strengthening for environmental and latent injury claims, partly offset by favorable loss development on casualty lines of business. The liability for prior accident years was decreased by $36 million in 1994 and was increased by $140 million during 1993. The adverse income impact in 1993 was the result of reserve strengthening principally for environmental and latent injury claims. The liability for claims and claim expenses for 1994 and prior accident years for the international operations, net of related reinsurance recoveries and foreign exchange, increased by $1 million in 1995.
Included in the Corporation's liability for claims and claim expenses are liabilities for environmental and latent injury damage claims. These claims are principally related to claims arising from cleanup costs associated with hazardous waste sites and bodily injury claims relating to asbestos products. These amounts include provisions for both reported and IBNR claims. The table below presents the three-year development of the balance sheet liability for environmental and latent injury claims:
The Corporation continually estimates its liabilities and related reinsurance recoverable for environmental and latent injury claims and claim expenses. While most of the Corporation's liabilities for such claims arise from exposures in the United States, the Corporation has also provided for international environmental and latent injury exposures. Environmental and latent injury exposures do not lend themselves to traditional methods of loss development determination and therefore may be considered less reliable than reserves for standard lines of business (e.g., automobile). The estimate is composed of four parts: known claims, development on known claims, IBNR and direct excess coverage litigation expenses. Although reliability is constrained by uncertainties, the Corporation has confidence in the reported, known claim liabilities and, based on alternative methods, has projected a fairly reliable estimate of development for these claims. The Corporation has also included an estimate for IBNR which is based on fitted curves of estimated future claim emergence; this estimate is less reliable than the estimated liability for reported claims. The effect of joint and several liability on the severity of claims and a provision for future claims inflation have been included in the loss development estimate.
Comprehensive environmental laws have been enacted in most European countries, generally imposing sanctions in the form of fines, cleanup costs or civil damage awards. To date, insureds in Europe have generally not recovered the costs from insurers arising from environmental cleanup except those claims considered sudden and accidental. Changes in environmental regulations and litigation practices within the European Union may affect future claim development.
Ceding companies report information about environmental and latent injury claims based upon their individual and differing methodologies for characterizing claims. For example, some ceding companies report one claim for a policyholder with a number of exposure sites, whereas others report each exposure at each site as a separate claim. In addition, a substantial number of latent injury claims, which are often reported to the Corporation on a precautionary basis by the ceding companies and insureds prior to reaching the reinsured layer, close without reinsurance payment. Due to these factors, the Corporation is unable to provide meaningful claim count information.
The liability for environmental and latent injury claims and claim expenses is management's best estimate of future claim and claim expense payments and recoveries which are expected to develop over the next several decades. The Corporation continues to monitor evolving case law and its effect on environmental and latent injury claims. Changing government regulations, newly identified toxins, newly reported claims, new theories of liability, new contract interpretations and other factors could significantly affect future claim development. While the Corporation has recorded its current best estimate of its liabilities for unpaid claims and claim expenses, it is reasonably possible that these estimated liabilities, net of estimated reinsurance recoveries, may increase in the future and that the increase may be material to the Corporation's results from operations, cash flows and financial position. It is not possible to estimate reliably the amount of additional net loss, or the range of net loss, that is reasonably possible.
The Corporation 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, 1995, GRC recorded $1,406 million in claim liability discount, of which $923 million relates to tabular reserves and $483 million relates to nontabular reserves for medical costs associated with tabular reserve claims. The Delaware Insurance Department has confirmed that GRC may discount both its tabular reserves and the medical expenses associated with such tabular reserves at 4.5 percent per year.
The asset and liability positions of the financial services operations fluctuate based on ongoing derivatives transactions and related risk management activities. The purchase of United States 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 sale of United States 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 1995, invested assets of these operations increased $817 million to $2,478 million. Securities purchased under agreements to resell (an asset) declined $747 million in 1995 to $66 million. Securities sold under agreements to repurchase (a liability) increased $325 million in 1995 to $1,263 million. Securities sold but not yet purchased represent obligations of the Corporation to deliver the specified security at the contracted price, thereby creating a liability to repurchase the security in the market at prevailing prices. Accordingly, the Corporation'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 decreased $313 million in 1995 to $614 million at December 31, 1995.
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 1995 aggregate weekly market risk limit across all trading books was $10 million.
