GRC Realty Corporation, also a wholly owned financial services subsidiary of General Re, has retained title to General Re's former home office site in Greenwich, Connecticut. This site consists of approximately four acres of land and an office building which has about 160,000 square feet of office space that is leased to nonaffiliates. The Greenwich site is subject to a mortgage expiring December 31, 1998, which had a remaining principal of $2 million at December 31, 1997.
In addition, General Re's North American property/casualty, financial services, international property/casualty and global life/health operations have branch and affiliate operations conducted from leased premises in various cities in the United States and foreign countries. At this time, General Re believes its facilities are suitable for its purpose and provide adequate capacity for General Re's present and anticipated needs.
(4) Operating return on equity is computed based on after-tax income, excluding realized gains/losses and cumulative effects of accounting changes, divided by average common shareowners' equity, excluding unrealized investment gains, at the beginning and end of the year. Prior years' operating return on equity have been revised to exclude the effect of unrealized investment gains/losses consistent with the new calculation. Total return on equity is computed based on net income plus the change in unrealized appreciation of investments and currency translation adjustments, net of deferred income taxes, divided by average common shareowners' equity at the beginning and end of the year.
Consolidated investment income was $1,288 million in 1997, compared with $1,205 million in 1996. Investment income for the North American property/casualty operations was $814 million in 1997, an increase of 11.8 percent over $727 million earned in 1996. Investment income for the international property/casualty operations decreased 6.3 percent to $369 million in 1997, compared with $394 million in 1996. The decline in global interest rates and the strengthening of the U.S. dollar, principally against the German mark, were the major factors in the decline of investment income. Adjusted for the effects of foreign exchange, international investment income would have been unchanged from 1996. The life/health operations earned investment income of $73 million in 1997, compared to $59 million in 1996. The financial services operations earned investment income of $32 million in 1997, compared with $25 million in 1996.
In 1996, General Re's net income was $894 million, or $11.00 per basic share, an increase of 10.9 percent over the $9.92 per basic share earned in 1995. These results include after-tax realized gains of $.21 per basic share in 1996 and $.45 per basic share in 1995. The increase in 1996 earnings was primarily attributable to improved property/casualty underwriting results and growth in investment income in the North American and international property/casualty operations. Due to General Re's reporting of its international operations on a quarter lag, the 1996 results also benefited from a full year of results for Kolnische Ruckversicherungs-Gesellschaft AG ("Cologne Re") and the related joint-venture company, General Re-CKAG Reinsurance and Investment S.a r.l. ("GR-CK"), compared to only three quarters in 1995.
General Re's consolidated underwriting combined ratio was 100.5 percent in 1996 compared with 101.0 percent in 1995. Both the North American and international property/casualty operations had an improved underwriting result compared with the prior year.
Consolidated investment income was $1,205 million in 1996, compared with $1,017 million in 1995. The consolidation of a full year of Cologne Re in 1996 accounts for approximately $90 million of the $188 million increase in consolidated investment income in 1996. Investment income for the North American property/casualty operations was $727 million in 1996, an increase of 2.3 percent over $711 million earned in 1995. Investment income for the international property/casualty operations increased 59.5 percent to $394 million in 1996, compared with $247 million in 1995. The life/health operations earned investment income of $59 million in 1996, compared to $40 million in 1995. The financial service operations earned investment income of $25 million in 1996, compared with $19 million in 1995.
North American property/casualty pretax income in 1997, excluding realized gains/losses, increased 14.4 percent over 1996 primarily due to growth in investment income of $87 million and increased other income of $25 million. The growth of pretax investment income in the North American operations was due to higher invested assets in existing operations and investment income from National Re. The growth in investment income was adversely affected by (1) the shift in assets from taxable to tax-advantaged securities over the past few years in response to General Re's tax planning strategies; (2) the maturity and calls of higher yielding fixed income securities; and (3) the use of North American cash flow from operations to fund common dividends and share repurchases. The growth in other income was from increased financial reinsurance fees and lower corporate expenses.
The combined underwriting ratio is computed based on the relationship of losses and underwriting expenses to premiums earned. This ratio is General Re's principal indicator of underwriting performance, with less than 100 percent indicating an underwriting profit. In 1997, the combined ratio for the North American property/casualty segment was 99.2 percent, compared to 99.1 percent in 1996 and 99.6 percent in 1995. Underwriting results for each year from 1995 through 1997 were consistent with General Re's operating objective of achieving an underwriting profit and were not significantly affected by catastrophes.
