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, 1997 -------------- 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 8, 1997, was 83,611,381.
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, 1997 and 1996 3 Consolidated Balance Sheets, March 31, 1997 (Unaudited) and December 31, 1996 4 Consolidated Statements of Shareholders' Equity, Three Months Ended March 31, 1997 (Unaudited) and Twelve Months Ended December 31, 1996 6 Consolidated Statements of Cash Flows (Unaudited), Three Months Ended March 31, 1997 and 1996 7 Notes to Consolidated Financial Statements (Unaudited) 8 Management's Discussion and Analysis of Financial Condition and Results of Operations 15 PART II. OTHER INFORMATION Item 1 through Item 6 22 Signatures 23 EXHIBIT INDEX 24
PART I FINANCIAL INFORMATION THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Income Unaudited (In thousands) Three Months Ended March 31 ------------------------- 1997 1996 ------ ------ Revenues: Premiums earned $1,171,453 1,030,576 Net investment income 218,662 192,379 Realized investment gains 95,592 47,920 Investment banking-asset management 58,605 53,340 Other 12,891 5,676 ----------- ----------- Total revenues 1,557,203 1,329,891 ----------- ----------- Expenses: Insurance losses and loss adjustment expenses 868,878 755,460 Policy acquisition expenses 254,760 230,488 Operating and administrative 188,355 166,455 ----------- ----------- Total expenses 1,311,993 1,152,403 ----------- ----------- Income from continuing operations before income taxes 245,210 177,488 Income tax expense (benefit): Federal current 64,671 35,655 Other (11,760) (2,578) ----------- ----------- Total income tax expense 52,911 33,077 ----------- ----------- Income from continuing operations 192,299 144,411 Discontinued operations: Operating loss, net of taxes - (15,590) Loss on disposal, net of taxes (67,750) - ----------- ----------- Loss from discontinued operations (67,750) (15,590) ----------- ----------- Net income $124,549 128,821 =========== =========== Primary earnings per common share: Income from continuing operations $2.25 1.67 Loss from discontinued operations (0.81) (0.18) ----------- ----------- Net income $1.44 1.49 =========== =========== Fully diluted earnings per common share: Income from continuing operations $2.10 1.57 Loss from discontinued operations (0.73) (0.17) ----------- ----------- Net income $1.37 1.40 =========== =========== Dividends declared on common stock $0.47 0.44 =========== =========== See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (In thousands) March 31, December 31, ASSETS 1997 1996 - ---------- ------------- ------------- (Unaudited) Investments: Fixed maturities, at estimated market value $11,772,252 11,944,085 Equities, at estimated market value 850,997 808,295 Real estate, at cost less accumulated depreciation of $77,367 (1996; $81,764) 729,257 693,910 Venture capital, at estimated market value 533,665 586,222 Other investments 45,272 43,311 Short-term investments, at cost 203,403 289,793 ------------ ------------ Total investments 14,134,846 14,365,616 Cash 38,383 37,214 Investment banking inventory securities 141,688 143,594 Reinsurance recoverables: Unpaid losses 1,783,981 1,890,105 Paid losses 84,258 68,692 Receivables: Underwriting premiums 1,462,116 1,558,967 Interest and dividends 218,551 213,883 Other 118,942 104,865 Deferred policy acquisition expenses 393,424 401,768 Ceded unearned premiums 208,460 243,663 Deferred income taxes 1,033,851 908,220 Office properties and equipment, at cost less accumulated depreciation of $237,062 (1996; $217,454) 285,832 281,093 Goodwill 239,024 167,338 Other assets 246,396 295,958 ------------ ------------ Total assets $20,389,752 20,680,976 ============ ============ 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 1997 1996 - ------------------------------------ ------------- ------------ (Unaudited) Liabilities: Insurance reserves: Losses and loss adjustment expenses $11,679,590 11,673,148 Unearned premiums 2,397,437 2,566,551 ------------ ------------ Total insurance reserves 14,077,027 14,239,699 Debt 707,588 689,141 Payables: Income taxes 260,522 219,081 Reinsurance premiums 157,561 181,524 Accrued expenses and other 428,604 484,062 Other liabilities 647,887 656,649 ------------ ------------ Total liabilities 16,279,189 16,470,156 ------------ ------------ 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; 981 shares outstanding (985 shares in 1996) 141,732 142,131 Guaranteed obligation - PSOP (123,000) (126,068) ------------ ------------ Total preferred shareholders' equity 18,732 16,063 ------------ ------------ Common: Common stock, 240,000 shares authorized; 83,525 shares outstanding (83,198 shares in 1996) 487,557 475,710 Retained earnings 3,020,490 2,935,928 Guaranteed