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 $67 million and $55 million at December 31, 1995 and 1994, respectively. GRFP has not experienced any credit losses as a result of counterparty defaults.
Common stockholders' equity at December 31, 1995 was $6,587 million, an increase of 35.6 percent over $4,859 million at December 31, 1994. The change in common stockholders' equity was primarily due to net income of $825 million, after-tax unrealized appreciation of $1,047 million, less stock repurchases of $35 million and dividends paid of $172 million. Common stockholders' equity at December 31, 1994 increased 2.1 percent over the $4,761 million at year end 1993.
United States and international operating cash flows grew in 1995 and 1994, primarily in response to growth in the property/casualty reinsurance business. United States property/casualty financing cash flows include the Corporation's stock repurchases and dividends to stockholders. As discussed earlier, the Corporation made a net cash investment in 1994 of $582 million in GR-CK, the holding company which owns approximately 66.3 percent of the economic interest of Cologne Re. The funds invested in GR-CK are subject to certain restrictions according to the joint-venture agreement. The Corporation's United States cash flow should not be significantly affected by the joint-venture structure, since interest paid to GR-CK on the intercompany note will generally be funded by dividends received from GR-CK.
At December 31, 1995, the Corporation had $150 million of senior debt outstanding, which is rated AAA by Standard & Poor's and Aa1 by Moody's. The Corporation issues commercial paper to provide additional financial flexibility for its operations. Commercial paper offered by the Corporation has been rated A1+ by Standard & Poor's and Prime 1 by Moody's. At December 31, 1995, no commercial paper was outstanding. During August 1995, the Corporation modified its $1.0 billion lines of credit to extend the commitment period for half of the facility. The new credit lines with nineteen participating banks consist of a 364-day facility of $500 million and a five-year credit facility for the remaining $500 million. The lines of credit provide the Corporation with support for the commercial paper program and enhance the Corporation's financial flexibility. At December 31, 1995, the Corporation had no outstanding loans under this facility.
The actuary relied upon by management in forming the basis of its belief as to the reasonableness of claim and claim expense liabilities is Lee R. Steeneck, FCAS, MAAA, Vice President and Actuary of General Re Corporation. In addition to the ongoing review by management, these liabilities are subject to independent review on a regular basis. The Corporation's independent public accountants use actuaries during their annual financial statement audit to review both current balance sheet liabilities and income statement provisions. In addition, the Audit Committee of the Board of Directors has periodically engaged the services of an actuarial consulting firm to compare the claim liabilities established by management with the estimates of an independent consulting actuary.
RECONCILIATION OF LIABILITY FOR PROPERTY/CASUALTY CLAIMS AND CLAIM EXPENSES (IN MILLIONS)
The Corporation discounts certain United States workers' compensation loss reserves at an interest rate of 4.5 percent per annum, the same rate used for reporting to state regulatory authorities with respect to the same claim liabilities. These claims are characterized by periodic indemnity payments principally for wage loss and medical/rehabilitation expenses which are generally fixed or determinable, both in amount and duration. The amortization of the discount is included in current operating results as part of the development of prior years' liabilities. The effect of discounting reduced liabilities for claims and claim expenses, net of reinsurance, is as follows:
Table 3 reconciles the difference between liabilities for claims and claim expenses, net of reinsurance, reported in the consolidated financial statements under GAAP with that reported in annual statements filed with state insurance regulators in accordance with SAP.
A number of major trends occurred within the industry which have significantly affected the development of the Corporation's liabilities for claims and claim expenses displayed in Tables 4 and 5. Starting in 1979, the Corporation considerably strengthened the liability for claims and claim expenses for latent injury (e.g., asbestos-related) and environmental (e.g., hazardous waste) claims. When originally written, these exposures, some dating back to the 1940s, were not known to cause bodily harm or property damage. Coverage, if any, was provided to policyholders on a very limited basis. Liberal interpretations of very carefully worded insurance policy contract language have, in retrospect, created unanticipated liabilities for the property/casualty insurance industry. Adjustments to the Corporation's liabilities have been made in each year's current operating results since 1979 to reflect the evolution of case law which has widened the nature and extent of insurance and reinsurance coverage for these exposures.
Table 6 and Table 7 present the development of net and gross balance sheet liabilities for the Corporation's international property/casualty operations beginning in 1994. The accident-year information required to complete Table 6 and Table 7 for the Corporation's wholly owned international subsidiaries was not available
in prior years. These liabilities, however, were not significant to the consolidated total in prior periods. Due to customary lags in 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 below.
In evaluating the information included in Tables 4 - 7, it should be noted that conditions and trends affecting the development of liabilities in the past may not occur in the future. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on these tables. Current actuarial studies indicate that liabilities for claims and claim expense as of December 31, 1995, net and gross of reinsurance, are adequate.
We have audited the consolidated financial statements and schedules of General Re Corporation and subsidiaries listed in the index on page 26 of this Form 10-K. These financial statements and schedules are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of General Re Corporation and subsidiaries as of December 31, 1995 and 1994, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. In addition, in our opinion, the financial statement schedules referred to above, when considered in relation to the basic financial statements taken as a whole, present fairly, in all material respects, the information required to be included therein.
CONSOLIDATED STATEMENTS OF INCOME YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN MILLIONS, EXCEPT SHARE DATA)
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1995 AND 1994 (IN MILLIONS, EXCEPT SHARE DATA)
CONSOLIDATED STATEMENTS OF COMMON STOCKHOLDERS' EQUITY YEARS ENDED DECEMBER 31, 1995, 1994, AND 1993 (IN MILLIONS)
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1995, 1994 AND 1993 (IN MILLIONS)
ORGANIZATION: General Re Corporation and Subsidiaries (the "Corporation") is a global reinsurance and financial services company. The Corporation operates in four principal business segments: United States property/casualty reinsurance, international property/casualty reinsurance, life/health reinsurance and financial services. The Corporation is the largest professional property/casualty reinsurer domiciled in the United States and is among the four largest in the world.
The Corporation's United States property/casualty subsidiaries produced revenues of $3,641 million, or 50.5 percent, of consolidated revenues in 1995. The principal business of these subsidiaries is treaty and facultative reinsurance underwritten on a direct basis throughout the United States and Canada. The Corporation predominately writes excess-of-loss reinsurance across various lines of business.
The Corporation's financial services operations include derivative products, insurance brokerage and management, investment management, reinsurance brokerage and real estate management operations. Through its subsidiary, General Re Financial Products Corporation ("GRFP"), a dealer in derivative products, the Corporation offers a full line of interest rate and cross-currency swaps, options, and other derivative products in all major currencies from offices or affiliates in New York, Toronto, London and Tokyo. The financial services operations produced $254 million, or 3.5 percent, of the Corporation's 1995 revenues.
The following are the significant accounting policies and practices of the Corporation:
BASIS OF PRESENTATION: The Corporation's consolidated financial statements have been prepared on the basis of generally accepted accounting principles in the United States. The consolidated financial statements include the Corporation and its subsidiaries. All significant intercompany transactions have been eliminated. International property/casualty and life/health subsidiaries report their results on a quarter lag. In 1995, all of GRFP's trading-related cash flows have been classified as operating in the statement of cash flows. Certain other reclassifications have been made to 1994 and 1993 balances to conform to the 1995 presentation.
INVESTMENTS: Fixed maturity securities that the Corporation has both the ability and intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. Fixed maturity securities that the Corporation 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. During the fourth quarter of 1995, the Corporation reassessed its categorization of fixed maturities in response to recent additional classification guidance issued by the Financial Accounting Standards Board. At December 31, 1995, all fixed maturity securities of the Corporation have been categorized as either available-for-sale or trading. Most of the securities transferred to the available-for-sale category were tax-exempt securities grandfathered under the Tax Reform Act of 1986 that the Corporation anticipates being called within the near future. The
recategorization of these securities had no effect on net income and increased common stockholders' equity by $53 million.
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 than temporary. Realized gains or losses include gains and losses arising from the translation into United States dollars of investments held by the United States operations and denominated in foreign currencies. Investment income is recognized as earned and includes the amortization of bond discount and accretion of bond premium.
PREMIUMS EARNED: Premiums are recognized in income over the contract period in proportion to the amount of insurance or reinsurance provided. Unearned premium liabilities are established to cover the unexpired portion of premiums written. Such liabilities are computed by pro rata methods based on statistical data and reports received from ceding companies. In the absence of ceding company reports, premiums are estimated using historical information and management judgment. Premium adjustments on contracts and audit premiums are accrued on an estimated basis throughout the contract term. Premiums are net of retrocessions.
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 the Corporation's method for establishing the related liability. Workers' compensation liabilities, after deduction of reinsurance recoverable for unpaid losses, were $1,244 million and $1,186 million at December 31, 1995 and 1994, respectively, after being discounted at an interest rate of 4.5 percent.
ACQUISITION COSTS: Acquisition costs, principally commissions that vary with and are primarily related to the acquisition of new business, are deferred and amortized with interest over the premium-paying period of traditional life and health insurance policies.
PRESENT VALUE OF FUTURE PROFITS: The present value of future profits ("PVP") is the actuarially determined present value of the projected profits from the continuation of in-force reinsurance on existing insurance policies on the date Cologne Re was acquired. The calculation of the estimated profits includes anticipated future premiums, death and benefit payments, reserve changes, profit sharing amounts, expenses and related investment income. PVP was determined using risk-adjusted discount rates ranging primarily from 10.0 percent through 16.0 percent. The interest rates selected for the valuation were determined based on the applicable interest rates in the country of risk and the risk inherent in the realization of the estimated future profits. PVP, which is included in "Other assets" on the balance sheet, was $125 million at December 31, 1995 and is being amortized over the duration of the related life business, approximately 20 years, based upon the assumed underlying profits of the business acquired using a 7.0 percent interest rate.
FOREIGN CURRENCY TRANSLATION: Revenues and expenses in foreign currencies are translated at the average rate of exchange during the period. Assets and liabilities are translated at the rate of exchange in effect at the close of the period. Gains or losses resulting from translating foreign currency financial statements are accumulated in a separate component of common stockholders' equity. Gains or losses resulting from foreign currency transactions (transactions denominated in a currency other than the entity's functional currency) are included in net income.
ACCOUNTING ESTIMATES: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. The Corporation's principal estimates include property/casualty claims and claim expenses, policy benefits for life/health contracts, estimated premium for situations where the Corporation has not received ceding company reports and nonexchange traded financial instruments. The Corporation utilizes historical information, actuarial analyses, financial modeling and other analytical techniques to prepare these estimates. Actual results for all these items could differ from the estimates included in the Corporation's income statement, balance sheet and statement of cash flows.
no effect on the Corporation's results from operations. See Note 1 for additional details on the Corporation's investment accounting policies.
The Corporation has an option after seven years to purchase the Class A shares of GR-CK owned by the CKAG at a formula price. The option has a minimum exercise price of DM 1,306 million and a maximum of DM 1,509 million, subject to certain warranty adjustments that may reduce the exercise price. If the Corporation does not exercise its option to purchase the Class A shares of GR-CK from CKAG, CKAG has the option to purchase the Class B shares of GR-CK from the Corporation under a similar exercise price formula.
The acquisition of the shares of Cologne Re through GR-CK has been accounted for as a purchase. The Corporation 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. The assets and liabilities of Cologne Re were included in the Corporation's balance sheet at December 31, 1994 at management's then best estimate of their fair values. The final evaluation of assets and liabilities was completed during 1995. The cost of the initial acquisition has been allocated on the basis of the estimated fair market value of the assets acquired and the liabilities assumed at the time of the transactions, with the excess of cost over net assets acquired recorded as goodwill.
In 1993, the Corporation entered into a joint venture with W.R. Berkley Corporation ("Berkley") to form Signet Star Holdings, Inc. ("SSH"), which acquired the common stock of North Star Reinsurance Corporation ("North Star"), a wholly owned subsidiary of the Corporation, and Signet Reinsurance Company, a wholly owned subsidiary of Berkley. Under the agreement, the Corporation acquired shares representing 40.0 percent of the equity interest of SSH, $36 million of 6.96 percent convertible debt due in January 2003 and $40 million of 9.8 percent senior debt due in January 2000. The Corporation accounted for its interest in SSH under the equity method. In November 1993, SSH called the senior debt at par plus accrued interest. The Corporation, through its wholly owned subsidiary, GRC, has retained the net claim and claim expense liability of North Star for all reinsurance contracts underwritten by North Star prior to January 1, 1993. These claim and claim expense liabilities are currently in runoff and did not have a material effect on the Corporation's results from operations or financial position during 1995.
In December 1995, the Corporation sold its 40.0 percent interest in SSH to Berkley in exchange for 458,667 shares of Series B cumulative redeemable preferred stock of Berkley having an aggregate liquidation preference of $69 million. The preferred stock has a dividend rate that increases quarterly to 6.0 percent during the first twelve months after issuance. Thereafter, the rate is subject to readjustment based on the then current market interest rate. Prior to this transaction, the Corporation purchased the common stock of North Star from SSH for its then current statutory surplus of $10 million. In addition, the $36 million SSH convertible debt was redeemed at par plus accrued interest and replaced with a $36 million subordinated note of SSH,
In September 1993, the Corporation acted as sponsor in the formation of Tempest Reinsurance Company Limited ("Tempest"), a Bermuda-based reinsurance company specializing in excess property catastrophe reinsurance. The Corporation accounted for its 20.7 percent interest in Tempest of $143 million and $112 million at December 31, 1995 and 1994, respectively, under the equity method. The Corporation provides underwriting and investment management services for Tempest.
The Corporation's United States 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, furniture and equipment, deferred income taxes and certain other items. Combined statutory surplus at December 31, 1995 and 1994 was $4,607 million and $3,770 million, respectively, and combined statutory net income for the years ended December 31, 1995, 1994 and 1993 was $621 million, $511 million and $655 million, respectively.
The Corporation's subsidiaries prepare their 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, the Corporation discounts certain workers' compensation liabilities at an annual rate of 4.5 percent. Included in the discount recognized for statutory purposes at December 31, 1995 was $483 million resulting from discounting permitted by the domiciliary insurance department.
The Corporation's international subsidiaries prepare statutory financial statements based on local laws and regulations. Some jurisdictions, such as the United Kingdom, impose complex regulatory requirements on reinsurance companies, while other jurisdictions, such as Germany, impose fewer requirements. Local reinsurance business conducted by the Corporation's subsidiaries in some countries require licenses issued by governmental authorities. These licenses may be subject to modification or revocation dependent on such factors as amount and types of reserves and minimum capital and solvency tests. Jurisdictions may impose fines, censure and/or criminal sanctions for violation of regulatory requirements.
The cost, fair value and gross unrealized appreciation and depreciation of short-term, fixed maturity, equity and other investments were as follows:
1 Cost is amortized cost for short-term investments and fixed maturities and original cost for equity securities and other invested assets.
Gross gains of $117 million, $57 million and $120 million and gross losses of $73 million, $120 million and $22 million were realized on sales of available-for-sale fixed maturities in 1995, 1994 and 1993, respectively. The contractual maturities of fixed maturity investments 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.
Securities with a market value of approximately $635 million at December 31, 1995 were on deposit with various state or governmental departments to comply with insurance laws.
The Corporation continually estimates its liabilities and related reinsurance recoveries for environmental and latent injury claims and claim expenses. These exposures do not lend themselves to traditional methods of loss development determination and, therefore, may be considered less reliable than reserves for standard lines of business (e.g., automobile). The estimate is composed of four parts: known claims, development on known claims, incurred but not reported ("IBNR") and direct excess coverage litigation expenses. Although reliability is constrained by uncertainties, the Corporation has confidence in the reported, known claim liabilities and, based on alternative methods, has projected a fairly reliable estimate of development for these claims. The Corporation has also included an estimate for IBNR which is based on fitted curves of estimated future claim emergence. This estimate is less reliable than the estimated liability for reported claims. The effect of joint and several liability on the severity of losses and a provision for future claim inflation have been included in the loss development estimate. The Corporation has established a liability for litigation costs associated with coverage disputes arising out of direct excess insurance policies, rather than from reinsurance assumed. Direct excess coverage litigation expenses are estimated using a modified count and amount actuarial study.
Income taxes were established on a consolidated basis for all United States and international subsidiaries of the Corporation. No provision has been made for United States income taxes on that portion of cumulative undistributed income of wholly owned international subsidiaries of $125 million at December 31, 1995, which is considered permanently reinvested. Applicable United States income taxes have been recorded for Cologne Re's income since it distributes dividends to its shareholders on an annual basis.
The components of pension expense related to both funded and unfunded plans were as follows:
Substantially all of the Corporation's employees in the United States will become eligible for certain health care and group life insurance benefits upon retirement from the Corporation. Effective January 1, 1993, the Corporation adopted Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other Than Pensions. The Corporation 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 the Corporation upon retirement. As of December 31, 1995 and 1994, the Corporation had funded $3 million and $2 million, respectively, for postretirement health care benefits for current retirees and had an accrued liability of $27 million and $23 million, respectively, for current employees.
The Corporation has a Long-Term Compensation Plan (the "Plan") which provides for the granting of incentive and nonqualified stock options to members of the Board of Directors, key executives and managerial employees. The Plan provides that the exercise price of the options granted may not be less than the fair market value of the Corporation's common stock on the date the options are granted. The options are exercisable cumulatively 20 percent each year commencing one year from the date of grant and expire ten years from the grant date. In certain circumstances, replacement options may be granted upon exercise of an original option, with the exercise price equal to the current market price and with a term extending to the expiration date of the original option.
The Plan also permits the granting of stock appreciation rights ("SARs") in connection with options granted under the Plan. SARs permit the grantee to surrender an exercisable option for an amount equal to the excess of the market price of the common stock over the option price when the right is exercised. No SARs have been granted since 1988.
The Corporation 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 $31 million in 1995, $32 million in 1994 and $33 million in 1993. At December 31, 1995, the future minimum annual rental commitments under noncancelable leases were as follows:
Future minimum rental payments above have not been reduced by $20 million of anticipated sublease rental income on noncancelable leases.
Premiums, claims and claim expenses and life/health benefits are reported net of reinsurance in the Corporation's statements of income. Direct, assumed, ceded and net amounts for these items were as follows:
As part of its retrocessional program, the Corporation placed a portion of its reinsurance with various Lloyd's of London syndicates. The syndicates act as managing agents for individual "Names" who bear the risks and rewards of the syndicates' underwriting results. Under Lloyd's current structure, Names have unlimited liability for potential claims. During 1995 Lloyd's announced a plan of "Reconstruction and Renewal," which is intended to act as a means to end litigation associated with losses from prior syndicate years, especially those years exposed to United States environmental and other mass tort exposures. The plan would allow Names to reinsure their pre-1992 underwriting years to a newly formed corporate reinsurer called "Equitas," which will reinsure and manage the runoff of these claims. The intent of the plan is to close out for accounting purposes Names' potential exposures for these prior underwriting years. Names, however, still have potential exposure
for these losses if Equitas is unable to meet its obligations. At December 31, 1995, the Corporation's reinsurance recoverables on paid and unpaid claims and claim expenses from all Lloyd's syndicates aggregated approximately $127 million.
The results of GRFP's trading activities are summarized by category of products in the following table. Trading revenues include any associated gains and losses on hedging instruments. Trading revenue was included in "Other revenues" in the income statement.
Interest rate and currency swaps are agreements between two parties to exchange, at particular intervals, payment streams calculated on a specified notional amount. The parties to a cross-currency swap typically exchange a principal amount in two currencies at inception of the contract, agreeing to reexchange the currencies at a future date and agreed exchange rate.
Futures contracts are commitments to either purchase or sell a financial instrument at a future date for a specified price and are usually settled in cash. Forward-rate agreements are contracts that settle in cash at a specified future date based on the differential between agreed interest rates applied to a notional amount.
The table below discloses the fair values at the reporting date (which are also the carrying amounts) for each class of derivative financial instruments and other instruments held or issued by GRFP for trading purposes, as well as the average fair values during the year, based on quarterly observations. The net fair values are net of amounts offset pursuant to rights of setoff and qualifying master netting arrangements with various counterparties. Interest rate and foreign currency swaps shown in the table below include forward rate agreements and foreign exchange spot and forward contracts.
GRFP's components of market risk include foreign exchange, interest rate, swap spread, volatility, correlation, equity 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 impact 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 1995 aggregate weekly market risk limit across all trading books was $10 million.
GRFP sets market risk limits for each type of risk based on a 95 percent probability that movements in market rates will not affect the results from operations in excess of the limit over a one-week period. Since inception, GRFP's largest weekly position change has been $5 million. In addition to these daily and weekly assessments of risk, GRFP prepares periodic stress tests to assess its exposure to extreme movements in various market risk factors.
Credit risk arises from the possible inability of counterparties to meet the terms of their 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. Counterparties to the financial instruments are, in decreasing order of magnitude, foreign and United States commercial banks, United States government-chartered organizations, sovereigns, supranationals and corporations. The spread of counterparties over geographical location and industry sector is such that GRFP does not believe that it has a significant concentration of credit risk to any particular changes in economic or other conditions. GRFP evaluates the creditworthiness of its counterparties by performing formal internal credit analyses and by referring to ratings of widely accepted credit rating services. Counterparty credit limits are determined based on this analysis and counterparty credit exposures are monitored in accordance with these limits. GRFP receives cash and/or investment grade securities from certain counterparties as collateral and, where appropriate, may purchase credit insurance or enter into other transactions to mitigate its credit exposure. GRFP also incorporates into contracts with certain counterparties provisions that allow the unwinding of these transactions in the event of a downgrade in credit rating or other indications of a decline in creditworthiness of either the counterparty or GRFP.
GRFP assesses credit risk by counterparty across all transactions with a counterparty. Assuming non-performance by all counterparties on all contracts potentially subject to a loss, the maximum potential loss, based on the cost of replacement at market rates prevailing at December 31, 1995, approximated $2,236 million. This value is net of amounts offset pursuant to rights of setoff and qualifying master netting arrangements with various counterparties and is presented in accordance with Interpretation No. 39, Offsetting of Amounts Related to Certain Contracts. The Interpretation further clarifies the definition of a right of setoff. The maximum potential loss will increase or decrease during the life of the transaction as a function of remaining time to maturity, contract values, and interest and currency rates. In the judgment of management, the likelihood that all counterparties would default, resulting in a maximum potential loss, is remote. GRFP has not had any credit losses as a result of counterparty defaults.
collateralized borrowings. GRFP's exposure to credit risks associated with the nonperformance of counterparties in fulfilling these contractual obligations can be directly affected by market fluctuations, which may impair the counterparties' ability to satisfy their obligations. It is GRFP's policy to take possession of securities purchased under agreements to resell. GRFP monitors the market value of the underlying securities as compared to the related receivable, including accrued interest, and requests additional collateral when appropriate. Counterparties to repurchase agreements and futures transactions are commercial banks and securities brokers and dealers. Securities purchased under agreements to resell and securities sold under agreements to repurchase are presented in accordance with FASB Interpretation No. 41, Offsetting of Amounts Related to Certain Repurchase and Reverse Repurchase Agreements.
Contract deposit assets/liabilities -- The fair value of contract deposit assets and liabilities approximates their carrying value.
Securities purchased under agreements to resell, securities sold under agreements to repurchase -- The carrying value for these financial instruments approximates their fair value.
The Corporation and its subsidiaries have been named as defendants in litigation in the ordinary course of conducting its insurance business. These lawsuits generally seek to establish liability under insurance or reinsurance contracts issued by the subsidiaries, and occasionally seek punitive or exemplary damages. The Corporation's reinsurance subsidiaries are also indirectly involved in coverage litigation. In those cases, plaintiffs seek coverage for their liabilities under insurance policies from insurance companies reinsured by the Corporation's reinsurance subsidiaries. In the judgment of management, none of these cases, individually or collectively, is likely to result in judgments for amounts which, net of claim and claim expense liabilities previously established and applicable reinsurance, or any other litigation, would be material to the financial position, results of operations or cash flow of the Corporation.
The Corporation has the authority to issue 250 million shares of $.50 par value common stock, of which 102 million have been issued. Common stock purchased in the open market is carried at cost and shown as a reduction to common stockholders' equity. When treasury shares are reissued, the treasury stock account is reduced for the cost of the common stock reissued on a first-in, first-out basis. No treasury stock of the Corporation is held by any subsidiary. The number of shares included in treasury stock were as follows:
The Corporation also has the authority to issue 20 million shares of preferred stock, of which 1,724,037 are issued and outstanding and held by the ESSOP, and 1 million (Series A Junior Participating Preferred) are reserved for the Stockholders' Rights Plan. Under the Stockholders' Rights Plan, one Right attaches to each outstanding share of common stock. In the event a person or group acquires or commences a tender or exchange offer for 20 percent or more of the Corporation's common stock, each Right entitles common stockholders to purchase Series A Junior Participating Stock, which is convertible to common stock having a value equal to two times the exercise price.
The Corporation conducts its operations principally through the following business segments: the property/casualty reinsurance operations, which include both United States and international subsidiaries, life/health operations and financial services.
The following is a summary of industry segment activity for 1995, 1994 and 1993: