Losses from coverages other than property insurance may also occur from an event giving rise to catastrophic property losses. For example, an earthquake or explosion could cause workers' compensation losses as well as property losses. TIG has estimated a PML for such an event and coordinates its underwriting guidelines and reinsurance covers to limit its probable maximum loss. It is possible that the PML estimated by TIG may either understate or overstate, perhaps to a significant degree, the possible losses to TIG which could be generated by insured loss events.
Aggregate Stop Loss Reinsurance. Both TIG Insurance and TIG Re purchase aggregate stop loss reinsurance to protect against unanticipated exposures not considered in other reinsurance coverages. In addition, aggregate stop loss coverage can be utilized to cover exposure to large deductibles under other reinsurance treaties, especially catastrophe treaties, and mitigate risk inherent in a changing book of business. TIG's aggregate stop loss reinsurance treaties generally provide excess of loss protection on all business written for losses incurred in excess of a specified loss retention ratio ("attachment point"). Stop loss reinsurance is "umbrella" protection which is utilized after all other specific reinsurance coverages have been exhausted.
TIG has consistently maintained aggregate stop loss protection in various forms since 1994. Coverages provide benefit of 70% to 100% of losses in excess of the attachment point. Premium cessions are generally made on a funds withheld basis. Funds withheld balances generally bear interest at rates of 7.0% to 8.5% (see Item 7.7 Investments). At December 31, 1997 and 1996, funds withheld balances related to aggregate stop loss reinsurance contracts were $264 million and $210 million, respectively, while related reinsurance recoverable balances were $466 million and $305 million, respectively.
Consolidated Statements of Income for each of the three years in the period ended December 31, 1997 ......................................53
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of TIG Holdings, Inc. and subsidiaries at December 31, 1997 and 1996, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1997, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
Dallas, Texas January 30, 1998, except for Note M, as to which the date is February 12, 1998
TIG Holdings is primarily engaged in the business of property/casualty insurance and reinsurance through its 14 domestic insurance subsidiaries, collectively "TIG" or "the Company". Of direct premium written by TIG in 1997, 26% was written in California, 9% in Michigan, 7% in Hawaii, and 6% each in Florida and New York. No other geographical area, including foreign operations, accounted for more than 5% of direct premium written. A description of each operating division's principal products follows (see also Note O - Business Segments).
Reinsurance. TIG's reinsurance operations are conducted through TIG Reinsurance Company ("TIG Re"). Reinsurance is a form of insurance whereby the reinsurer (i.e. TIG Re) agrees to indemnify another insurance company (the "ceding company") for all or a portion of the insurance risks underwritten by the ceding company under an insurance policy or policies. TIG Re writes both pro rata and excess of loss coverages. TIG Re provides pro rata coverages when the ceding company's underwriting capabilities are considered superior and where the relationship with the ceding company provides an opportunity for long-term profitability. TIG Re's primary strategy for excess of loss treaties is to take large participations in working layers of a limited number of programs. By assuming a significant participation in each treaty, TIG Re exercises significant control over the terms and structure of each treaty. TIG Re's predominant source of business is through reinsurance intermediaries. Net premium written for the Reinsurance division comprised 36%, 36% and 32% of consolidated net premium written for the years ended December 31, 1997, 1996 and 1995, respectively.
Commercial Specialty. Commercial Specialty coverages provide protection against property loss and legal liability for injuries to other persons or damage to their property arising from the policyholder's business operations. Commercial Specialty primarily develops and markets insurance programs where the nature of the risk does not lend itself to traditional commercial insurance. Significant programs include Sports and Leisure, with products for professional and amateur sports events, Workers' Compensation, which provides liability coverage to employers for payment of employee benefits associated with employment related accidents as mandated by state laws, Primary Casualty which focuses on commercial auto, professional liability, construction and marine programs, Excess Casualty which offers lead umbrella and excess umbrella policies and participation in three Lloyd's of London syndicates writing marine, UK property and aviation business. Commercial Specialty products are principally marketed through large general agents, with which TIG sometimes has exclusive marketing contracts. Net premium written for the Commercial Specialty division comprised 41%, 29% and 27% of consolidated net premium written for the years ended December 31, 1997, 1996 and 1995, respectively.
Earnings per Share ("EPS"). In December 1997, TIG adopted Statement of Financial Accounting Standards No. 128 "Earnings Per Share", which established a new calculation of EPS. Prior period amounts have been restated to conform with the new requirements. Basic earnings per share is calculated based upon the weighted average common shares outstanding during the period. In order to calculate EPS, unallocated Employee Stock Ownership Plan ("ESOP") shares and treasury shares are deducted from the outstanding common shares. For diluted EPS, Class A common stock and common stock options (See Note K - Incentive Compensation Plans) increase weighted average shares outstanding to the extent that they are dilutive. To obtain net income attributable to common shareholders for EPS computations, the annual preferred stock dividend is deducted from net income. The following schedule presents the calculation of Basic and Diluted EPS:
Interest on fixed maturity investments is recorded as income when earned and is adjusted for any amortization of purchase premium or accrual of discount. Realized gains and losses on the sale of investments are generally determined on a first-in-first-out basis.
Realized losses are recorded when an investment's net realizable value is below cost, and the decline is considered other than temporary.
Stock Compensation. TIG adopted Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" ("SFAS 123") effective January 1, 1996. SFAS 123 establishes financial accounting and reporting standards for stock-based employee compensation plans. TIG elected to continue to account for employee stock-based compensation as prescribed by APB Opinion No. 25, "Accounting for Stock Issued to Employees" and to provide pro forma disclosures in the Notes to Financial Statements of the effects of SFAS 123 on net income and earnings per share. There was no effect on net income or earnings per share as a result of adopting SFAS 123.
Recognition of Premium Revenues. Premium is earned principally on a pro rata basis over the terms of the policies which are generally not more than one year. Unearned premium represents the portion of premium written applicable to the unexpired terms of policies in force.
Other Assets. Property, leasehold improvements and furniture and equipment of $40 million and $41 million at December 31, 1997 and 1996, respectively, are included in other assets. These balances are carried at cost less accumulated depreciation of $24 million and $38 million at December 31, 1997 and 1996, respectively. Depreciation is computed under the straight-line method over the estimated useful lives of the assets over periods ranging from three to ten years. Goodwill and other intangible assets of $18 million and $4 million at December 31, 1997 and 1996, respectively, are also included in other assets. These balances are amortized on a straight-line basis over periods ranging from 10 to 20 years. TIG's accounting policy governing the measurement of goodwill impairment includes an annual analysis of the recoverability of goodwill as of each balance sheet date.
Restructuring Charges. In February 1996, TIG announced the reorganization of its commercial operations and plans to exit certain lines of business that failed to meet profitability standards. As a result of this reorganization, TIG took the following actions: 1) combined its Specialty Commercial and Workers' Compensation divisions to form a new division called Commercial Specialty, 2) identified field offices for consolidation and closure, 3) identified lines of business for non-renewal or cancellation for which 1995 net premium written was approximately $190 million, 4) formed a run-off division (called "Other Lines") to administer contractually required policy renewals for run-off lines of business, and 5) outsourced to third party service providers or otherwise terminated the responsibilities of approximately 600 employees. The consolidation/closure of field offices was completed by December 31, 1996, although various lease obligations remain at December 31, 1997.
TIG recorded a $100 million accrual in first quarter 1996 for estimated restructuring charges comprised of severance of $17 million; contractual policy obligations of $37 million; office lease termination of $18 million; furniture, equipment and capitalized software write-downs of $12 million; and a reserve for litigation and credit issues related to terminated producers of $16 million. In 1997, TIG re-evaluated the $100 million restructuring charge. Although the total amount of the restructuring charge remained unchanged, the components were revised to the following: severance of $13 million; contractual policy obligations of $43 million; office lease terminations of $16 million; furniture, equipment and capitalized software write-downs of $10 million; and a reserve for litigation and credit issues related to terminated producers of $18 million. Severance costs were less than originally estimated due to the employment of certain TIG associates by third party service providers. The reduction in severance was effectively offset by increased costs for contractual policy obligations associated with outsourcing contracts. The revised estimates for leases, asset write-downs, and producer credit issues reflect minor adjustments to original assumptions based on activity through December 31, 1997. Charges against the restructure accrual of $85 million have been recorded since March 1996 and are comprised of $12 million in severance, $43 million in contractual policy obligations, $12 million in lease termination costs, $10 million in asset write-downs and $8 million related to producer credit issues. At December 31, 1997, TIG's exit plan was substantially complete with the remaining restructure accrual of $15 million projected to be paid out over the next three to four years.
- -------------------------------------------------------------------------------- NOTE C. SALE OF INDEPENDENT AGENTS BUSINESS UNIT - --------------------------------------------------------------------------------
PART II NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- NOTE D. INVESTMENTS - -------------------------------------------------------------------------------- Market Values and Amortized Cost of Invested Assets:
Approximately one-fourth of TIG's portfolio consists of mortgage-backed securities ("MBS"). United States federal government and government agency mortgages now represent approximately 82% of TIG's exposure to MBS, offering AAA credit quality. A risk inherent to MBS is prepayment risk related to interest rate volatility. The underlying mortgages may be repaid earlier or later than originally anticipated, depending on the repayment and refinancing activity of the underlying homeowners. Should this occur, TIG would receive paydowns on principal amounts which may have been purchased at a premium or discount, and TIG's investment income would be affected by any adjustments to amortization resulting from the prepayments. TIG's consolidated financial results have not been materially impacted by prepayments of MBS. In addition, interest rate volatility can affect the market value of MBS. Substantially all MBS held in the portfolio can be actively traded in the public market.
TIG routinely enters into commitments to purchase securities on a "To Be Announced" ("TBA") basis for which the interest rate risk remains with TIG until the date of delivery and payment. Delivery and payment of securities purchased on a TBA basis can take place a month or more after the date of the transaction. These securities are subject to market fluctuations during this period and it is the Company's policy to recognize any gains or losses only when they are realized. TIG maintains cash and short-term investments with a fair value exceeding the amount of its TBA purchase commitments. At December 31, 1997, the TBA purchase commitments amounted to $24 million, and had a fair value of $26 million, compared to TBA commitments of $46 million with a fair value of $46 million at December 31, 1996.
Market Amortized (In millions) Value Cost ==================================================== ============= ============= Due in on year or less $373 $368 Due after one year through five years 275 273 Due after five years through ten years 614 605 Due after ten years 1,671 1,546 Mortgage-backed securities 941 933 - ---------------------------------------------------- ------------- ------------- Total fixed maturity investments $3,874 $3,725 ==================================================== ============= =============
Years Ended December 31, ----------------------------- (In millions) 1997 1996 1995 ================================================== ========== ========= ======== Fixed maturity investments $297 $298 $273 Short-term and other investments 8 6 7 - -------------------------------------------------- ---------- --------- -------- Total gross investment income 305 304 280 Investment expenses, interest and other (15) (14) (12) - -------------------------------------------------- ---------- --------- -------- Total net investment income $290 $290 $268 ================================================== ========== ========= ========
Activity in the loss and loss adjustment expense reserve account is summarized as follows:
The unfavorable loss and LAE reserve development for prior years in 1996 of $16 million is due primarily to adverse development in Other Lines. In connection with the February 1996 restructuring, TIG completed a re-evaluation of loss and LAE reserves related to run-off lines using additional loss development data received during the first quarter of 1996. This data confirmed adverse loss development trends observed in the second half of 1995 and was a consideration in the decision to exit certain lines of business as discussed at Note B. Summary of Significant Accounting Policies. As a result of this re-evaluation and management's belief that the restructuring decision will make the claims settlement process less consistent and more volatile, TIG increased loss and LAE reserves by $31 million in the first quarter of 1996 for run-off lines, principally for long haul trucking and large accounts. This reserve strengthening was partially offset by continuing favorable development of 1993 and prior workers' compensation reserves.
TIG's reserves include an estimate of TIG's ultimate liability for asbestos-related matters, environmental pollution, toxic tort and other non-sudden and accidental claims for which ultimate values cannot be estimated using traditional reserving techniques. TIG's environmental claims activity is predominately from hazardous waste and pollution-related claims arising from commercial insurance policies. Most of TIG's pollution claims are from small regional operations or local business involved with disposing wastes at dump sites or having pollution on their own property due to hazardous material use or leaking underground storage tanks. In connection with the initial public offering of TIG Holding's common stock ("IPO"), an affiliate of Transamerica agreed to pay 75% of up to $119 million of reserve development and newly incurred claims, up to a maximum reimbursement of $89 million, on policies written prior to January 1, 1993 with respect to certain environmental claims involving paid losses and certain LAE in excess of TIG's environmental loss and LAE reserves at December 31, 1992. At December 31, 1997, the Transamerica affiliate had incurred no liability under this agreement.
Years Ended December 31, ----------------------------------- (In millions) 1997 1996 1995 ============================ =========== =========== =========== Written premium: Direct $1,221 $1,274 $1,387 Assumed 722 650 649 Ceded (507) (395) (426) - ---------------------------- ----------- ----------- ------------ Net $1,436 $1,529 $1,610 - ---------------------------- ----------- ----------- ------------ Earned premium: Direct $1,232 $1,307 $1,377 Assumed 667 632 629 Ceded (433) (400) (388) - ---------------------------- ----------- ----------- ------------ Net $1,466 $1,539 $1,618 - ---------------------------- ----------- ----------- ------------ Incurred losses and LAE: Gross $1,751 $1,417 $1,443 Ceded (600) (279) (267) - ---------------------------- ----------- ----------- ------------ Net $1,151 $1,138 $1,176 ============================ =========== =========== ============
Reinsurance contracts do not relieve TIG from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to TIG; accordingly, allowances are established for amounts estimated to be ultimately uncollectible. TIG evaluates the financial condition of its reinsurers and monitors concentrations of credit risk arising from similar geographic regions, activities, or economic characteristics of the reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. At December 31, 1997, TIG held collateral related to reinsurance amounts in the form of letters of credit totaling $349 million, trust funds totaling $236 million, and funds held totaling $319 million.
TIG files a consolidated federal income tax return. At December 31, 1997, TIG had a net operating loss carryover of $199 million, of which $34 million will expire in 2008, $96 million will expire in 2009, $5 million will expire in 2011 and $64 million will expire in 2012. Additionally, TIG has a $20 million capital loss carryover, of which $16 million will expire in 2000, and $4 million will expire in 2001. For the tax years ended December 31, 1997, 1996 and 1995, TIG made tax payments of $52 million (including the $40 million advance payment discussed below), $5 million and $1 million, respectively.
Years Ended December 31, ---------------------------------- (In millions) 1997 1996 ================================================================== Current asset (liability) $57 ($9) Net deferred tax asset 83 111 ------------------------------------------------ ----------------- Total $140 $102 ==================================================================
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of TIG's deferred tax assets and liabilities as of December 31, 1997 and 1996 are shown in the following table:
The exercise of stock options which have been granted under the Company's various stock option plans gives rise to compensation which is includable in the taxable income of the applicable employees and deductible by the company for federal and state income tax purposes. Such compensation results from increases in the fair market value of the Company's common stock subsequent to the date of grant of the applicable exercised stock options and, accordingly, in accordance with Accounting Principles Board Opinion No. 25, such compensation is not recognized as an expense for financial accounting purposes and the related tax benefits are taken directly to Additional Paid-in Capital. In 1997, Additional Paid-in Capital which is a component of Common Stock in the accompanying financial statements was increased $13 million as a result of the exercise of such options. Tax benefits from the exercise of stock options by employees were not material in 1996 and 1995 (see Note K. Incentive Compensation Plans).
TIG's Federal income tax returns are routinely audited by the Internal Revenue Service (IRS) and provisions are made in the financial statements in anticipation of the results of these audits. Following a routine federal income tax audit by the IRS, in September 1997, the IRS issued a Statutory Notice of Deficiency for the tax year 1993 and a Revenue Agents Report for 1994 asserting a tax liability of approximately $170 million excluding interest. The IRS's asserted tax adjustments principally relate to the acquisition made by TIG under the Section 338(h)(10) election of April 27, 1993 in conjunction with TIG's IPO and primarily generate temporary differences by creating income in 1993 with corresponding deductions in 1993 and future tax years. TIG strongly disagrees with the IRS's position and, on December 11, 1997, TIG filed a Tax Court Petition challenging it. In connection with the Statutory Notice of Deficiency issued by the IRS for the 1993 tax year, TIG made a $40 million advance tax payment in December 1997, that has been reflected as a current tax asset. While the timing of cash tax payments may be impacted, management believes that revisions to TIG's recorded tax liability, if any, arising from the IRS's audit will not materially impact consolidated net income or financial condition.
Notes Payable. In April 1995, TIG Holdings issued $100 million of 8.125% Notes maturing 2005. Interest is payable on a semi-annual basis, and a lump sum principal repayment for the non-callable notes is due April 15, 2005. Included in the restrictive covenants are limitations on the disposition of the stock of TIG Insurance Company ("TIC"), limitations on liens and limitations on the merger of the Company. Interest expense was $8 million in 1997 and 1996 and $6 million in 1995. Interest paid was $8 million in 1997 and 1996 and $4 million in 1995.
Sale - Leaseback. In December 1995, TIG entered into a $50 million credit facility, of which approximately $24 million was outstanding as of December 31, 1997. The facility is a direct financing arrangement with a third party related to the sale and leaseback of certain fixed assets, excluding data processing equipment. The initial draw of $22 million against the facility in December 1995 is being amortized over 5 years with interest at 5.9% payable quarterly. Subsequent draws against the facility are amortized over 5 years and interest, based on a floating rate, is payable quarterly. Interest rates during 1997 ranged from 5.9% to 6.6%. Interest expensed and paid was $1.6 million and $1.4 million for 1997 and 1996, respectively. No interest was expensed or paid in 1995.
Capital Securities. In January of 1997, TIG Capital Trust I ("TIG Capital" or the "Trust"), a statutory business trust created under Delaware law and a trust subsidiary of TIG Holdings, completed a private offering for $125 million of 8.597% mandatory redeemable capital securities. TIG Holdings is the initial holder of 100% of the common securities of TIG Capital. Holders of the capital securities of the Trust have a preference under certain circumstances over the holders of common securities of the Trust with respect to cash distributions and amounts payable on liquidation, redemption, or otherwise.
TIG Holdings issued $128.75 million in 8.597% Junior Subordinated Debentures to TIG Capital Trust I (including approximately $3.75 million with respect to the capital contributed to the Trust by TIG Holdings). Included in the restrictive covenants are limitations on the merger of the Company. TIG Holdings guaranteed the payment of distributions and payments on liquidation or redemption of the capital securities but only in each case to the extent of funds held by the Trust. The guarantee does not cover payment of distributions when the Trust does not have sufficient funds to pay such distributions. The net proceeds received by TIG Holdings from the issuance of the debentures were used for general corporate purposes which includes repurchases of the Company's common stock. Interest expense was $9.9 million in 1997. Interest paid was $4.9 million in 1997.
Class A Common Stock. In April 1993, TIG Holdings issued 224,600 shares of Class A common stock of which 81,191 had been canceled as of December 31, 1997. The Class A common stock was convertible into shares of common stock one year after issuance but not prior to the vesting of such shares in accordance with the terms of their issuance. Accordingly, as of December 31, 1997, the number of Class A common shares converted to common stock was 143,409 (see Note K - Incentive Compensation Plans). As of December 31, 1997, no shares of Class A common stock are outstanding.
Subsidiary Dividend Restrictions. Payment of dividends to TIG Holdings by its insurance subsidiaries is subject to certain restrictions. State insurance laws limit the amount that may be paid without prior notice or approval by insurance regulatory authorities. As of December 31, 1997, $180 million of dividends are currently available for payment to TIG Holdings from its insurance subsidiaries during 1998 without restriction. Cash dividends paid by the insurance subsidiaries in 1997, 1996 and 1995 were $145 million, $130 million and $55 million, respectively. In addition a $20 million dividend of subsidiary common stock was paid in 1995.
As of December 31, 1997, the Company has three stock based compensation plans, which are described below. The Company adopted SFAS 123 effective January 1, 1996 and has elected to continue to account for employee stock-based compensation as prescribed by APB Opinion No. 25 (See Note B - Summary of Significant Accounting Policies).
The 1996 Non-Employee Directors Compensation Program. The 1996 Non-Employee Directors Compensation Program (the "1996 Program") provides for awards of stock options and restricted share units. These awards are not to exceed 200,000 shares. As of December 31, 1997, there were 33,873 restricted share units and stock options representing the right to acquire 67,746 shares of common stock. Each restricted share unit converts into one share of common stock based upon an irrevocable election made by each non-employee director. The 1996 Program will terminate on the close of business on the date of the Company's annual meeting of stockholders in 1999. Restricted share units and stock options granted prior to the date of the annual meeting of stockholders in 1997 will vest in three substantially equal installments on the dates of each annual meeting of stockholders in 1997, 1998 and 1999. Restricted share units and stock options granted on or after the date of the 1997 annual meeting of stockholders but prior to the date of the 1998 annual meeting of stockholders will vest in two equal installments on the dates of each annual meeting of stockholders in 1998 and 1999. Restricted share units and stock options granted on or after the date of the 1998 annual meeting of stockholders but prior to the 1999 annual meeting of stockholders will vest in one installment on the date of the 1999 annual meeting of stockholders. The maximum term of any stock option granted will be ten years from the date of grant.
The 1993 Long-Term Incentive Plan. The 1993 Long-Term Incentive Plan (the "1993 Plan") provides for awards of stock options, stock appreciation rights, restricted stock grants and/or performance units (collectively referred to as "awards"). These awards are not to exceed 15 million shares in the aggregate. As of December 31, 1997, there were no stock appreciation rights or performance units outstanding. The 1993 Plan terminated May 2, 1996, except with respect to outstanding awards, with the approval of the 1996 Plan. Stock options under the 1993 Plan have a term of ten years from the date of grant and vest in equal annual installments over four years. Restricted stock grants vest in equal annual installments over three years.
A summary of the status of the Company's three stock based compensation plans as of December 31, 1997 and changes during the three years ended December 31, 1997 is presented below:
The weighted average option exercise price was $25.06, $22.74 and $22.08 for options outstanding at December 31, 1997, 1996 and 1995 respectively. The weighted average option exercise price was $33.82 for options granted during 1997, $22.01 for options exercised in 1997 and $27.25 for options forfeited in 1997.
The DSP is available to all salaried employees. Most employees who elect to participate may contribute up to 12% of their pre-tax salary, plus bonuses, commissions, and overtime pay ("Employee Compensation") for each calendar year. TIG Holdings administers the DSP and will make matching contributions to the DSP in an amount equal to 75% of the participant's contribution up to a maximum of 6% of Employee Compensation. Certain IRC required limitations may be imposed for participants who are treated as "highly compensated employees" for purposes of the IRC. Generally, an employee vests in the matching employer contributions based upon years of service. Employer matching contributions were $3 million, $3 million, and $4 million for 1997, 1996 and 1995, respectively.
Employee Stock Ownership Plan. Most salaried employees are eligible to participate in the ESOP. Generally, TIG Holdings will contribute, for each calendar year, an amount equal to one percent of Employee Compensation, as defined, on behalf of each participant employed on the last working day of that year or who was employed but died during the year. No employee contributions are permitted to be made to the ESOP. Effective January 1, 1995, an employee vests 25% after one year of service, 50% after two years of service and 100% after three years of service. In April 1993, the ESOP borrowed $24 million from TIG Holdings to purchase 1,124,754 newly issued shares of common stock. The loan obligation of the ESOP is considered unearned employee compensation, and as such, is recorded as a reduction of TIG Holdings' shareholders' equity. As loan repayments are made by the ESOP, common stock is released to participant accounts. Unearned compensation is amortized based on the number of shares committed to be released and compensation expense is recognized based on the current market price. Compensation expense of $2 million was recognized in each year of 1997, 1996 and 1995. At December 31, 1997, 266,243 shares are allocated, 59,728 shares are committed to be released, and 429,688 shares are in suspense. As of December 31, 1997, the market value of unallocated shares was $14 million. Contributions to the ESOP were $1 million for 1997 and $2 million for 1996 and 1995. A participant's ESOP account will be distributed in full shares of common stock or cash after termination of service.
ESOP Restoration Plan. The TIG Holdings, Inc. ESOP Restoration Plan is an unfunded plan for the purpose of providing deferred compensation for a select group of management or highly compensated employees whose allocations under the qualified ESOP plan are limited by annual restrictions as determined by the Internal Revenue Code. Highly compensated employees whose allocations under the qualified plan are limited by the Internal Revenue Code restrictions will be eligible for participation immediately upon the date of hire if annual earnings, including bonus in the year paid, exceed a specified threshold. The threshold for each year will be the amount of the cap on compensation that may be taken into account under the qualified plan for that year, or such greater amount as may be determined by the Committee in its discretion. A Participant vests 25% after one year of service, 50% after two years of service and 100% after three years of service. Participants' accounts are credited in dollar amounts for the difference between the cash value of the stock that would have been allocated to the participant's account under the qualified ESOP plan and the cash value of the stock that would have been allocated in the absence of the restrictions noted above. Participants' accounts are adjusted for gains, losses and earnings as if invested in the same manner as such associate's account under the qualified ESOP plan. Liabilities due to the participants were less than $1 million as of December 31, 1997, and 1996.
Postretirement Benefits Other Than Pensions. TIG participated in Transamerica's defined benefit health care plan that provided postretirement benefits to eligible retirees of Transamerica and affiliates. TIG assumed all liabilities with respect to its retirees and active employees at the date of the IPO. Contributions for these contributory plans are adjusted annually. Consideration for the adjustments include deductibles and coinsurance. Medical benefits are based on the employee's length of service and age at retirement from the Company. Assets held in trust consist of short term investments with a fair value of approximately $6 million and $5 million at December 31, 1997 and 1996, respectively.
The following table sets forth the amounts recognized in the balance sheet for other postretirement benefit plans:
Leases. Future minimum rental commitments as of December 31, 1997 for all noncancelable operating leases are as follows:
Substantially all of the leases are for rental of office space, the initial terms of which range from 1 to 20 years. Total rental expense for 1997, 1996, and 1995 was $18 million, $17 million and $30 million, respectively. As a result of the reorganization of TIG's commercial operations in the first quarter of 1996, certain lease termination costs in the amount of $18 million were incurred and are included in the $100 million restructuring charges recorded in 1996 as discussed in Note B - Summary of Significant Accounting Policies.
Litigation. TIG's insurance subsidiaries are routinely engaged in litigation in the normal course of their business. As a liability insurer, the Company defends third-party claims brought against its insureds. As an insurer, the Company defends against coverage claims. In the opinion of TIG, based upon information available at the date of this report, no individual item of litigation, or group of similar items of litigation (including asbestos-related and environmental pollution matters and the matters referred to below), taken net of reserves established therefor and giving effect to insurance and reinsurance, is likely to result in judgments for amounts material to TIG's consolidated results of operations or financial condition.
On January 11, 1994, a Los Angeles County Superior Court jury returned a verdict of $28 million for punitive damages against TIG Insurance Company ("TIC") in Talbot Partners v. Cates Construction, Inc. and TIC (the "Talbot Case"). The award arose out of TIC's handling of a surety bond claim on a construction project. On March 28, 1997, the California Court of Appeal reduced the trial court's punitive damage award to $15 million. On July 23, 1997, the California Supreme Court granted TIC's petition to review the Court of Appeal's decision. Management believes that the ultimate liability arising from the Talbot Case will not materially impact consolidated operating results.
See Note G - Income Taxes regarding Tax Court Petition filed in December 1997.
London Market Activity. Through various indirect subsidiaries, the Company became a limited liability participant in the Lloyd's of London ("Lloyd's") market in 1997. As a prerequisite to admittance to the Lloyd's market, irrevocable letters of credit totaling $123 million and collateralized by $105 million of the Company's investment securities were provided in favor of the Society and Council of Lloyd's at December 31, 1997. The letters of credit effectively secure the syndicate's 1997 results and future contingent obligations of the Company should the Lloyd's underwriting syndicates in which the Company participates incur net losses. The Company's contingent liability to the Society and Council of Lloyd's is limited to the amount of the letters of credit.
At December 31, 1997, the statutory "risk-based" capital for each TIG insurance subsidiary was such that no action (company or regulatory) would be required.
Years Ended December 31, -------------------------------------- (In millions) 1997 1996 1995 ===================================================================== Statutory Net Income (Loss): Primary operations $143 $88 $67 Reinsurance operations (22) 96 69 ----------------------------------------- ------------- ------------- Total $121 $184 $136 =====================================================================
December 31, -------------------------------------- (In millions) 1997 1996 1995 ===================================================================== Statutory Surplus: Primary operations $505 $460 $512 Reinsurance operations 508 515 440 ----------------------------------------- ------------- ------------- Total $1,013 $975 $952 =====================================================================
TIG's operations are comprised of two business segments. Reinsurance operations, conducted principally through TIG Reinsurance and Primary Insurance operations, conducted principally through TIG Insurance. Primary Insurance operations are further broken down into Commercial Specialty, Retail, and Other Lines. Premium produced through Aon Corporation and its subsidiaries ("Aon") accounted for 32%, 23%, and 22% of consolidated net premium written in 1997, 1996 and 1995, respectively, of which Aon produced 31%, 19% and 22% of net premium written in Reinsurance operations and 32%, 25% and 22% of net premium written in Primary Operations for each year, respectively. In addition, Reinsurance operations assumed approximately $58 million in 1997 and $50 million in premiums in 1996 and 1995 from primary operations. Reinsurance operations ceded $43 million in premium in 1995 to primary operations. No such amounts were ceded in 1997 or 1996. Revenues, pre-tax operating income and identifiable assets for each segment were as follows:
Years Ended December 31, ------------------------------------------ (In millions) 1997 1996 1995 - ------------------------------------- ------------- ------------- -------------- Primary premium earned: Commercial Specialty $496 $416 $419 Retail 418 350 323 Other Lines 36 239 393 - ------------------------------------- ------------- ------------- -------------- Total primary premium earned $950 $1,005 $1,135 - ------------------------------------- ------------- ------------- -------------- Underwriting gain (loss): Commercial Specialty $1 ($5) ($2) Retail 10 (5) (7) Other Lines (13) (41) (33) - ------------------------------------- ------------- ------------- -------------- Total underwriting loss ($2) ($51) ($42) - ------------------------------------- ------------- ------------- --------------
In the second quarter of 1995, a reserve of $6.3 million was established for exit costs resulting from management's decision to reduce small individually underwritten commercial policies, while a normal re-evaluation of the Company's allowance for reinsurance recoverables in the fourth quarter of 1995 resulted in an increase to pretax income of approximately $11 million for the quarter. In the first quarter of 1996, an after-tax restructuring charge of $65 million was taken for costs related to management's decision to restructure operations (see Note B. - Summary of Significant Accounting Policies). In the fourth quarter of 1997 the Company recognized net unfavorable current and prior year loss and LAE reserve development of $145 million in its Reinsurance Operations (see Note E. - Loss and Loss Adjustment Expense Reserves) and sold the Independent Agents unit of its Retail Division (see Note C - Sale of Independent Agents Business Unit) as a result of which favorable adjustments of policy acquisition and other underwriting expenses totalling $8 million were recorded.