SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) ----- OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1998 ---------------- or TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) ----- OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to -------------- ------------- Commission File Number 0-3021 ------ THE ST. PAUL COMPANIES, INC. ----------------------------------------------- (Exact name of Registrant as specified in its charter) Minnesota 41-0518860 ---------------------------- --------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 385 Washington St., Saint Paul, MN 55102 ---------------------------------- -------- (Address of principal executive (Zip Code) offices) Registrant's telephone number, including area code: (612) 310-7911 ------------- Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes X No ----- ----- The number of shares of the Registrant's Common Stock, without par value, outstanding at May 6, 1998, was 234,585,388. This total includes the shares to be issued pursuant to the Registrant's merger with USF&G Corporation, and also reflects the impact of the 2-for-1 stock split approved and declared by the Registrant's board of directors on May 5, 1998.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES TABLE OF CONTENTS Page No. PART I. FINANCIAL INFORMATION Consolidated Statements of Income, (Unaudited), Three Months Ended March 31, 1998 and 1997 3 Consolidated Balance Sheets, March 31, 1998 (Unaudited) and December 31, 1997 4 Consolidated Statements of Shareholders' Equity, Three Months Ended March 31, 1998 (Unaudited) and Twelve Months Ended 6 December 31, 1997 Consolidated Statements of Comprehensive Income (Unaudited), Three Months Ended March 31, 1998 and 1997 7 Consolidated Statements of Cash Flows (Unaudited), Three Months Ended March 31, 1998 and 1997 8 Notes to Consolidated Financial Statements (Unaudited) 9 Management's Discussion and Analysis of Financial Condition and Results of Operations 19 PART II. OTHER INFORMATION Item 1 through Item 6 26 Signatures 28 EXHIBIT INDEX 29
PART I FINANCIAL INFORMATION THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Income Unaudited (In thousands) Three Months Ended March 31 ------------------- 1998 1997 ------ ------ Revenues: Premiums earned $1,114,756 1,171,453 Net investment income 219,299 218,662 Asset management-investment banking 71,402 58,605 Realized investment gains 44,804 95,592 Other 16,896 12,891 --------- --------- Total revenues 1,467,157 1,557,203 --------- --------- Expenses: Insurance losses and loss adjustment expenses 811,096 868,878 Policy acquisition expenses 253,053 254,760 Operating and administrative 209,799 188,355 --------- --------- Total expenses 1,273,948 1,311,993 --------- --------- Income from continuing operations before income taxes 193,209 245,210 Income tax expense 39,209 52,911 --------- --------- Income from continuing operations 154,000 192,299 Loss on disposal of discontinued operations, net of taxes - (67,750) --------- --------- Net income $154,000 124,549 ========= ========= Basic earnings per common share: Income from continuing operations $0.90 1.14 Loss from discontinued operations - (0.41) --------- --------- Net income $0.90 0.73 ========= ========= Diluted earnings per common share: Income from continuing operations $0.83 1.05 Loss from discontinued operations - (0.37) --------- --------- Net income $0.83 0.68 ========= ========= Dividends declared on common stock $0.25 0.235 ========= ========= See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands) March 31, December 31, ASSETS 1998 1997 - ------ ---------- ----------- (Unaudited) Investments: Fixed maturities, at estimated market value $12,205,321 12,449,793 Equities, at estimated market value 1,080,733 1,033,920 Real estate, at cost less accumulated depreciation of $96,960 (1997; $93,015) 668,502 649,114 Venture capital, at estimated market value 489,906 461,892 Other investments 58,493 41,359 Short-term investments, at cost 575,652 400,004 ---------- ---------- Total investments 15,078,607 15,036,082 Cash 42,647 22,660 Investment banking inventory securities 58,117 130,203 Reinsurance recoverables: Unpaid losses 1,841,053 1,893,122 Paid losses 53,088 69,693 Receivables: Underwriting premiums 1,405,600 1,503,497 Interest and dividends 212,063 216,099 Other 81,110 78,360 Deferred policy acquisition expenses 382,867 404,274 Ceded unearned premiums 175,925 192,591 Deferred income taxes 736,512 845,331 Office properties and equipment, at cost less accumulated depreciation of $269,348 (1997; $246,158) 288,407 294,705 Goodwill 399,501 408,534 Other assets 371,013 405,506 ---------- ---------- Total assets $21,126,510 21,500,657 ========== ========== See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (continued) (In thousands) March 31, December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997 - ------------------------------------ ---------- ----------- (Unaudited) Liabilities: Insurance reserves: Losses and loss adjustment expenses $11,722,580 11,817,633 Unearned premiums 2,241,953 2,379,703 ---------- ---------- Total insurance reserves 13,964,533 14,197,336 Debt 654,663 782,825 Payables: Income taxes 220,511 274,177 Reinsurance premiums 125,449 142,554 Accrued expenses and other 481,244 587,689 Other liabilities 653,755 682,366 ---------- ---------- Total liabilities 16,100,155 16,666,947 ---------- ---------- Company-obligated mandatorily redeemable preferred securities of St. Paul Capital L.L.C. 207,000 207,000 ---------- ---------- Shareholders' equity: Preferred: Series B convertible preferred stock; 1,450 shares authorized; 952 shares outstanding (956 shares in 1997) 137,307 137,892 Guaranteed obligation - PSOP (121,167) (121,167) ---------- ---------- Total preferred shareholders' equity 16,140 16,725 ---------- ---------- Common: Common stock, 480,000 shares authorized; 168,050 shares outstanding (167,456 shares in 1997) 523,700 512,162 Retained earnings 3,563,068 3,450,601 Guaranteed obligation - ESOP - (8,453) Accumulated other comprehensive income: Unrealized appreciation of investments 735,374 677,069 Unrealized loss on foreign currency translation (18,927) (21,394) ---------- ---------- Total accumulated other comprehensive income 716,447 655,675 ---------- ---------- Total common shareholders' equity 4,803,215 4,609,985 ---------- ---------- Total shareholders' equity 4,819,355 4,626,710 ---------- ---------- Total liabilities, redeemable preferred securities and