On October 3, 1996, General Re acquired all of the outstanding shares of National Re, a North American property/casualty reinsurance group, in exchange for 4,023,901 shares of General Re's common stock and $313 million in cash, for a total cost of $900 million. National Re provides property and casualty reinsurance to insurers on a direct basis. In 1996, National Re's full-year gross premiums written were $364 million, of which approximately 70 percent was casualty business and 30 percent was property business. National Re's clients were predominantly small- to medium-sized, regional and specialty property/casualty insurers. Like General Re, National Re principally writes treaty and facultative reinsurance predominantly on an excess basis.
General Re's reinsurance business includes both portfolio and facultative premiums. Portfolio business includes reinsurance treaties and programs. Programs are similar to treaties in that they reinsure a group, or portfolio, of policies, but exhibit the higher risk volatility characteristics more often associated with facultative reinsurance, and accordingly are structured on a per policy rather than per occurrence basis. Net premiums written by the reinsurance operations declined by 1.2 percent in 1997. The decline in 1997 was primarily attributable to a competitive environment in both the primary and reinsurance markets, which together resulted in downward pressure on reinsurance rates and terms. General Re has continued to emphasize underwriting discipline in this competitive market.
In 1996 and 1997, the North American operations experienced favorable portfolio premium growth from regional and specialty insurance companies. In 1997, portfolio business with regional and specialty companies increased 10.2 percent due to organic growth and the acquisition of National Re. Regional company business has increased from approximately 65 percent to 77 percent of General Re's North American portfolio business. This growth was offset by a continued decline in portfolio business from large national companies. The decline in large company premium cessions has been primarily due to increased risk retentions and consolidation activity within this segment of the primary insurance industry.
The wholesale nature of reinsurance transactions periodically results in somewhat volatile premium trends between quarters and years. The addition or loss of a large contract may significantly affect General Re's premium growth, although large contracts generally have a smaller effect on earnings than on premium trends. General Re's treaty contracts usually include short-term cancellation provisions. During 1997, General Re's largest treaty, which had annualized net premiums written of approximately $250 million and contributed less
than one half of one percent of General Re's 1997 net income, was terminated as of September 30, 1997 as a result of the cedent's decision to retain the related risk.
For the General Star operations, which primarily write excess, surplus and specialty insurance, net premiums written grew 5.3 percent in 1997 due to increased direct writings and higher retention levels. General Star has produced an underwriting profit for thirteen consecutive years.
Income before taxes and realized gains/losses for the international property/casualty operations was $315 million in 1997, a decrease of 1.3 percent from 1996. The comparisons of 1997 to 1996 were affected adversely by the 11.5 percent strengthening of the U.S. dollar relative to the German mark, the most important currency in this segment. Adjusted for the effects of foreign exchange, income before taxes and realized gains/losses of the international property/casualty segment would have increased by approximately 4.0 percent.
International net premiums written were $2,268 million in 1997, compared with $2,505 million in 1996. The composition of international property/casualty premiums by currency presented in the chart to the left displays the geographic diversification of General Re's international business. The category labeled "Other" represents more than 100 currencies.
The reported decline in premiums was affected by a stronger U.S. dollar which reduced international premiums when translated into U.S. dollars. Adjusted for the effects of foreign exchange, international property/casualty premiums written decreased approximately 1.0 percent in 1997. The decline in international property/casualty premiums was primarily due to higher ceding company retention levels and disciplined underwriting in the face of increased competition in European insurance markets.
International property/casualty investment income decreased 6.3 percent from 1996. Adjusted for the effects of foreign exchange, investment income was essentially flat, despite positive cash flow, due to the decline in global interest rates over the last few years.
This segment includes the North American and international life/health operations of Cologne Re. During 1997, the life/health operations' income before taxes and realized gains increased by 56.7 percent primarily due to increased investment income derived from growth in the business, improved mortality experience in the North American individual life operations and improved health underwriting experience.
Net premiums written in 1997 were $1,219 million, an increase of 13.4 percent over 1996. Approximately 38 percent of General Re's life/health net premiums were written in Europe, another 47 percent were written in North America and the remaining 15 percent were written throughout the rest of the world. The segment experienced strong premium growth both in North America and internationally. The North American operation's growth was primarily in the individual life, group life and individual health segments. The international operation's growth was spread throughout continental Europe, the United Kingdom and Australia. Adjusted for the effects of foreign exchange, 1997 global life reinsurance premiums increased approximately 16.0 percent compared to 1996. Health reinsurance premiums written increased 36.5 percent in 1997 compared to 1996. This growth was primarily due to two new blocks of individual health reinsurance business written in the United States. Premium growth rates for global life/health operations for 1998 may be lower than those experienced in 1997.