obligation - ESOP (16,786) (20,353) Unrealized appreciation of investments 407,730 616,968 Unrealized loss on foreign currency translation (14,160) (20,496) ------------ ------------ Total common shareholders' equity 3,884,831 3,987,757 ------------ ------------ Total shareholders' equity 3,903,563 4,003,820 ------------ ------------ Total liabilities, redeemable preferred securities and shareholders' equity $20,389,752 20,680,976 ============ ============ 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 ------------- ----------- 1997 1996 ------- ------- (Unaudited) Preferred shareholders' equity: Series B convertible preferred stock: Beginning of period $142,131 144,165 Change during period (399) (2,034) ------------ ------------ End of period 141,732 142,131 ------------ ------------ Guaranteed obligation - PSOP: Beginning of period (126,068) (133,293) Principal payments 3,068 7,225 ------------ ------------ End of period (123,000) (126,068) ------------ ------------ Total preferred shareholders' equity 18,732 16,063 ------------ ------------ Common shareholders' equity: Common stock: Beginning of period 475,710 460,458 Stock issued under stock option and other incentive plans 11,853 23,057 Reacquired common shares (6) (7,805) ------------ ------------ End of period 487,557 475,710 ------------ ------------ Retained earnings: Beginning of period 2,935,928 2,704,075 Net income 124,549 450,099 Dividends declared on common stock (39,122) (145,956) Dividends declared on preferred stock, net of taxes (2,185) (8,664) Reacquired common shares (61) (67,445) Tax benefit on employee stock options and awards 1,381 3,819 ------------ ------------ End of period 3,020,490 2,935,928 ------------ ------------ Guaranteed obligation - ESOP: Beginning of period (20,353) (32,294) Principal payments 3,567 11,941 ------------ ------------ End of period (16,786) (20,353) ------------ ------------ Unrealized appreciation of investments, net of taxes: Beginning of period 616,968 627,791 Change during the period (209,238) (10,823) ------------ ------------ End of period 407,730 616,968 ------------ ------------ Unrealized loss on foreign currency translation, net of taxes: Beginning of period (20,496) (40,781) Change during the period 6,336 20,285 ------------ ------------ End of period (14,160) (20,496) ------------ ------------ Total common shareholders' equity 3,884,831 3,987,757 ------------ ------------ Total shareholders' equity $3,903,563 4,003,820 ============ ============ 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 ------------------------- 1997 1996 -------- ------- OPERATING ACTIVITIES Underwriting: Net income $181,410 137,466 Adjustments: Change in net insurance reserves (98,727) (11,594) Change in underwriting premiums receivable 119,656 92,293 Provision for deferred taxes (4,270) (7,226) Realized investment gains (92,713) (42,298) Other (41,341) 43,355 ----------- ----------- Total underwriting 64,015 211,996 ----------- ----------- Investment banking-asset management: Net income 13,845 13,288 Adjustments: Change in inventory securities 1,906 180,066 Change in short-term investments 40,674 (180,973) Change in short-term borrowings - (25,000) Change in open security transactions (3,589) 1,784 Other (12,487) 26,627 ----------- ----------- Total investment banking-asset management 40,349 15,792 ----------- ----------- Parent company, consolidating eliminations and discontinued operations: Net loss (70,706) (21,933) Adjustments: Provision for loss on disposal, net of taxes 67,750 - Realized investment gains (2,879) (5,622) Other adjustments (34,241) 11,644 ----------- ----------- Total parent company, consolidating eliminations and discontinued operations (40,076) (15,911) ----------- ----------- Net cash provided by operating activities 64,288 211,877 ----------- ----------- INVESTING ACTIVITIES Purchases of investments (790,346) (732,306) Proceeds from sales and maturities of investments 721,727 528,421 Change in short-term investments 51,489 84,531 Change in open security transactions (9,659) (32,926) Net purchases of office properties and equipment (15,791) (6,097) Other (11,529) 9,130 ----------- ----------- Net cash used in investing activities (54,109) (149,247) ----------- ----------- FINANCING ACTIVITIES Dividends paid on common and preferred stock (39,453) (36,487) Proceeds from issuance of debt 30,000 - Repayment of debt (8,662) (3,819) Reacquired common shares (67) (20,206) Other 9,103 1,616 ----------- ----------- Net cash used in financing activities (9,079) (58,896) ----------- ----------- Effect of exchange rate changes on cash 69 (77) ----------- ----------- Increase in cash 1,169 3,657 Cash at beginning of period 37,214 25,475 ----------- ----------- Cash at end of period $38,383 29,132 =========== =========== See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Unaudited March 31, 1997 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. 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 53 to 69 of the Registrant's annual report to shareholders for the year ended December 31, 1996. 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 1996 consolidated financial statements have been reclassified to conform with the 1997 presentation. These reclassifications had no effect on net income or shareholders' equity, as previously reported.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 2 Earnings Pper Share - --------------------------- Earnings per common share (EPS) amounts were calculated by dividing operating earningsnet income, as adjusted, by the adjusted average common shares outstanding. Three Months Ended March 31 ------------------------- 1997 1996 ------ ------ (In thousands) PRIMARY Net income, as reported $124,549 128,821 PSOP preferred dividends declared (net of taxes) (2,185) (2,165) Premium on preferred shares redeemed (260) (208) ---------- ---------- Net income, as adjusted $122,104 126,448 ========== ========== FULLY DILUTED Net income, as reported $124,549 128,821 Additional PSOP expense (net of taxes) due to assumed conversion of preferred stock (670) (758) Dividends on monthly income preferred securities (net of taxes) 2,018 2,018 Premium on preferred shares redeemed (260) (208) ---------- ---------- Net income, as adjusted $125,637 129,873 ========== ========== ADJUSTED AVERAGE COMMON SHARES OUTSTANDING Primary 84,505 85,150 ======= ======= Fully diluted 91,948 92,596 ======= ======= Adjusted average common shares outstanding include the common and common equivalent shares outstanding for the period and, for fully diluted EPS, 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 ------------------------------ 1997 1996 ------ ------ (In thousands) Purchases: Fixed maturities $344,439 490,613 Equities 347,817 207,698 Real estate 56,395 3,488 Venture capital 23,134 25,992 Other investments 18,561 4,515 ----------- ---------- Total purchases 790,346 732,306 ----------- ---------- Proceeds from sales and maturities: Fixed maturities: Sales 245,599 63,830 Maturities and redemptions 100,156 209,549 Equities 318,856 211,586 Real estate 16,028 1,466 Venture capital 37,567 41,428 Other investments 3,521 562 ----------- ----------- Total sales and maturities 721,727 528,421 ----------- ----------- Net purchases $ 68,619 203,885 =========== =========== 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, 1997 December 31, 1996 ------------------ ----------------- (In thousands) Fixed maturities $(213,147) (198,855) Equities (41,064) 25,975 Venture capital (66,291) 163,110 ----------- ---------- Total change in pretax unrealized appreciation (320,502) (9,770) Increase (decrease) in deferred tax asset 111,264 (1,053) ----------- ---------- Total change in unrealized appreciation, net of taxes $(209,238) (10,823) =========== ==========
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 ----------------------- 1997 1996 ------ ------ (In thousands) Federal current tax expense $64,671 35,655 Federal deferred tax benefit (17,889) (7,875) -------- -------- Total federal income tax expense 46,782 27,780 Foreign income taxes 4,606 3,881 State income taxes 1,523 1,416 -------- -------- Total income tax expense on continuing operations $52,911 33,077 ======== ======== 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, 1997 1996 ---------------- ----------------- Book Fair Book Fair Value Value Value Value ------ ------ ------ ------ (In thousands) Medium-term notes $460,425 454,000 430,427 435,500 Commercial paper 122,833 122,833 131,610 131,610 9 3/8% notes 99,997 100,700 99,994 101,500 Guaranteed ESOP debt 11,113 11,200 13,890 14,000 Real estate mortgage 13,220 13,000 13,220 13,220 --------- -------- -------- -------- Total debt $707,588 701,733 689,141 695,830 ========= ======== ======== ======== 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 ------------------------- 1997 1996 ------- -------- (In thousands) Premiums written: Direct $875,539 782,710 Assumed 218,133 223,610 Ceded (64,452) (71,709) ----------- ---------- Net premiums written $1,029,220 934,611 =========== ========== Premiums earned: Direct $1,023,494 918,121 Assumed 250,303 229,759 Ceded (102,344) (117,304) ----------- ---------- Net premiums earned $1,171,453 1,030,576 =========== ========== Insurance losses and loss adjustment expenses: Direct $724,755 623,489 Assumed 161,230 189,399 Ceded (17,107) (57,428) ----------- ---------- Net insurance losses and loss adjustment expenses $868,878 755,460 =========== ==========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 8 Discontinued Operations - ------------------------------- In early April, The St. Paul reached agreement with Aon Corporation to sell its insurance brokerage operation, Minet, to Aon. The sale is scheduled to close on or before May 26, 1997. The St. Paul's gross proceeds from the sale are expected to be approximately equal to its remaining carrying value of Minet. The St. Paul agreed to indemnify Aon against most preclosing liabilities of the Minet businesses in connection with the transaction. 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. The following summarizes discontinued operations for the first quarter of 1997 and 1996: Three Months Ended March 31 ------------------------ 1997 1996 -------- -------- (In thousands) Operating loss, before income taxes $ - (13,408) Income tax expense - 2,182 -------- --------- Operating loss, net of taxes - (15,590) -------- --------- Loss on disposal, before income taxes (103,280) - Income tax benefit 35,530 - -------- --------- Loss on disposal, net of taxes (67,750) - -------- --------- Loss from discontinued operations $(67,750) (15,590) ======== =========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations March 31, 1997 Consolidated Results -------------------- The St. Paul's pretax income from continuing operations totaled $245 million in the first quarter of 1997, 38% higher than income of $177 million in the same 1996 period. The improvement over 1996 was centered in the underwriting segment, driven by an increase in realized gains from investment sales and growth in investment income. The St. Paul recorded an after-tax loss from discontinued operations of $67.8 million in the first quarter of 1997, relating to the sale of its brokerage operation, Minet. Refer to Note 8 on page 14 of this report for further information regarding The St. Paul's discontinued operations. Consolidated revenues of $1.56 billion in the first quarter increased by almost $230 million, or 17%, from the equivalent 1996 total of $1.33 billion. Growth in insurance premiums earned, investment income and realized investment gains accounted for the revenue growth in 1997. The following table summarizes The St. Paul's results for the first quarters of 1997 and 1996. Three Months Ended March 31 ------------------ 1997 1996 Pretax income (loss): ---- ---- Underwriting: GAAP underwriting result $(51) (42) Net investment income 218 189 Realized investment gains 93 42 Other (19) (16) ---- ---- Total underwriting 241 173 Investment banking-asset management 23 22 Parent and other (19) (18) ---- ---- Income from continuing operations before income taxes 245 177 Income tax expense 53 33 ---- ---- Income from continuing operations 192 144 Loss from discontinued operations, net of taxes (67) (15) ---- ---- Net income $125 129 ==== ==== Fully diluted net income per common share $1.37 1.40 ==== ====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Underwriting ------------ The following summarizes key financial results by underwriting operation: Three Months % of 1997 Ended March 31 Written -------------- ($ in Millions) Premiums 1997 1996 -------- ---- ---- Specialized Commercial: Written Premiums 29% $300 264 Underwriting Result $(3) (10) Combined Ratio 101.5 105.5 Commercial: Written Premiums 24% $241 155 Underwriting Result $(16) (9) Combined Ratio 112.6 106.3 Personal Insurance: Written Premiums 17% $175 164 Underwriting Result $(23) (28) Combined Ratio 112.9 116.9 Medical Services: Written Premiums 9% $95 102 Underwriting Result $4 20 Combined Ratio 105.6 94.4 ---- ----- ----- Total St. Paul Fire and Marine: Written Premiums 79% $811 685 Underwriting Result $(38) (27) Combined Ratio 107.7 106.1 St. Paul International Underwriting: Written Premiums 5% $53 56 Underwriting Result $(7) (6) Combined Ratio 113.9 112.2 ---- ----- ----- Total Worldwide Insurance Operations: Written Premiums 84% $864 741 Underwriting Result $(45) (33) Combined Ratio 108.1 106.6 St. Paul Re: Written Premiums 16% $165 194 Underwriting Result $(6) (9) Combined Ratio 104.2 104.7 ---- ----- ----- Total Underwriting: Written Premiums 100% $1,029 935 GAAP Underwriting Result $(51) (42) Statutory Combined Ratio: Loss and Loss Expense Ratio 74.2 73.3 Underwriting Expense Ratio 33.3 32.8 ----- ----- Combined Ratio 107.5 106.1 ===== ===== Combined Ratio Incl. Policyholders' Dividends 107.8 106.3 ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Written Premiums - ---------------- First quarter written premiums of $1.03 billion were 10% higher than the comparable 1996 total of $935 million. Premium volume in The St. Paul's Commercial operation increased $86 million over the first quarter of 1996, reflecting the impact of The St. Paul's acquisition of Northbrook Holdings, Inc. and its three commercial underwriting companies (Northbrook) in the third quarter of 1996. Specialized Commercial written premiums of $300 million grew 14% over the same period of 1996. Several business centers within Specialized Commercial, including Construction, Financial and Professional Services, and Public Sector Services, experienced premium growth over 1996. Specialized Commercial premium volume in last year's first quarter was reduced by $20 million for returned premiums associated with The St. Paul's withdrawal from an insurance pool arrangement. Personal Insurance premiums grew 7%, to $175 million, compared with the first quarter of 1996, primarily the result of price increases on existing business. Medical Services' written premiums in 1997's first quarter were down 8% from 1996, reflecting the competitive market conditions that persist in the medical liability marketplace. The decline in Medical Services' written premiums resulted principally from pricing reductions. Reinsurance premiums were down $29 million, or 15%, from the same period of 1996. Worldwide reinsurance markets are characterized by excess capacity and competitive market conditions, causing downward pressure on premium rates. Underwriting Results - -------------------- The first quarter GAAP underwriting loss was $51 million, compared with a loss of $42 million in the first quarter of 1996. Improvements in Specialized Commercial and Personal Insurance results were more than offset by a decline in Medical Services' profitability and an increase in Commercial losses. Pretax catastrophe losses in the 1997 period totaled just $5 million, compared with last year's first quarter total of $62 million. An East Coast blizzard and numerous other winter storms were the source of 1996's sizable first quarter catastrophe activity. The company-wide expense ratio of 33.3 was one-half point worse than last year, primarily due to an increase in expenses associated with ongoing efforts to integrate Northbrook into The St. Paul's existing Commercial operations. The Personal Insurance expense ratio of 29.0 was over three points better than last year, reflecting the impact of several corrective measures implemented in 1997 aimed at improving this operation's results. Key factors in the change in underwriting results from 1996 were as follows: - Specialized Commercial - $7 million better than 1996 - Improved Surety results and a decline in losses from insurance pools were the primary factors driving the improvement over 1996. - Personal Insurance - $5 million better than 1996 - A decline in expenses and an improvement in prior year loss development accounted for the favorable variance over 1996. - Medical Services - $16 million worse than 1996 - Loss costs continued to rise in a market suffering through a sustained period of aggressive competition. Despite the unfavorable variance from 1996, Medical Services was still profitable for the quarter. - Commercial - $7 million worse than 1996 - An increase in expenses, primarily relating to Northbrook integration initiatives, along with less favorable prior year loss development more than offset a decline in catastrophe losses.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Investments - ----------- First quarter pretax investment income in the underwriting segment was $218 million, 15% higher than first quarter 1996 income of $189 million. Approximately half of the increase was attributable to income derived from investments acquired in the Northbrook purchase last year. The remainder of the increase resulted from underlying growth in the underwriting operations' investment portfolio, fueled by steady investment cash flows over the last twelve months. Fixed maturities purchased in the first quarter of 1997 were predominantly taxable securities, due to The St. Paul's consolidated tax position. The new money rate on taxable fixed maturities in the first quarter of 1997 was 7.0%, compared with 5.8% on tax- exempt securities. The weighted average pretax yield on the fixed maturities portfolio at March 31, 1997 was 7.1%, and the portfolio had an average life of 9.0 years. Approximately 96% of that portfolio is rated at investment grade levels (BBB or better). Sales of equity and venture capital investments in the first quarter of 1997 generated pretax realized gains of $54 million and $40 million, respectively. Environmental and Asbestos Claims --------------------------------- The St. Paul's underwriting operations continue to receive claims under policies written many years ago alleging injuries from environmental pollution or alleging covered property damages for the cost to clean up polluted sites. These operations also receive asbestos claims arising out of product liability coverages under general liability policies. Significant legal issues, primarily pertaining to issues of coverage, exist with regard to the company's alleged liability for both environmental and asbestos claims. In the company's opinion, court decisions in certain jurisdictions have tended to expand insurance coverage beyond the intent of the original policies. The underwriting operations' ultimate liability for environmental claims is difficult to estimate. 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. In addition, variables, such as the length of time necessary to clean up a polluted site, 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 claims experience, both of which are still developing. In 1995, The St. Paul's underwriting operations recorded additional gross reserves of $360 million and specifically reallocated $113 million of previously recorded net reserves for North American environmental and asbestos losses on policies written in the United Kingdom prior to 1980. The table on the next page represents a reconciliation of total gross and net environmental reserve development for the three months ended March 31, 1997, and the years ended Dec. 31, 1996 and 1995. Amounts in the "net" column are reduced by reinsurance recoverable.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued 1997 1996 1995 Environmental (three months) ---- ---- - ------------- ------------ (in millions) Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Beginning reserves $581 368 528 319 275 200 Reserves acquired - - 18 7 - - Incurred losses 3 - 67 72 59 68 Reserve reallocation - - - - 233 79 Paid losses (5) (1) (32) (30) (39) (28) ---- ---- ---- ---- ---- ---- Ending reserves $579 367 581 368 528 319 ==== ==== ==== ==== ==== ==== Many significant environmental claims currently being brought against insurance companies arise out of contamination that occurred 20 to 30 years ago. Since 1970, the underwriting operations' 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, 1997, and the years ended Dec. 31, 1996 and 1995. 1997 1996 1995 Asbestos (three months) ---- ---- - -------- ------------ (in millions) Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Beginning reserves $278 169 283 158 185 145 Reserves acquired - - 6 6 - - Incurred losses (12) (6) 12 18 (13) (9) Reserve reallocation - - - - 127 34 Paid losses (8) (6) (23) (13) (16) (12) ---- ---- ---- ---- ---- ---- Ending reserves $258 157 278 169 283 158 ==== ==== ==== ==== ==== ==== 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 underwriting operations' Commercial General Liability policy has included the industry standard absolute pollution exclusion, which the company believes applies to asbestos claims. Based on all information currently available, The St. Paul's reserves for environmental and asbestos losses represent its best estimate of its ultimate liability for such losses. Because of the difficulty inherent 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, 1997, of $837 million represented approximately 7% of gross consolidated reserves of $11.68 billion.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Investment Banking-Asset Management ----------------------------------- The company's portion of pretax earnings from The John Nuveen Company (Nuveen) was $23 million in the first quarter of 1997, compared with $22 million in 1996's first quarter. The company holds a 78% interest in Nuveen. Fees earned from investment advisory services provided on assets under Nuveen's management grew $4 million, or 8%, over the first quarter of 1996. Total assets under management at March 31, 1997 of $36.8 billion were up $4.4 billion from year- end 1996. In January 1997, Nuveen completed its acquisition of Flagship Resources Inc., a tax-exempt mutual fund and money management firm. The increases in assets under management and related fee income reflect the addition of Flagship to Nuveen's operations. The total cost of the acquisition was $63 million (substantially all of which represented goodwill), plus as much as an additional $20 million, contingent upon meeting future growth targets. Contributing to the increase in assets under management were gross product sales of $493 million, consisting of $208 million in unit investment trusts, $208 million in mutual funds, and $77 million in managed accounts. Gross product sales in the same 1996 period were $289 million. Capital Resources ----------------- Common shareholders' equity of $3.9 billion at March 31, 1997 was down $103 million from year-end 1996 common equity of $4.0 billion. First quarter net income was offset by a $140 million decline (net of taxes) in the unrealized appreciation of the company's fixed maturities portfolio. An increase in market interest rates negatively impacted bond values in the first quarter. The after-tax unrealized appreciation on The St. Paul's equity and venture capital portfolios declined by $70 million since the end of 1996, primarily due to the sale of investments which generated realized gains during the quarter. Total debt outstanding at quarter-end of $708 million was up 3% from year-end 1996, due to the issuance of $30 million of medium-term notes during the quarter. The ratio of total debt to total capitalization of 15% increased slightly over the year-end 1996 ratio of 14%. The company anticipates that any major capital expenditures during the remainder of 1997 would involve acquisitions of existing businesses or stock repurchases; there are no major capital improvements planned for 1997. The company's ratio of earnings to fixed charges was 13.59 for the first three months of 1997, compared with 11.70 for the same period of 1996. The company's ratio of earnings to combined fixed charges and preferred stock dividends was 9.80 for the first three months of 1997, compared with 8.03 for the same period of 1996. Fixed charges consist of interest expense and one-third of rental expense, which is considered to be representative of an interest factor. 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 $64 million in the first three months of 1997, compared to $212 million in 1996. The decrease from 1996 was primarily due to a decline in cash flows in the underwriting segment resulting from an increase in loss payments.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Impact of Accounting Pronouncement to be Adopted in the Future - -------------------------------------------------------------- In February 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings Per Share," which revises the calculation and presentation provisions of Accounting Principles Board Opinion No. 15 and its related interpretations. SFAS No. 128 is effective for fiscal years and interim periods ending after December 15, 1997. It replaces the presentation of primary earnings per share with "basic earnings per share," and fully diluted earnings per share with "diluted earnings per share." If the provisions of SFAS No. 128 had been applied for the periods ended March 31, 1997 and 1996, basic earnings per share would have been $2.28 and $1.69, respectively, for income from continuing operations, and $1.47 and $1.51, respectively, for net income. Diluted earnings per share would have been the same as fully diluted earnings per share for both periods.
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's annual shareholders' meeting was held on May 6, 1997. (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 74,878,751 464,136 John H. Dasburg 74,764,469 578,418 W. John Driscoll 74,859,353 483,534 Pierson M. Grieve 74,822,094 520,793 Ronald James 74,834,125 508,762 David G. John 74,837,058 505,829 William H. Kling 74,831,967 510,920 Douglas W. Leatherdale 74,801,535 541,352 Bruce K. MacLaury 74,840,116 502,771 Glen D. Nelson 74,850,513 492,374 Anita M. Pampusch 74,846,415 496,472 Gordon M. Sprenger 74,851,560 491,327 Patrick A. Thiele 74,837,295 505,592 (2) By a vote of 64,562,572 in favor, 3,898,309 against and 776,901 abstaining, the shareholders approved the Company's Special Leveraged Stock Purchase Program. (3) By a vote of 74,678,848 in favor, 282,885 against and 381,154 abstaining, the shareholders ratified the selection of KPMG Peat Marwick LLP as the independent auditors for The St. Paul.
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 27, 1997, announcing its financial results for the year ended December 31, 1996. 2) The St. Paul filed a Form 8-K Current Report dated February 7, 1997, announcing share repurchase and stock ownership plans. 3) The St. Paul filed a Form 8-K Current Report dated April 28, 1997, announcing its financial results for the quarter ended March 31, 1997, and the anticipated impact of flooding in the Red River Valley on its second quarter 1997 financial results. 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 13, 1997 By /s/ Bruce A. Backberg ------------------------ Bruce A. Backberg Vice President and Corporate Secretary (Authorized Signatory) Date: May 13, 1997 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) Articles of incorporation and by-laws*...................... (4) Instruments defining the rights of security holders, including indentures*................................... (10) Material contracts a) Letter Agreement dated May 8, 1997 between the Company and Mr. Paul J. Liska related to the terms of his employment**..............................(1) b) Letter Agreement, agreed to January 20, 1997 between the Company and Mr. Paul J. Liska related to severanc benefits**.................................(1) c) The Special Leveraged Stock Purchase Plan**..............(1) d) Amendment to Deferred Stock Agreement with Mr. Mark L.Pabst**.....................................(1) (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.