shareholders' equity $21,126,510 21,500,657 ========== ========== See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity (In thousands) Three Twelve Months Ended Months Ended March 31 December 31 ------------ ------------ 1998 1997 -------- -------- (Unaudited) Preferred shareholders' equity: Series B convertible preferred stock: Beginning of period $137,892 142,131 Redemptions during period (585) (4,239) --------- --------- End of period 137,307 137,892 --------- --------- Guaranteed obligation - PSOP: Beginning of period (121,167) (126,068) Principal payments - 4,901 --------- --------- End of period (121,167) (121,167) --------- --------- Total preferred shareholders' equity 16,140 16,725 --------- --------- Common shareholders' equity: Common stock: Beginning of period 512,162 475,710 Stock issued under stock incentive plans 10,109 28,224 Stock issued for preferred shares redeemed 1,429 8,678 Stock issued for acquisition - 1,676 Reacquired common shares - (2,126) --------- --------- End of period 523,700 512,162 --------- --------- Retained earnings: Beginning of period 3,450,601 2,935,928 Net income 154,000 705,473 Dividends declared on common stock (40,756) (156,692) Dividends declared on preferred stock, net of taxes (2,149) (8,645) Reacquired common shares - (24,377) Premium on preferred shares redeemed (844) (4,441) Other changes during period 2,216 3,355 --------- --------- End of period 3,563,068 3,450,601 --------- --------- Guaranteed obligation - ESOP: Beginning of period (8,453) (20,353) Principal payments 8,453 11,900 --------- --------- End of period - (8,453) --------- --------- Unrealized appreciation of investments, net of taxes: Beginning of period 677,069 616,968 Change during the period 58,305 60,101 --------- --------- End of period 735,374 677,069 --------- --------- Unrealized gain (loss)loss on foreign currency translation, net of taxes: Beginning of period (21,394) (20,496) Change during the period 2,467 (898) --------- --------- End of period (18,927) (21,394) --------- --------- Total common shareholders' equity 4,803,215 4,609,985 --------- --------- Total shareholders' equity $4,819,355 4,626,710 ========= ========= See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income Unaudited (In thousands) Three Months Ended March 31 ------------------- 1998 1997 ----- ----- Net income $154,000 124,549 ------- ------- Other comprehensive income, net of taxes: Change in unrealized appreciation of investments 58,305 (209,238) Change in unrealized loss on foreign currency translation 2,467 6,336 ------- ------- Other comprehensive income (loss) 60,772 (202,902) ------- ------- Comprehensive income (loss) $214,772 (78,353) ======= ======= See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Unaudited (In thousands) Three Months Ended March 31 ------------------ 1998 1997 ----- ----- OPERATING ACTIVITIES Underwriting: Net income $ 139,033 181,410 Adjustments: Change in net insurance reserves (122,417) (98,727) Change in underwriting premiums receivable 96,137 119,656 Realized investment gains (43,171) (92,713) Other (12,365) (45,611) ------- ------- Total underwriting 57,217 64,015 ------- ------- Asset management-investment banking: Net income 14,133 13,845 Adjustments: Change in inventory securities 72,085 1,906 Change in short-term investments (11,571) 40,674 Change in short-term borrowings (69,500) - Change in open security transactions 7,105 (3,589) Other (4,917) (12,487) ------- ------- Total asset management-investment banking 7,335 40,349 ------- ------- Parent company and consolidating eliminations: Net income (loss) from continuing operations 834 (2,956) Adjustments: Realized investment gains (1,633) (2,879) Other (13,054) (34,241) ------- ------- Total parent company and consolidating eliminations (13,853) (40,076) ------- ------- Net cash provided by operating activities 50,699 64,288 ------- ------- Cash outflow resulting from sale of discontinued operations (12,748) - ------- ------- INVESTING ACTIVITIES Purchases of investments (598,012) (790,346) Proceeds from sales and maturities of investments 726,076 721,727 Change in short-term investments (168,037) 51,489 Change in open security transactions 7,157 (9,659) Net purchases of office properties and equipment (5,061) (15,791) Other 62,755 (11,529) ------- ------- Net cash provided by (used in) investing activities 24,878 (54,109) ------- ------- FINANCING ACTIVITIES Dividends paid on common and preferred stock (42,105) (39,453) Repayment of debt (55,663) (8,662) Proceeds from issuance of debt - 30,000 Other 54,926 9,036 ------- ------- Net cash used in financing activities (42,842) (9,079) ------- ------- Effect of exchange rate changes on cash - 69 ------- ------- Increase in cash 19,987 1,169 Cash at beginning of period 22,660 37,214 ------- ------- Cash at end of period $42,647 38,383 ======= ======= See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Unaudited March 31, 1998 Note 1 Basis of Presentation - ----------------------------- The financial statements include The St. Paul Companies, Inc. and subsidiaries, and have been prepared in conformity with generally accepted accounting principles. The financial statements do not include the results of USF&G Corporation, except for Note 11. These consolidated financial statements rely, in part, on estimates. In the opinion of management, all necessary adjustments have been reflected for a fair presentation of the results of operations, financial position and cash flows in the accompanying unaudited consolidated financial statements. The results for the period are not necessarily indicative of the results to be expected for the entire year. Reference should be made to the "Notes to Consolidated Financial Statements" on pages 57 to 74 of The St. Paul's annual report to shareholders for the year ended December 31, 1997. The amounts in those notes have not changed except as a result of transactions in the ordinary course of business or as otherwise disclosed in these notes. Some figures in the 1997 consolidated financial statements have been reclassified to conform with the 1998 presentation. These reclassifications had no effect on net income or shareholders' equity, as previously reported. All references in the consolidated financial statements and related footnotes to per share amounts and to the number of common shares for both 1998 and 1997 reflect the effect of the 2-for-1 stock split approved by The St. Paul's board of directors on May 5, 1998 (see Note 10).
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 2 Earnings Per Share - -------------------------- Earnings per common share (EPS) amounts were calculated by dividing net income, as adjusted, by the average common shares outstanding. Average common shares outstanding for both periods reflect the impact of the 2-for-1 stock split approved by the board of directors on May 5, 1998. Three Months Ended March 31 ------------------ 1998 1997 ------ ------ (In thousands) BASIC Net income, as reported $154,000 124,549 PSOP preferred dividends declared (net of taxes) (2,149) (2,185) Premium on preferred shares redeemed (844) (260) ------- ------- Net income, as adjusted $151,007 122,104 ======= ======= DILUTED Net income, as reported $154,000 124,549 Additional PSOP expense (net of taxes) due to assumed conversion of preferred stock (576) (670) Dividends on monthly income preferred securities (net of taxes) 2,018 2,018 Premium on preferred shares redeemed (844) (260) ------- ------- Net income, as adjusted $154,598 125,637 ======= ======= AVERAGE COMMON SHARES OUTSTANDING Basic 167,746 166,738 ======= ======= Fully diluted 185,184 183,896 ======= ======= EARNINGS PER SHARE Basic $0.90 0.73 ======= ======= Diluted $0.83 0.68 ======= ======= Average common shares outstanding for diluted EPS include the common and common equivalent shares outstanding for the period and common shares that would be issuable upon conversion of PSOP preferred stock and the company-obligated mandatorily redeemable preferred securities of St. Paul Capital L.L.C. (monthly income preferred securities).
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 3 Investments - ------------------- Investment Activity. A summary of investment transactions is presented below. Three Months Ended March 31 --------------------------- 1998 1997 ------ ------ (In thousands) Purchases: Fixed maturities $255,230 344,439 Equities 259,591 347,817 Real estate 24,664 56,395 Venture capital 38,560 23,134 Other investments 19,967 18,561 ------- ------- Total purchases 598,012 790,346 ------- ------- Proceeds from sales and maturities: Fixed maturities: Sales 131,241 245,599 Maturities and redemptions 227,007 100,156 Equities 346,205 318,856 Real estate 2,374 16,028 Venture capital 19,225 37,567 Other investments 24 3,521 ------- ------- Total sales and maturities 726,076 721,727 ------- ------- Net purchases (sales) $(128,064) 68,619 ======= ======= Change in Unrealized Appreciation. The increase (decrease) in unrealized appreciation of investments recorded in common shareholders' equity was as follows: Three Months Ended Twelve Months Ended March 31, 1998 December 31, 1997 ------------------ ------------------ (In thousands) Fixed maturities $(13,862) 184,874 Equities 92,136 63,236 Venture capital 8,838 (154,826) ------- ------- Total change in pretax unrealized appreciation 87,112 93,284 Change in deferred taxes (28,807) (33,183) ------- ------- Total change in unrealized appreciation, net of taxes $58,305 60,101 ======= =======
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 4 Income Taxes - -------------------- The components of income tax expense on continuing operations are as follows: Three Months Ended March 31 ------------------ 1998 1997 ------ ------ (In thousands) Federal current tax expense $44,794 64,671 Federal deferred tax benefit (13,749) (17,889) ------ ------ Total federal income tax expense 31,045 46,782 Foreign income taxes 5,631 4,606 State income taxes 2,533 1,523 ------ ------ Total income tax expense on continuing operations $39,209 52,911 ====== ====== Note 5 Contingent Liabilities - ------------------------------ In the ordinary course of conducting business, the company and some of its subsidiaries have been named as defendants in various lawsuits. Some of these lawsuits attempt to establish liability under insurance contracts issued by those companies. Plaintiffs in these lawsuits are asking for money damages or to have the court direct the activities of our operations in certain ways. Although it is possible that the settlement of a contingency may be material to the company's results of operations and liquidity in the period in which the settlement occurs, the company believes that the total amounts that it or its subsidiaries will ultimately have to pay in all of these lawsuits will have no material effect on its overall financial position. In some cases, plaintiffs seek to establish coverage for their liability under environmental protection laws. See "Environmental and Asbestos Claims" in Management's Discussion and Analysis for information on these claims.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 6 Debt - ------------ Debt consists of the following: March 31, December 31, 1998 1997 ---------------- -------------- Book Fair Book Fair Value Value Value Value ------ ------ ------ ------ (In thousands) Medium-term notes $511,919 528,900 511,920 529,000 Commercial paper 127,548 127,548 168,429 168,429 Real estate mortgages 15,196 15,400 15,196 15,400 Nuveen short-term borrowings - - 69,500 69,500 Nuveen notes payable - - 15,000 15,100 Guaranteed ESOP debt - - 2,780 2,800 ------- ------- ------- ------- Total debt $654,663 671,848 782,825 800,229 ======= ======= ======= ======= Note 7 Reinsurance - ------------------- The company's consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions. Assumed reinsurance refers to the company's acceptance of certain insurance risks that other insurance companies have underwritten. Ceded reinsurance involves transferring certain insurance risks the company has underwritten to other insurance companies who agree to share these risks. The primary purpose of ceded reinsurance is to protect the company from potential losses in excess of the amount it is prepared to accept. The company expects those with whom it has ceded reinsurance to honor their obligations. In the event these companies are unable to honor their obligations, the company will pay these amounts. The company has established allowances for possible nonpayment of amounts due to it.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The effect of assumed and ceded reinsurance on premiums written, premiums earned and insurance losses and loss adjustment expenses is as follows: Three Months Ended March 31 ---------------------- 1998 1997 ------ ------ (In thousands) Premiums written: Direct $901,730 875,539 Assumed 199,950 218,133 Ceded (100,833) (64,452) --------- --------- Net premiums written $1,000,847 1,029,220 ========= ========= Premiums earned: Direct $998,688 1,023,494 Assumed 233,725 250,303 Ceded (117,657) (102,344) --------- --------- Net premiums earned $1,114,756 1,171,453 ========= ========= Insurance losses and loss adjustment expenses: Direct $723,648 724,755 Assumed 157,499 161,230 Ceded (70,051) (17,107) --------- --------- Net insurance losses and loss adjustment expenses $811,096 868,878 ========= =========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 8 Segment Information - --------------------------- Three Months Ended March 31 ---------------------- 1998 1997 ------ ------ Revenues from Continuing Operations Underwriting: St. Paul Fire and Marine: Specialized Commercial $ 312,957 317,173 Commercial 206,426 268,709 Personal Insurance 188,894 180,243 Medical Services 147,112 148,842 --------- --------- Total St. Paul Fire and Marine 855,389 914,967 St. Paul International 77,070 63,355 --------- --------- Total Worldwide Insurance Operations 932,459 978,322 St. Paul Re 182,297 193,131 --------- --------- Total premiums earned 1,114,756 1,171,453 Net investment income 218,803 218,269 Realized investment gains 43,171 92,713 Other 14,228 10,704 --------- --------- Total underwriting 1,390,958 1,493,139 --------- --------- Asset management-investment banking 72,469 61,122 --------- --------- Total reportable segments 1,463,427 1,554,261 Parent company and consolidating eliminations 3,730 2,942 --------- --------- Total revenues $1,467,157 1,557,203 ========= ========= Income (Loss) from Continuing Operations Before Income Taxes Underwriting: St. Paul Fire and Marine: Specialized Commercial $ (6,371) (2,656) Commercial (12,008) (16,304) Personal Insurance (4,180) (22,971) Medical Services (27,937) 3,463 -------- --------- Total St. Paul Fire and Marine (50,496) (38,468) St. Paul International (18,592) (7,041) -------- --------- Total Worldwide Insurance Operations (69,088) (45,509) -------- --------- St. Paul Re 8,465 (5,544) -------- --------- Total GAAP underwriting result (60,623) (51,053) Net investment income 218,803 218,269 Realized investment gains 43,171 92,173 Other (10,076) (18,617) -------- --------- Total underwriting 191,275 240,772 -------- --------- Asset management-investment banking: Pretax income before minority interest 31,450 29,194 Minority interest (7,833) (6,490) -------- --------- Total asset management-investment banking 23,617 22,704 -------- --------- Total reportable segments 214,892 263,476 Parent company and consolidating eliminations (21,683) (18,266) -------- --------- Total income from continuing operations before income taxes $193,209 245,210 ======== =========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 9 Discontinued Operations - ------------------------------- In May 1997, The St. Paul completed the sale of its brokerage operation, Minet, to Aon Corporation. The St. Paul's gross proceeds from the sale were approximately equal to its remaining carrying value of Minet. In connection with the transaction, The St. Paul agreed to indemnify Aon against most preclosing liabilities of the Minet businesses. The company recorded a net after-tax loss on disposal of $67.8 million in the first quarter of 1997, which resulted primarily from The St. Paul's agreement to be responsible for certain severance, employee benefits, future lease commitments and other costs relating to Minet. Note 10 Subsequent Event - Common Stock Split - ---------------------------------------------- The St. Paul's Restated Articles of Incorporation were amended after the vote of shareholders at the 1998 Annual Meeting of Shareholders on May 5, 1998, to increase the authorized common shares of the company from 240 million to 480 million. Subsequent to this action, The St. Paul's board of directors approved a 2-for-1 common stock split. One additional share of common stock for each outstanding share was issued on May 11, 1998, to shareholders of record on May 6, 1998. Note 11 Subsequent Event - Completion of Merger With USF&G Corporation - ----------------------------------------------------------------------- In January 1998, The St. Paul and USF&G Corporation (USF&G) announced an agreement to merge, subject to the approval of both companies' shareholders and various regulatory authorities. On April 24, 1998, having obtained all such approvals, The St. Paul completed its merger with USF&G. The combined company operates under The St. Paul name and remains based in Saint Paul, Minn. The merger was a tax-free exchange of stock accounted for as a pooling of interests. Under the terms of the merger agreement, USF&G shareholders received 0.5642 of one of The St. Paul's common shares (post-stock split) for each USF&G common share. The St. Paul issued approximately 66.5 million of its common shares (post-stock split) to USF&G shareholders. Based on The St. Paul's closing common stock price of $42.125 (post-stock split) on April 24, 1998, the total value of the transaction was approximately $3.7 billion, which included the assumption of USF&G's debt and capital securities. The St. Paul anticipates incurring a pretax charge of approximately $500 million in the second quarter of 1998 for restructuring and other nonrecurring charges related to the consummation of the merger. The table on the next page presents unaudited statements of income for the quarters ended March 31, 1998 and 1997 for The St. Paul and USF&G on a combined basis.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued The St. Paul Companies Inc. and USF&G Corporation Combined Statements of Income Unaudited (In thousands) Three Months Ended March 31 ------------------------ 1998 1997 ------ ------ Revenues: Premiums earned $1,782,000 1,840,000 Net investment income 397,000 391,000 Asset management-investment banking 71,000 59,000 Realized investment gains 50,000 95,000 Other 24,000 17,000 --------- --------- Total revenues from continuing operations 2,324,000 2,402,000 --------- --------- Expenses: Insurance losses, loss adjustment expenses and policy benefits 1,331,000 1,385,000 Policy acquisition expenses 433,000 427,000 Operating and administrative 310,000 281,000 --------- --------- Total expenses 2,074,000 2,093,000 --------- --------- Income before income taxes 250,000 309,000 Income tax expense 56,000 72,000 --------- --------- Income from continuing operations 194,000 237,000 Loss on disposal of discontinued operations, net of taxes - (68,000) --------- --------- Net income $194,000 169,000 ========= ========= Basic earnings per common share: Income from continuing operations $0.82 1.01 Net income 0.82 0.71 Diluted earnings per common share: Income from continuing operations $0.77 0.94 Net income 0.77 0.67 Adjusted average common shares outstanding (post-stock split): Basic 234,000 231,000 Diluted 256,000 253,000 This statement was prepared by combining the companies' respective statements of income for the three months ended March 31, 1998 and 1997, and adjusting the result to conform the accounting policies of both companies with regard to loss and loss adjustment expense reserves. USF&G discounted all of its workers' compensation reserves to present value in its financial statements,
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued whereas The St. Paul did not discount any of its loss reserves. On a combined basis, The St. Paul and USF&G will discount only tabular workers' compensation reserves to present value using an interest rate of up to 4%. Accordingly, the combined income statement includes a reduction in insurance losses and loss adjustment expenses of $3.9 million for the quarter ended March 31, 1998, and an increase in insurance losses and loss adjustment expenses of $0.2 million for the quarter ended March 31, 1997, to conform the discounting policies of both companies. The combined income statement does not reflect an estimated pretax charge of approximately $500 million for restructuring costs and other nonrecurring charges related to the merger, which will be recorded during the quarter ended June 30, 1998. For purposes of the combined earnings per common share calculation, USF&G's weighted average common shares outstanding was multiplied by the exchange ratio of 0.5642. On a combined basis, shareholders' equity totaled $6.8 billion on March 31, 1998, and $6.6 billion on Dec. 31, 1997.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations March 31, 1998 Consolidated Results -------------------- The St. Paul's pretax income from continuing operations of $193 million in the first quarter of 1998 was down 21% from pretax income of $245 million in the same period of 1997, primarily due to a decline in realized investment gains, and, to a lesser extent, deterioration in underwriting results. On April 24, 1998, The St. Paul completed its merger with USF&G Corporation. Refer to Note 11 on page 16 of this report for further information regarding the merger, including unaudited combined results of The St. Paul and USF&G for the first quarter of 1998. The following discussion addresses only the financial condition and results of operations of The St. Paul and does not include a discussion of the results of USF&G Corporation. The St. Paul's net income of $154 million in the first quarter of 1998 increased $29 million over comparable 1997 net income of $125 million. In the 1997 period, The St. Paul recorded an after- tax loss from discontinued operations of $67.8 million relating to the sale of its brokerage operation, Minet. Consolidated revenues of $1.47 billion in the first quarter of 1998 declined $90 million, or 6%, from the equivalent 1997 total of $1.56 billion. A reduction in realized investment gains and insurance premiums earned accounted for the revenue decline in 1998. The following table summarizes The St. Paul's results for the first quarters of 1998 and 1997. Three Months Ended March 31 ------------------ 1998 1997 Pretax income (loss): ----- ----- Underwriting: GAAP underwriting result $(61) (51) Net investment income 219 218 Realized investment gains 43 93 Other (10) (19) --- --- Total underwriting 191 241 Asset management-investment banking 24 23 Parent and other (22) (19) --- --- Income from continuing operations before income taxes 193 245 Income tax expense 39 53 --- --- Income from continuing operations 154 192 Loss from discontinued operations, net of taxes - (67) --- --- Net income $154 125 === === Diluted net income per common share $0.83 0.68 ==== ====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Underwriting ------------ The following summarizes key financial results by underwriting business segment: Three Months % of 1998 Ended March 31 Written -------------- ($ in Millions) Premiums 1998 1997 --------- ---- ---- Specialized Commercial: Written Premiums 29% $292 300 Underwriting Result $(6) (3) Combined Ratio 103.9 101.5 Commercial: Written Premiums 20% $198 241 Underwriting Result $(12) (16) Combined Ratio 106.2 112.6 Personal Insurance: Written Premiums 17% $175 175 Underwriting Result $(4) (23) Combined Ratio 103.1 112.9 Medical Services: Written Premiums 10% $95 95 Underwriting Result $(28) 4 Combined Ratio 125.0 105.6 --- ----- ----- Total St. Paul Fire and Marine: Written Premiums 76% $760 811 Underwriting Result $(50) (38) Combined Ratio 108.1 107.7 St. Paul International Underwriting: Written Premiums 9% $87 53 Underwriting Result $(19) (7) Combined Ratio 120.8 113.9 --- ----- ----- Total Worldwide Insurance Operations: Written Premiums 85% $847 864 Underwriting Result $(69) (45) Combined Ratio 109.2 108.1 St. Paul Re: Written Premiums 15% $154 165 Underwriting Result $8 (6) Combined Ratio 99.2 104.2 --- ----- ----- Total Underwriting: Written Premiums 100% $1,001 1,029 GAAP Underwriting Result $(61) (51) Statutory Combined Ratio: Loss and Loss Expense Ratio 72.8 74.2 Underwriting Expense Ratio 34.7 33.3 ----- ----- Combined Ratio 107.5 107.5 ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Written Premiums - ---------------- First quarter written premiums of $1.00 billion were 3% below the comparable 1997 total of $1.03 billion. Premium volume in The St. Paul's Commercial segment was down $43 million, or 18%, from 1997's first quarter. Competitive pressures in this market sector are intense, resulting in price declines and severely limiting opportunities for new business. In addition, premium volume in last year's first quarter included certain business from Northbrook Holdings (acquired in August 1996) that was purposely not renewed in subsequent periods. The Reinsurance segment experienced an $11 million decline in premiums from the first quarter of 1997, reflecting the soft demand for reinsurance products throughout domestic and international markets. The International segment posted a $34 million increase in premium volume over the first quarter of 1997. New business in Europe and Canada, in addition to approximately $10 million of volume from The St. Paul's new operation in Botswana, accounted for the strong increase over 1997. In March 1998, St. Paul International sold the renewal rights to its personal insurance business in the United Kingdom for approximately $4 million in order to focus on its commercial and surety underwriting operations. That business accounted for approximately $57 million of The St. Paul's written premium volume for the year 1997. Premiums written in the Personal Insurance and Medical Services segments in the first three months of 1998 were level with the same period of 1997, while Specialized Commercial premiums were down 3%. Underwriting Results - -------------------- The first quarter GAAP underwriting loss was $61 million, compared with a loss of $51 million in the first quarter of 1997. A sharp deterioration in Medical Services results and an increase in catastrophe losses were to a significant extent offset by favorable prior year loss development in several of The St. Paul's underwriting business segments. Pretax catastrophe losses totaled $39 million in the first three months of 1998, compared with losses of just $5 million in the same period of 1997. The majority of 1998 losses originated from tornadoes in the Midwest and South and ice storms in Canada. The lack of premium growth in the first quarter negatively impacted the underwriting operations' expense ratio, which, at 34.7, was 1.4 points worse than 1997's first quarter ratio. Agent and broker commission expenses as a percentage of premiums written were higher in 1998 than in 1997, reflecting the intense competition to retain existing business and underwrite new business throughout the property- liability industry. Key factors in the change in underwriting results from 1997 were as follows: - Medical Services - $32 million worse than 1997 - An increase in the severity of prior year loss development on medical malpractice coverages was the primary factor in the deterioration from 1997. - Personal Insurance - $19 million better than 1997 - Improvements in both current year loss experience and prior year loss development contributed to the favorable 1998 result. - Reinsurance - $14 million better than 1997 - The absence of significant catastrophe losses in this segment and substantial favorable prior year loss development accounted for the improvement over 1997. - International - $12 million worse than 1997 - Catastrophe losses resulting from ice storms in Canada and adverse loss development on personal insurance coverages in Europe were the major factors in the 1998 underwriting loss.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Investments - ----------- The St. Paul's underwriting operations posted first quarter pretax investment income of $219 million in 1998, virtually level with first quarter 1997 income of $218 million. The lack of written premium growth and an increase in insurance losses paid in recent quarters have resulted in a decline in new funds available for investment. In addition, market yields available on new investments continue to decline. These factors accounted for the negligible increase in investment income in the first quarter of 1998. The weighted average pretax yield on the fixed maturities portfolio was 6.9% at the end of the quarter, down from 7.1% at the same time in 1997. Approximately 97% of that portfolio is rated at investment grade levels (BBB or better). Pretax realized investment gains of $43 million in the first quarter largely resulted from the sale of equity investments. Gains of $93 million in the first quarter of 1997 were fueled by sales of equity and venture capital holdings. Environmental and Asbestos Claims --------------------------------- The St. Paul's underwriting operations continue to receive claims alleging injuries from environmental pollution or alleging covered property damages for the cost to clean up polluted sites. The company also receives asbestos injury claims arising out of product liability coverages under general liability policies. The vast majority of these claims arise from policies written many years ago. The St. Paul's alleged liability for both environmental and asbestos claims is complicated by significant legal issues, primarily pertaining to the scope of coverage. In the company's opinion, court decisions in certain jurisdictions have tended to broaden insurance coverage beyond the intent of the original policies. The company's ultimate liability for environmental claims is difficult to estimate because of these issues. Insured parties have submitted claims for losses not covered in the insurance policy, and the ultimate resolution of these claims may be subject to lengthy litigation, making it difficult to estimate The St. Paul's potential liability. In addition, variables, such as the length of time necessary to clean up a polluted site and controversies surrounding the identity of the responsible party and the degree of remediation deemed necessary, make it difficult to estimate the total cost of an environmental claim. Estimating the ultimate liability for asbestos claims is equally difficult. The primary factors influencing the estimate of the total cost of these claims are case law and a history of prior claim development, both of which are still developing. The table on the next page represents a reconciliation of total gross and net environmental reserve development for the three months ended March 31, 1998, and the years ended Dec. 31, 1997 and 1996. Amounts in the "net" column are reduced by reinsurance recoverable.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued 1998 1997 1996 Environmental (three months) ------ ------ - ------------- -------------- (in millions) Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Beginning reserves $563 373 581 368 528 319 Reserves acquired - - - - 18 7 Incurred losses 6 7 18 32 67 72 Paid losses (15) (14) (36) (27) (32) (30) --- --- --- --- --- --- Ending reserves $554 366 563 373 581 368 === === === === === === Many significant environmental claims currently being brought against the insurance industry arise out of contamination that occurred 20 to 30 years ago. Since 1970, The St. Paul's commercial general liability policy form has included a specific pollution exclusion, and, since 1986, an industry standard absolute pollution exclusion for policies underwritten in the United States. The following table represents a reconciliation of total gross and net reserve development for asbestos claims for the three months ended March 31, 1998, and the years ended Dec. 31, 1997 and 1996. 1998 1997 1996 Asbestos (three months) ------ ------ - -------- ------------- (in millions) Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Beginning reserves $271 153 278 169 283 158 Reserves acquired - - - - 6 6 Incurred losses 5 2 25 (1) 12 18 Paid losses (7) (1) (32) (15) (23) (13) --- --- --- --- --- --- Ending reserves $269 154 271 153 278 169 === === === === === === Most of the asbestos claims the company has received pertain to policies written prior to 1986. Since 1986, for policies underwritten in the United States, The St. Paul's commercial general liability policy has included the industry standard absolute pollution exclusion, which the company believes applies to asbestos claims. The St. Paul's reserves for environmental and asbestos losses at March 31, 1998 represent its best estimate of its ultimate liability for such losses, based on all information currently available. Because of the inherent difficulty in estimating such losses, however, the company cannot give assurances that its ultimate liability for environmental and asbestos losses will, in fact, match current reserves. The company continues to evaluate new information and developing loss patterns, but it believes any future additional loss provisions for environmental and asbestos claims will not materially impact the results of operations, liquidity or financial position. Total gross environmental and asbestos reserves at March 31, 1998, of $823 million represented approximately 7% of gross consolidated reserves of $11.72 billion.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Asset Management-Investment Banking ----------------------------------- The company's portion of pretax earnings from The John Nuveen Company (Nuveen) was $24 million in the first quarter of 1998, compared with $23 million in 1997's first quarter. The company holds a 77% interest in Nuveen. Asset management revenues of $64 million in the first quarter were $14 million, or 28%, higher than in the same period of 1997. The increase was primarily due to Nuveen's acquisition of Rittenhouse Financial Services, Inc., which manages individual equity and balanced accounts for affluent investors, in September 1997. The Rittenhouse acquisition added approximately $9 billion to Nuveen's managed asset base. Total managed assets grew to $51.3 billion at March 31, 1998, an increase of $1.7 billion over year-end 1997. Growth in the market value of underlying assets, together with new product sales during the quarter, accounted for the increase. Nuveen's gross product sales in the first quarter of 1998 totaled $1.7 billion, consisting of $1.1 billion in managed accounts, $395 million in mutual funds and $167 million in unit investment trusts. Gross product sales in the same 1997 period were $493 million. Capital Resources ----------------- Common shareholders' equity grew to $4.8 billion at March 31, 1998, an increase of nearly $200 million over year-end 1997. In addition to the impact of first quarter net income on shareholders' equity, the after-tax unrealized appreciation on The St. Paul's investment portfolio increased by $58 million during the quarter. Total debt outstanding at March 31, 1998 of $655 million declined $128 million from year-end 1997, largely due to Nuveen's repayment of $70 million of short-term borrowings and $15 million of other notes payable. After final payment of its ESOP debt in the first quarter, The St. Paul's debt at March 31, 1998 was largely comprised of medium- term notes ($512 million) and commercial paper ($128 million). The medium-term notes bear a weighted-average interest rate of 7.1%. The ratio of total debt to total capitalization of 12% declined from the year-end 1997 ratio of 14%. The company anticipates that any major capital expenditures during the remainder of 1998 would involve acquisitions of existing businesses. In February 1998, The St. Paul's board of directors rescinded management's authority for repurchasing common shares of the company. There are no major capital improvements planned for the remainder of 1998. The merger with USF&G Corporation was a noncash, tax-free exchange of stock accounted for on a pooling-of-interests basis. The St. Paul anticipates incurring a pretax charge of approximately $500 million in the second quarter of 1998 for restructuring and other nonrecurring charges related to the USF&G merger. The company's ratio of earnings to fixed charges was 11.29 for the first three months of 1998, compared with 13.59 for the same period of 1997. The company's ratio of earnings to combined fixed charges and preferred stock dividends was 8.10 for the first three months of 1998, compared with 9.80 for the same period of 1997. Fixed charges consist of interest expense and one-third of rental expense, which is considered to be representative of an interest factor.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Liquidity --------- Liquidity refers to the company's ability to generate sufficient funds to meet the short- and long-term cash requirements of its business segments. Net cash provided by operations was $51 million in the first three months of 1998, compared to $64 million in the same period of 1997. Cash flows in The St. Paul's underwriting operations declined $7 million from the first quarter of 1997, primarily due to the decline in written premiums. Operational cash flows at The John Nuveen Company were also down from first quarter 1997, primarily due to the repayment of short-term borrowings. Year 2000 Issues ---------------- Many computer systems in the world have the potential of being disrupted at the turn of the century due to programming limitations that may cause the two-digit year code of "00" to be recognized as the year 1900, instead of 2000. For several years, The St. Paul has been evaluating its financial and operational computer systems to determine the impact of the "Year 2000" issue on those systems. With the completion of the merger with USF&G Corporation, The St. Paul has further evaluated USF&G's activities to become "Year 2000" compliant. The St. Paul has developed and implemented plans to address the required system modifications., and does not expect the financial impact of making these modifications to be material to its results of operations, cash flows or consolidated financial position. The St. Paul also faces potential "Year 2000" claims stemming from coverages offered in insurance policies it has sold to customers. In some instances, coverage is not provided under the insurance policies, while in other instances, coverage may be provided under certain circumstances. The company continues to assess its exposure to insurance claims arising from those coverages, and it is taking a number of actions to address that exposure, including individual risk evaluation and classification of high hazard exposures. Currently, The St. Paul does not believe that such claims will have a material effect on its results of operations, cash flows or consolidated financial position. Forward-looking Statement Disclosure ------------------------------------ This report contains certain forward-looking statements within the meaning of the Private Litigation Reform Act of 1995. Forward-looking statements are statements other than historical information or statements of current condition. Words such as expects, anticipates, intends, plans, believes, seeks or estimates, or variations of such words, and similar expressions are also intended to identify forward-looking statements. In light of the risks and uncertainties inherent in future projections, many of which are beyond The St. Paul's control, actual results could differ materially from those in forward- looking statements. These statements should not be regarded as a representation that the objectives will be achieved. Risks and uncertainties include, but are not limited to, the following: general economic conditions including changes in interest rates and the performance of financial markets; changes in domestic and foreign laws, regulations and taxes; changes in the demand for, pricing of, or supply of reinsurance or insurance; catastrophic events of unanticipated frequency or severity; loss of significant customers; judicial decisions and rulings; and various other matters, including the effects of the merger with USF&G Corporation. The St. Paul undertakes no obligation to release publicly the results of any future revisions we may make to forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
PART II OTHER INFORMATION Item 1. Legal Proceedings. The information set forth in Note 5 to the consolidated financial statements is incorporated herein by reference. Item 2. Changes in Securities. Not applicable. Item 3. Defaults Upon Senior Securities. Not applicable. Item 4. Submission of Matters to a Vote of Security Holders. The St. Paul held a special shareholders' meeting on April 7, 1998. (1) By a vote of 66,877,859 in favor, 427,887 against and 79,339 abstaining, the shareholders approved the issuance of common stock of The St. Paul pursuant to the Agreement and Plan of Merger, dated as of January 19, 1998 among USF&G Corporation, The St. Paul and SP Merger Corporation, pursuant to which SP Merger Corporation will be merged with and into USF&G and USF&G will become a wholly owned subsidiary of The St. Paul. The St. Paul's annual shareholders' meeting was held on May 5, 1998. (1) All thirteen persons nominated for directors by management were named in proxies for the meeting which were solicited pursuant to Regulation 14A of the Securities Exchange Act of 1934. There was no solicitation in opposition to management's nominees as listed in the proxy statements. All thirteen nominees were elected by the following votes: In favor Withheld ----------- ---------- Michael R. Bonsignore 72,423,850 126,854 John H. Dasburg 72,400,544 150,160 W. John Driscoll 72,403,483 147,221 Pierson M. Grieve 72,395,933 154,771 Thomas R. Hodgson 72,417,868 132,836 David G. John 72,419,655 131,049 William H. Kling 72,398,247 152,457 Douglas W. Leatherdale 72,415,736 134,968 Bruce K. MacLaury 72,410,117 140,587 Glen D. Nelson 72,422,627 128,077 Anita M. Pampusch 72,426,464 124,240 Gordon M. Sprenger 72,423,192 127,512 Patrick A. Thiele 72,418,479 132,225 (2) By a vote of 72,260,092 in favor, 125,187 against and 165,425 abstaining, the shareholders ratified the selection of KPMG Peat Marwick LLP as the independent auditors for The St. Paul.
(3) By a vote of 69,723,277 in favor, 2,674,220 against and 153,207 abstaining, the shareholders amended the Restated Articles of Incorporation of The St. Paul to increase the number of authorized shares of voting common stock from 240 million to 480 million. (4) By a vote of 62,462,370 in favor, 9,056,577 against and 1,031,757 abstaining, the shareholders approved The St. Paul's Amended and Restated 1994 Stock Incentive Plan. (5) By a vote of 62,126,111 in favor, 9,425,661 against and 998,932 abstaining, the shareholders approved The St. Paul's Global Stock Option Plan. Item 5. Other Information. Not applicable. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits. An Exhibit Index is set forth as the last page in this document. (b) Reports on Form 8-K. 1) The St. Paul filed a Form 8-K Current Report dated January 19, 1998, relating to the announcement of its definitive merger agreement and stock option agreement with USF&G Corporation. 2) The St. Paul filed a Form 8-K Current Report dated January 26, 1998, relating to the announcement of its financial results for the year ended Dec. 31, 1997. 3) The St. Paul filed a Form 8-K Current Report dated February 26, 1998, containing the following documents for The St. Paul for the year ended Dec. 31, 1997: Audited Financial Statements, Notes to Consolidated Financial Statements, Management's Discussion and Analysis of Financial Condition and Results of Operations, Eleven-year Summary of Selected Financial Data, Independent Auditors' Report, Statement Regarding Management's Responsibility for Financial Statements, Consent of Independent Auditors and Financial Data Schedule. 4) The St. Paul filed a Form 8-K Current Report dated April 24, 1998, relating to the consummation of its merger with USF&G Corporation. 5) The St. Paul filed a Form 8-K Current Report dated April 27, 1998, relating to the announcement of its financial results for the quarter ended March 31, 1998. 6) The St. Paul filed a Form 8-K Current Report dated May 5, 1998, relating to the election of three former directors of USF&G Corporation to The St. Paul's board of directors, and the approval of a two-for-one common stock split to shareholders of record on May 6, 1998.
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE ST. PAUL COMPANIES, INC. (Registrant) Date: May 12, 1998 By /s/ Bruce A.Backberg -------------------- Bruce A. Backberg Senior Vice President and Chief Legal Counsel (Authorized Signatory) Date: May 12, 1998 By /s/ Howard E. Dalton -------------------- Howard E. Dalton Senior Vice President Chief Accounting Officer
EXHIBIT INDEX --------------- Method of Exhibit Filing - ------- --------- (2) Plan of acquisition, reorganization, arrangement, liquidation or succession*............................. (3) (i) Articles of incorporation**...........................(1) (ii) By-laws*............................................. (4) Instruments defining the rights of security holders, including indentures*.................................. (10) Material contracts*....................................... (11) Statement re computation of per share earnings**..........(1) (12) Statement re computation of ratios**......................(1) (15) Letter re unaudited interim financial information*........ (18) Letter re change in accounting principles*................ (19) Report furnished to security holders*..................... (22) Published report regarding matters submitted to vote of security holders*.............................. (23) Consents of experts and counsel*.......................... (24) Power of attorney*........................................ (27) Financial data schedule**.................................(1) (99) Additional exhibits*...................................... * These items are not applicable. ** This exhibit is included only with the copies of this report that are filed with the Securities and Exchange Commission. However, a copy of the exhibit may be obtained from the Registrant for a reasonable fee by writing to The St. Paul Companies, 385 Washington Street, Saint Paul, MN 55102, Attention: Corporate Secretary. (1) Filed electronically herewith.