During 1997 calls and maturities on grandfathered tax-exempt bonds were approximately $73 million and preferred equity calls were $251 million. The called bonds had an average yield of approximately 7.93 percent and the proceeds from the calls were reinvested at an average yield of approximately 5.40 percent. The preferred equities had an average yield of approximately 7.82 percent and the proceeds from the calls were reinvested at an average yield of approximately 7.20 percent. Based on its current investment portfolio and the current yield curve, General Re presently anticipates additional calls and maturities through the end of 1998 of approximately $89 million for grandfathered tax-exempt bonds and $109 million for preferred equities, with average yields of approximately 7.40 percent and 8.15 percent, respectively. Reinvestment of these funds may occur at lower yields.
PIE CHART Corporate & other bonds 33% Other foreign government 21% Common equities 12% Short-term 11% U.S. Government bonds 10% German federal and state government 10% Other 3%
The composition of the international investment portfolio by major asset class at December 31, 1997 is presented in the chart above. The composition of the international investment portfolio did not change significantly from the prior period with slightly over 85 percent of the portfolio invested in fixed income securities. The fixed income investment policy is increasingly focused on earning a stable yield spread relative to Government bond markets by concentrating on the management of credit risk.
The fixed income portfolio of the international operations consists of high credit quality securities. Substantially all bonds were investment grade; the average rating of the portfolio was above AA. The table to the left presents the credit ratings of fixed-maturity securities held in the international investment portfolios. The common equity portfolio was well diversified with holdings principally from the major stock markets in Europe, the United States and Japan. The real estate portfolio of $161 million was internationally diversified with principal holdings in Germany. The relatively high share of short-term investments in the portfolio is due to the need to hedge investment crediting provisions in certain deposit contracts.
The gross liability for claims and claim expenses, which provides for estimated future payments arising from current and prior property/casualty reinsurance transactions, amounted to $15,797 million and $15,977 million at December 31, 1997 and 1996, respectively. The decrease in the liability of $180 million during 1997 was due to a decrease of $83 million in the North American property/casualty segment and a decrease of $97 million in the international property/casualty segment. The decline in the North American property/casualty gross liability for claims and claim expenses was due to slower premium growth and commutation activity. Adjusted for the effects of foreign exchange, the international liability for claims and claim expenses increased approximately 8.0 percent. In addition to the gross liability for property/casualty claim and claim expenses, General Re had a gross liability for policy benefits for life/health contracts of $907 million and $751 million at December 31, 1997 and 1996, respectively.
The gross liability and reinsurance recoverable for claims and claim expenses were based on General Re's analysis of reports and individual case estimates received from ceding companies. The liability and related recoverables, which include an amount estimated by General Re for claims and claim expenses incurred but not
Included in General Re'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 remediation costs associated with hazardous waste sites and bodily injury claims relating to asbestos products and environmental hazards. 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:
General Re has established a liability for litigation costs associated with coverage disputes arising out of direct excess insurance policies (rather than from reinsurance assumed). Such coverage litigation expenses are estimated using an actuarial estimate of actionable items and their projected costs. General Re paid $6 million in such costs during 1997, and as of December 31, 1997, the liability for future litigation costs related to coverage disputes for environmental and latent injury claims was $96 million (included in the table above). As coverage disputes are tried and verdicts rendered, General Re expects that the settled case law will result in a downward
trend in future direct excess litigation expenses. Because reinsurance contracts generally contain arbitration clauses which control disputes between the ceding company and the reinsurer, General Re does not expect the future litigation costs associated with reinsurance disputes to be material.
General Re discounts certain liabilities associated with workers' compensation claims. Current statutory rules allow the discounting of "tabular reserves" as defined and allow discounting of nontabular reserves if permitted by the insurer's state of domicile. As of December 31, 1997, General Re recorded $1,658 million in claim liability discount, of which $1,047 million relates to tabular reserves and $611 million relates to nontabular reserves for medical costs associated with tabular reserve claims. The Delaware Insurance Department has confirmed that General Re may discount both its tabular reserves and the medical expenses associated with such tabular reserves at 4.5 percent per year.
The asset and liability positions of the financial service operations fluctuate based on ongoing derivatives transactions and related risk management activities. The purchase of U.S. and foreign government securities (fixed maturities at fair value), which are primarily financed through collateralized repurchase agreements (securities sold under agreements to repurchase), and the "short" sale of U.S. and foreign government securities (securities sold but not yet purchased), whose proceeds are invested in reverse repurchase agreements (securities purchased under agreements to resell), contribute to the short-term fluctuations in the operations' total assets and liabilities, while generally not having any material effect on common shareowners' equity. During 1997, invested assets of these operations decreased $613 million to $2,780 million. Securities purchased under agreements to resell (an asset) increased $903 million in 1997. Securities sold under agreements to repurchase (a liability) decreased $955 million in 1997 to $1,030 million. Securities sold but not yet purchased represent obligations of General Re to deliver the specified security at the contracted price, thereby creating a liability to repurchase the security in the market at prevailing prices. Accordingly, General Re's ultimate obligation to satisfy the sale of securities sold but not yet purchased may exceed the amount recognized in the balance sheet. The liability for securities sold but not yet purchased increased $321 million in 1997 to $1,190 million at December 31, 1997.
The major components of market risk affecting the reinsurance operations are interest rate, foreign currency and equity risk. The reinsurance operations have fixed income investment portfolios with a value of $16,847 million at December 31, 1997 that are subject to changes in value due to changes in market interest rates. In addition, certain mortgage-backed and asset-backed securities are exposed to accelerated prepayment risk generally caused by interest rate movements. Should interest rates decline, mortgage holders are more likely to refinance existing mortgages at lower rates. Acceleration of repayments could adversely affect future investment income, if reinvestment of the cash received from repayments is in lower yielding securities.
In addition to interest rate risk, General Re's common equity portfolio of $4,748 million at December 31, 1997 is subject to changes in value based on changes in equity prices, predominately from the United States and European equity markets. General Re's U.S. and European common equity portfolios are highly correlated with the S&P 500 and Eurotop 100 indices, respectively. The unrealized change in value of the equity portfolios would be included net of deferred taxes in shareowners' equity. To hedge a portion of its exposure to movement in the value of its North American equity portfolio, General Re entered into futures contracts which had a notional value of $379 million at December 31, 1997.
Value at risk estimates are presented in the table below and represent the potential after-tax change in value of General Re's invested assets, which, to the extent unrealized, would be included directly in shareowners' equity. These estimates exclude any potentially offsetting effect resulting from movements in the economic value of General Re's liabilities, most importantly, loss reserves and minority interest. The estimates shown in the table were calculated using Monte Carlo simulation involving 5,000 stochastic paths with a 95 percent confidence level based on weekly correlations and volatilities observed for 1993-1997. Mean assumptions included no change in weekly interest and foreign exchange rates and an 8 percent annual appreciation for the common equity portfolio. General Re's total value at risk includes a diversification benefit since interest rate, equity and currency risks are only partially correlated. The overall after- tax value at risk for General Re at December 31, 1997 was as follows:
General Re's financial service operations are subject to market risk principally through GRFP. 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, correlation data and informed judgment. This evaluation is done on an individual trading book basis, against limits set by individual book, to a 95% probability level. GRFP sets market risk limits for each type of risk, and for an aggregate measure of risk, based on a 99% probability that movements in market rates will not affect the results from operations in excess of the limit over a one week period. Risk is measured primarily by Monte Carlo simulations to obtain the required degree of confidence. GRFP's 1997 aggregate weekly market risk limit across all trading books increased from $10 million to $15 million from April 1997 onward, consistent with the growth in GRFP's business. 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.
The table below shows the highest, lowest and average value at risk, as calculated using the above methodology, by broad category of market risk to which GRFP is exposed. The table also shows the highest, lowest and average profit and losses recorded over one week periods. There was no one-week period during the year in which reported profit or loss exceeded the risk limit.
For 1997 and 1996, respectively, the largest weekly pretax gains were $5 million and $4 million, respectively, while the largest weekly pretax loss was $3 million in both years. The average effect of these risks on income was neutral.
General Re's property/casualty and life/health operations enter into contracts that are recorded as deposits. Cash flows from these transactions, which are included in financing activities, can be volatile from year to year, but generally do not have a material effect on consolidated net income. During 1998, General Re expects approximately $300 million of deposits to mature. The effect of these maturities is net likely to be material to the financial position or results from operations of General Re.
General Re's financial service operations have issued various debt instruments in connection with their match-funded investment operations. The obligations and related investments have been swapped into variable rate U.S. dollar LIBOR instruments.
Dividends paid to General Re common and preferred shareowners were $185 million, $174 million and $172 million in 1997, 1996 and 1995, respectively. General Re used $864 million, $735 million and $35 million to repurchase 4,692,300 shares, 4,989,000 shares and 235,200 shares of its common stock in the years ended December 31, 1997, 1996 and 1995, respectively. Through December 31, 1997, General Re has used $3.2 billion to repurchase 31,825,800 shares of its common stock since the inception of its repurchase program in 1987. On December 10, 1997, General Re's Board of Directors authorized $750 million of share repurchases, in addition to the standing authority to repurchase shares in anticipation of shares to be issued under various compensation plans. The December 1997 repurchase authorization had $696 million of remaining capacity as of December 31, 1997. On February 11, 1998, the Board of Directors declared a regular quarterly dividend of $.59 per share on
On December 18, 1997 General Re Corporation and General Re Funding Corporation ("GRFC") established a $1 billion European Medium Term Note Program. Notes issued under the program by GRFC will be guaranteed by General Re Corporation and will be primarily used for match-funded transactions. The program allows for issuance of debt with maturities up to 30 years and denominated in a number of major currencies. With certain exceptions, the instruments may not be offered, sold or delivered in the United States or to U.S. persons. There were no notes outstanding under the program at December 31, 1997. Notes issued under the European Medium Term Note Program are expected to be rated AAA by Standard & Poor's and Aa1 by Moody's.
2) Changes in the demand for reinsurance, including changes in ceding companies' risk retentions, and changes in the demand for excess and surplus lines insurance coverages in North America, and changes in the demand for financial service operations' products, including derivatives offered by GRFP;
3) The ability of General Re to execute its strategies in its property/casualty, life/health and financial service operations;
4) Catastrophe losses in General Re's North American or international property/casualty businesses;
7) Changes in General Re's property/casualty and life/health businesses' retrocessional arrangements;
11) Decline in the value of General Re's common equity investments;
14) Credit losses on General Re's investment portfolio; credit and market losses on GRFP's portfolio of derivatives and other transactions;
15) Adverse results in litigation matters, including, but not limited to, litigation related to environmental, asbestos and other potential mass tort claims;
16) Gains or losses related to changes in foreign currency exchange rates; and
In addition to the factors outlined above that are directly related to General Re's businesses, General Re is also subject to general business risks, including, but not limited to, adverse state, federal or foreign legislation and regulation, adverse publicity or news coverage, changes in general economic factors and the loss of key employees.
The 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. General Re'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.
Table 1 presents the development of net balance sheet liabilities for General Re's North American property/casualty operations from 1987 through 1997. Table 2 presents the development of the gross balance sheet liability for General Re's North American property/casualty operations from 1992 through 1997.
The "cumulative (deficiency) redundancy" represents the aggregate change in the initial estimates from the original balance sheet date through December 31, 1997. Annual changes in the estimates are included in current operating results each year as the liabilities are reevaluated. The deficiencies shown in the tables represent cumulative differences between the original estimate and the current balance sheet liabilities and therefore they should not be summed. The lower "triangle" of data shows the cumulative amount paid with respect to the previously recorded liability as of the end of each succeeding year.
With respect to the information included in Tables 1-4, 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, 1997, net and gross of reinsurance, are adequate.
General Re discounts certain North American 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 shown in Table 5.
ANALYSIS OF NORTH AMERICAN NET CLAIMS AND CLAIM EXPENSE DEVELOPMENT (IN MILLIONS)
We have audited the consolidated financial statements and schedules of General Re Corporation and subsidiaries listed in the index on page 28 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, 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. 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, 1997, 1996 AND 1995 (IN MILLIONS, EXCEPT SHARE DATA)
CONSOLIDATED STATEMENTS OF COMMON SHAREOWNERS' EQUITY YEARS ENDED DECEMBER 31, 1997, 1996, AND 1995 (IN MILLIONS)
CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1997, 1996 AND 1995 (IN MILLIONS)
BASIS OF PRESENTATION: General Re's consolidated financial statements have been prepared on the basis of generally accepted accounting principles in the United States. The consolidated financial statements include General Re Corporation and its subsidiaries. All significant intercompany transactions have been eliminated. International property/casualty and global life/health subsidiaries report their results on a quarter lag. Certain reclassifications have been made to prior years' financial statements to conform to the 1997 presentation.
ACQUISITION COSTS: Acquisition costs, consisting principally of commissions and brokerage expenses incurred at contract issuance, are deferred and amortized over the contract period in which the related premiums are earned, generally one year. Deferred acquisition costs are reviewed to determine that they do not exceed recoverable amounts, after considering investment income.
CLAIMS AND CLAIM EXPENSES: The liability for claims and claim expenses is based on reports and individual case estimates received from ceding companies. The liability also includes incurred but not reported claims and claim expenses, which are actuarially estimated based on past experience and are reduced by anticipated salvage and subrogation recoverable. The methods of determining such estimates and establishing the related liabilities are regularly reviewed and updated, and any resulting adjustments are included in income currently. Reinsurance recoveries on unpaid claims and claim expenses, net of uncollectible amounts, are recognized as assets at the same time and in a manner consistent with General Re's method for establishing the related liability.
PREMIUMS EARNED: Premiums for life contracts are recognized in income when due. Premiums for health contracts are earned 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 health premiums written. Premiums are reported net of retrocessions.
POLICY BENEFITS FOR LIFE/HEALTH CONTRACTS: The liability for policy benefits for life contracts has been computed based upon estimated future investment yields, expected mortality and withdrawal rates anticipated at the later of either the acquisition of Cologne Re or at the date of contract issuance. These
DEFERRED INCOME TAXES: Deferred income taxes have been provided for all temporary differences between the bases of assets and liabilities used in the financial statements and General Re's United States and foreign tax returns. Deferred income taxes are also provided for unrealized appreciation (depreciation) of equity securities and available-for-sale fixed maturities, and for foreign currency translation gains or losses by a charge or credit directly to the applicable component of common shareowners' equity.
FOREIGN CURRENCY TRANSLATION: Revenues and expenses denominated 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 shareowners' equity. General Re's international operations have exposures to major European currencies, principally the German mark and British pound. A deterioration in the value of these currencies could have an adverse effect on General Re's financial position and operating results. 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.
DEPOSITS: Reinsurance contracts that do not meet insurance accounting risk transfer requirements are classified as deposits and included in "Other reinsurance balances." These deposits are treated as financing transactions and are credited or charged with interest income or expense according to contract terms. Cash flows from these deposit transactions are included in "financing activities" in the statement of cash flows.
ALLOWANCE FOR DOUBTFUL ACCOUNTS: Allowances are provided for uncollectible reinsurance recoverables and other doubtful receivables. Write-offs of receivables reduce the allowance. At December 31, 1997 and 1996, the allowance was $119 million and $126 million, respectively.
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. General Re's principal estimates include property/casualty claims and claim expenses, policy benefits for life/health contracts, estimated premiums when General Re has not received ceding company reports and valuation of nonexchange traded financial instruments. General Re 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 General Re's income statements and balance sheets.
In the fourth quarter of 1997, General Re adopted Statement of Financial Accounting Standards No. 128, Earnings Per Share, which established a new standard for computing and disclosing earnings per share data. As a result, General Re presented both basic and diluted earnings per share as computed under the new standard. Under previous guidance, General Re only reported primary earnings per share, which was the same result for General Re as basic earnings per share. Basic earnings per share excludes dilution and is computed by dividing income available to common shareowners by the weighted-average number of common shares outstanding for the period. Diluted earnings per share include the effect of all potentially dilutive securities.
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. General Re also receives an annual Class B cash dividend of 50.1 percent of GR-CK's distributable income, as defined in the joint-venture agreement. Dividends related to the 1996 calendar result, which were paid in 1997 with respect to the Class A and B shares, were $22 million and $14 million, respectively.
In addition to its ownership in Cologne Re through GR-CK, General Re has purchased for its own account an additional 11.2 percent of the ordinary and preference shares of Cologne Re through December 31, 1997 for aggregate consideration of $127 million, which increased General Re's consolidated economic interest in Cologne Re to 77.5 percent. The purchases of additional Cologne Re shares are accounted for as a step acquisition, under which the fair value of assets and liabilities are recorded at each acquisition date, with the excess of cost over fair value recorded as incremental goodwill.
In September 1993, General Re acted as sponsor in the formation of Tempest Reinsurance Company Limited ("Tempest"), a Bermuda-based reinsurance company specializing in property catastrophe reinsurance. On July 1, 1996, General Re sold its 20.7 percent interest in Tempest and its stock options, and terminated its underwriting services agreement with Tempest for $216 million in aggregate consideration.
Prescribed accounting practices include a variety of publications of the National Association of Insurance Commissioners, 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. General Re discounts certain workers' compensation liabilities at an annual rate of 4.5 percent. These discounted liabilities were $1,501 million and $1,490 million at December 31, 1997 and 1996, respectively. Included in the discount recognized for statutory purposes at December 31, 1997 was $611 million resulting from discounting permitted by the domiciliary insurance department.
General Re'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 General Re 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.
General Re Corporation is dependent upon the ability of its operating subsidiaries to provide it funds, predominantly through dividends. Insurance holding company laws require prior regulatory approval for extraordinary distributions made to insurance company shareowners. General Reinsurance Corporation ("GRC") is subject to the insurance laws of Delaware, its state of domicile. Under Delaware law, dividends or distributions in a rolling twelve- month period exceeding the greater of 10 percent of an insurance company's surplus or 100 percent of net income, excluding realized gains, for the previous calendar year are generally considered extraordinary and require prior regulatory approval.
The components of realized gains (losses) on available-for-sale securities and total investment income were as follows:
The table below provides a reconciliation of the beginning and ending property/casualty claim and claim expense liability for the past three years:
General Re continuously estimates its liabilities and related reinsurance recoverable for environmental and latent injury claims and claim expenses. While most of its liabilities for such claims arise from exposures in North America, General Re 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 reserves related to these exposures may be considered less reliable than reserves for standard lines of business (e.g., automobile). The estimate for environmental and latent injury losses is composed of four parts: known claims, development on known claims, IBNR and direct excess coverage litigation expenses. General Re's estimate for IBNR 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. General Re has established a liability for litigation costs associated with coverage disputes arising out
Income taxes were established on a consolidated basis for all United States and international operations of General Re. No provisions have been made for U.S. income taxes relating to $213 million of cumulative undistributed income of wholly owned international subsidiaries as of December 31, 1997 which is considered permanently reinvested. Applicable U.S. income taxes have been recorded for Cologne Re's income since it distributes dividends to its shareholders on an annual basis. Income taxes paid were $262 million, $219 million and $216 million in 1997, 1996 and 1995, respectively.
An analysis comparing the U.S. statutory income tax rate to General Re's effective tax rate based on percentages of pretax income is as follows:
The components of the net deferred income tax liability were as follows:
Notes payable and commercial paper of the Parent company, General Re Corporation, and its reinsurance operations are presented below:
The 9.00 percent note was issued in 1989 by General Re Corporation in connection with establishing the Employee Savings and Stock Ownership Plan (Note 11). The note is noncallable and has a covenant requiring General Re not to encumber its common stock holding in GRC, the largest subsidiary of General Re. The 8.85 percent and 7.50 percent noncallable notes were issued by National Re on January 19, 1995 and July 31, 1995, respectively. These notes have a par value of $100 million and $25 million, respectively, and were included in General Re's balance sheet at fair value on the date National Re was acquired. The difference between their fair value and par value is recognized as an adjustment to interest expense over the life of the notes.
General Re Corporation issues commercial paper periodically to meet its short- term funding needs or those of the reinsurance operations. Related commercial paper activity is summarized as follows:
Consolidated interest expense and interest paid for loans payable and commercial paper were as follows:
The projected benefit obligation for U.S. employees was determined using an assumed discount rate of 7.00 percent in 1997, 7.50 percent in 1996 and 7.00 percent for 1995, and an assumed long-term compensation
increase of 5.50 percent in 1997, 6.00 percent for 1996 and 5.75 percent for 1995. An assumed long-term rate of return on plan assets of 8.50 percent was used in determining pension expense in 1997, 1996 and 1995. The projected benefit obligation for most Cologne Re employees was determined using an assumed discount rate of 7.00 percent in 1997, 1996 and 1995 and an assumed long-term compensation increase of 3.50 percent in 1997, 1996 and 1995.
General Re has a leveraged Employee Savings and Stock Ownership Plan ("ESSOP"), in which substantially all U.S. employees may participate. This is a defined contribution plan which allows employees to make regular contributions that the ESSOP matches up to a maximum of 6 percent of the employee's salary. In 1989, the ESSOP borrowed $150 million from General Re at 9.25 percent, payable annually through 2014. The proceeds of this borrowing were used by the ESSOP to purchase 1,754,386 shares of 7.25 percent ($6.20 dividend per share) cumulative convertible preferred stock of General Re. All preferred stock outstanding is held by the ESSOP and is convertible into common stock, under certain conditions, on a one-to-one basis. The preferred stock is held by the ESSOP trustee as collateral for the loan from General Re.
expense for the ESSOP is based on the amount of contributions made to the plan, subject to a floor related to the percentage of allocated shares to total shares. During 1997 General Re recognized compensation expense for the ESSOP based on the shares-allocated floor.
The Plan also permits the granting of 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.
The table that follows provides a summary of the activity for options and SARs:
The expense of the Plan was $15 million in 1997, $7 million in 1996 and $4 million in 1995.
General Re leases office space and computer equipment under noncancelable leases expiring in various years through 2010. Several of the leases have renewal options with various terms and rental rate adjustments. Rental expense was $35 million in 1997, $32 million in 1996 and $31 million in 1995. At December 31, 1997, the future minimum annual rental commitments under noncancelable leases were as follows:
Future minimum rental payments above have not been reduced by $41 million of anticipated sublease rental income on noncancelable leases.
GRFP is engaged as a dealer in various types of derivative instruments, including interest rate, currency and equity swaps and options, as well as structured finance products. These instruments are carried at their current estimates of fair value, which is a function of underlying interest rates, currency rates, security values, volatilities and the creditworthiness of counterparties. Future changes in these factors or a combination thereof may affect the fair value of these instruments with any resulting adjustment, including amounts in excess of those previously recognized in the financial statements, being included currently in the income statement.
The results of GRFP's trading activities are summarized in the following table. Trading revenues include any associated gains and losses on hedging instruments. Trading revenue is included in "Other revenues" in the income statement.
A summary of notional amounts of derivative contracts at December 31, 1997 and 1996 is included in the table below. For these transactions, the notional amount represents the principal volume, which is referenced by the counterparties in computing payments to be exchanged, and are not indicative of GRFP's exposure to market or credit risk, future cash requirements or receipts from such transactions. Approximately 64 percent of the notional
volume outstanding for derivative contracts at December 31, 1997 have a term of five years or less and approximately 93 percent of the contracts have a term of less than ten years.
The table below discloses the net fair value or carrying amount at the reporting date for each class of derivative financial contract held or issued by GRFP for trading purposes, as well as the average fair value during the year, based on monthly observations. The net fair values reflect rights of setoff and qualifying master netting arrangements with various counterparties in accordance with FASB Interpretation 39, Offsetting Amounts Related to Certain Contracts. Interest rate and foreign currency swaps shown in the table below include forward rate agreements and foreign exchange spot and forward contracts.
Counterparties to the financial instruments are, in decreasing order of magnitude, foreign and domestic commercial banks, corporations, sovereigns, foreign and domestic brokers/dealers and government-chartered organizations. 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 which allow the unwinding of these transactions in the event of a downgrade in credit rating or other indications of decline in creditworthiness of either the counterparty or GRFP.
The following table presents GRFP's derivatives portfolio by counterparty credit quality and maturity at December 31, 1997. The amounts shown under gross exposure in the table are before consideration of netting arrangements and collateral held by GRFP. Net fair value shown on the table represents unrealized gains on financial instrument contracts in gain positions, net of any unrealized loss owed to these counterparties on offsetting positions. Net exposure shown on the table is net fair value less collateral held by GRFP.
In connection with certain purchases and sales of government securities, GRFP enters into collateralized repurchase and reverse repurchase agreements which may result in credit losses in the event the counterparty to the transaction is unable to fulfill its contractual obligations. All of these transactions are collateralized by U.S. and foreign government securities. In addition to interest amounts shown in Note 9, GRFP had $30 million, $96 million and $90 million of interest expense in 1997, 1996 and 1995, respectively, on related 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 affect 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.
the offsetting or netting of mutual obligations. GRFP seeks to reduce legal risk by consulting with internal and external legal counsel (in relevant jurisdictions) to determine legality and enforceability of various transactions with different types of counterparties.
Statement of Financial Accounting Standards No. l07, Disclosures about Fair Value of Financial Instruments, requires disclosures of fair values for certain financial instruments. Insurance contracts are among certain types of transactions which were considered difficult to fair value and therefore were specifically excluded from the statement's disclosures. General Re carries other financial instruments generally at fair values on its balance sheet, with the exception of those financial instruments listed below:
Securities purchased under agreements to resell and securities sold under agreements to repurchase--The carrying value for these financial instruments approximates their fair value.
Trading account assets/liabilities--The fair value for trading account assets/liabilities was based on the use of valuation models that utilize, among other factors, current interest and foreign exchange rates and market volatility data.
General Re, through its subsidiaries, has been named as a defendant in litigation or a respondent in arbitration in the ordinary course of conducting its insurance and reinsurance business. These lawsuits generally seek to establish liability under insurance or reinsurance contracts issued by the subsidiaries, and occasionally seek punitive or exemplary damages. General Re'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 General Re'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 General Re.
Basic earnings per common share were based on earnings less preferred dividends, divided by the weighted average common shares outstanding during each year. Diluted earnings per share assume the conversion of all outstanding convertible preferred stock and the maximum dilutive effect of common stock equivalents. The following is a reconciliation of the numerators and denominators used in the basic and diluted earnings per share calculations for 1997, 1996 and 1995.
The following is summarized financial information for General Re's business segments for 1997, 1996 and 1995: