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 June 30, 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 (651) 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 on August 10, 1998, was 236,102,543.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES TABLE OF CONTENTS Page No. -------- PART I. FINANCIAL INFORMATION Consolidated Statements of Operations (Unaudited), Three Months and Six Months Ended June 30, 1998 and 1997 3 Consolidated Balance Sheets (Unaudited), June 30, 1998 and December 31, 1997 4 Consolidated Statements of Shareholders' Equity (Unaudited), Six Months Ended June 30, 1998 and Twelve Months Ended December 31, 1997 6 Consolidated Statements of Comprehensive Income (Unaudited), Six Months Ended June 30, 1998 and 1997 7 Consolidated Statements of Cash Flows (Unaudited), Six Months Ended June 30, 1998 and 1997 8 Notes to Consolidated Financial Statements (Unaudited) 9 Management's Discussion and Analysis of Financial Condition and Results of Operations 18 PART II. OTHER INFORMATION Item 1 through Item 6 30 Signatures 31 EXHIBIT INDEX 32
PART I FINANCIAL INFORMATION THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Operations Unaudited (In thousands) Three Months Ended Six Months Ended June 30 June 30 ------------------- ------------------- 1998 1997 1998 1997 ------- ------- ------ ------ Revenues: Premiums earned $1,752,167 1,856,347 3,533,724 3,696,972 Net investment income 397,656 390,331 794,547 780,411 Realized investment gains 132,667 171,384 182,508 267,473 Asset management- investment banking 74,919 59,755 146,321 118,360 Other 19,407 15,285 43,908 32,137 --------- --------- --------- --------- Total revenues 2,376,816 2,493,102 4,701,008 4,895,353 --------- --------- --------- --------- Expenses: Insurance losses and loss adjustment expenses 1,662,018 1,321,084 2,933,872 2,647,041 Life policy benefits 61,994 62,348 121,631 121,636 Policy acquisition expenses 416,998 443,241 850,116 869,870 Operating and administrative 682,454 275,509 991,710 556,643 --------- --------- --------- --------- Total expenses 2,823,464 2,102,182 4,897,329 4,195,190 --------- --------- --------- --------- Income (loss) from continuing operations before income taxes (446,648) 390,920 (196,321) 700,163 Income tax expense (benefit) (149,367) 101,978 (93,718) 174,053 --------- --------- --------- --------- Income (loss) from continuing operations (297,281) 288,942 (102,603) 526,110 Loss on disposal of discontinued operations, net of taxes - - - (67,750) --------- --------- --------- --------- Net income (loss) ($297,281) 288,942 (102,603) 458,360 ========= ========= ========= ========= Basic earnings (loss) per common share: Income (loss) from continuing operations ($1.28) 1.25 (0.46) 2.26 Loss from discontinued operations - - - (0.30) --------- --------- --------- --------- Net income (loss) ($1.28) 1.25 (0.46) 1.96 ========= ========= ========= ========= Diluted earnings (loss) per common share: Income (loss) from continuing operations ($1.28) 1.15 (0.46) 2.09 Loss from discontinued operations - - - (0.27) --------- --------- --------- --------- Net income (loss) ($1.28) 1.15 (0.46) 1.82 ========= ========= ========= ========= Dividends declared on common stock $ 0.25 0.235 0.50 0.47 ========= ========= ========= ========= See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets Unaudited (In thousands) June 30, December 31, ASSETS 1998 1997 - ------ ---------- ---------- Investments: Fixed maturities, at estimated market value $20,843,281 20,945,219 Equities, at estimated market value 1,146,784 1,052,370 Real estate, at cost less accumulated depreciation of $100,985 (1997; $93,015) 915,659 985,317 Mortgage loans, at cost 702,035 640,734 Venture capital, at estimated market value 491,817 461,892 Other investments 932,599 923,933 Short-term investments, at cost 974,492 970,568 ---------- ---------- Total investments 26,006,667 25,980,033 Cash 129,107 113,175 Investment banking inventory securities 43,602 130,203 Reinsurance recoverables: Unpaid losses 4,043,507 3,839,051 Paid losses 126,515 128,422 Ceded unearned premiums 343,115 376,343 Receivables: Underwriting premiums 2,276,459 2,213,926 Interest and dividends 345,512 355,970 Other 137,761 104,727 Deferred policy acquisition expenses 837,490 872,460 Deferred income taxes 1,216,008 1,213,790 Office properties and equipment, at cost less accumulated depreciation of $397,536 (1997; $369,414) 532,890 602,381 Goodwill 599,428 618,528 Other assets 810,131 809,819 ---------- ---------- Total assets $37,448,192 37,358,828 ========== ========== See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Balance Sheets (continued) Unaudited (In thousands) June 30, December 31, LIABILITIES AND SHAREHOLDERS' EQUITY 1998 1997 - ------------------------------------ ----------- ----------- Liabilities: Insurance reserves: Losses and loss adjustment expenses $18,646,485 18,153,080 Future policy benefits 3,876,671 3,816,050 Unearned premiums 3,392,302 3,528,234 ---------- ---------- Total insurance reserves 25,915,458 25,497,364 Debt 1,075,895 1,304,008 Payables: Income taxes 224,717 303,549 Reinsurance premiums 305,611 258,495 Accrued expenses and other 1,481,548 1,327,549 Other liabilities 1,453,391 1,556,995 ---------- ---------- Total liabilities 30,456,620 30,247,960 ---------- ---------- Company-obligated mandatorily redeemable preferred securities of subsidiaries 502,700 502,700 ---------- ---------- Shareholders' equity: Preferred: Series B convertible preferred stock; 1,450 shares authorized; 945 shares outstanding (956 shares in 1997) 136,320 137,892 Guaranteed obligation - PSOP (121,167) (121,167) ---------- ---------- Total preferred shareholders' equity 15,153 16,725 ---------- ---------- Common: Common stock, 480,000 shares authorized; 235,848 shares outstanding (233,130 shares in 1997) 2,120,746 2,057,108 Retained earnings 3,509,146 3,720,140 Guaranteed obligation - ESOP - (8,453) Accumulated other comprehensive income: Unrealized appreciation 866,335 845,811 Unrealized loss on foreign currency translation (22,508) (23,163) ---------- ---------- Total accumulated other comprehensive income 843,827 822,648 ---------- ---------- Total common shareholders' equity 6,473,719 6,591,443 ---------- ---------- Total shareholders' equity 6,488,872 6,608,168 ---------- ---------- Total liabilities, redeemable preferred securities and shareholders' equity $37,448,192 37,358,828 ========== ========== See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Shareholders' Equity Unaudited (In thousands) Six Twelve Months Ended Months Ended June 30, December 31, 1998 1997 ------------ ------------ Preferred shareholders' equity: Series B convertible preferred stock: Beginning of period $137,892 142,131 Redemptions during period (1,572) (4,239) ---------- ---------- End of period 136,320 137,892 ---------- ---------- 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 15,153 16,725 ---------- ---------- Common shareholders' equity: Common stock: Beginning of period 2,057,108 1,895,608 Stock issued under stock incentive plans 44,110 32,421 Stock issued for preferred shares redeemed 3,777 8,708 Stock issued for acquisitions - 113,264 Reacquired common shares - (13,892) Other 15,751 20,999 ---------- ---------- End of period 2,120,746 2,057,108 ---------- ---------- Retained earnings: Beginning of period 3,720,140 3,097,261 Net income (loss) (102,603) 929,292 Dividends declared on common stock (108,972) (186,036) Dividends declared on preferred stock, net of taxes (4,269) (10,304) Reacquired common shares - (114,232) Premium on preferred shares converted or redeemed (2,205) (4,052) Other changes during period 7,055 8,211 ---------- ---------- End of period 3,509,146 3,720,140 ---------- ---------- Guaranteed obligation - ESOP: Beginning of period (8,453) (20,353) Principal payments 8,453 11,900 ---------- ---------- End of period - (8,453) ---------- ---------- Unrealized appreciation, net of taxes: Beginning of period 845,811 679,381 Change during the period 20,524 166,430 ---------- ---------- End of period 866,335 845,811 ---------- ---------- Unrealized loss on foreign currency translation, net of taxes: Beginning of period (23,163) (20,500) Currency translation adjustments 655 (2,663) ---------- ---------- End of period (22,508) (23,163) ---------- ---------- Total common shareholders' equity 6,473,719 6,591,443 ---------- ---------- Total shareholders' equity $6,488,872 6,608,168 ========== ========== See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Comprehensive Income Unaudited (In thousands) Three Months Ended Six Months Ended June 30 June 30 ------------------ ---------------- 1998 1997 1998 1997 ------ ------ ------ ------ (In thousands) Net income (loss), $(297,281) 288,942 (102,603) 458,360 ------- ------- ------- ------- Other comprehensive income, net of taxes: Change in unrealized appreciation (27,881) 198,086 20,524 (113,420) Change in unrealized loss on foreign currency translation (4,197) (1,037) 655 5,299 ------- ------- ------- ------- Other comprehensive income (32,078) 197,049 21,179 (108,121) ------- ------- ------- ------- Comprehensive income (loss) $(329,359) 485,991 (81,424) 350,239 ======= ======= ======= ======= See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Unaudited (In thousands) Six Months Ended June 30 --------------------- 1998 1997 ---- ---- OPERATING ACTIVITIES Net income (loss) ($102,603) 458,360 Adjustments: Change in net property-liability insurance reserves 219,047 (60,548) Change in insurance premiums receivable (58,182) (62,697) Change in asset management balances (3,122) 63,063 Realized investment gains (182,508) (267,473) Provision for loss on disposal of discontinued operations - 67,750 Other 108,651 61,049 --------- --------- Net Cash Provided by (Used in) Operating Activities (18,717) 259,504 --------- --------- Cash outflow resulting from sale of discontinued operations (13,772) (20,284) --------- --------- INVESTING ACTIVITIES Purchase of investments (2,288,072) (2,887,202) Proceeds from sales and maturities of investments 2,433,067 2,757,640 Change in short-term investments 16,274 (31,580) Change in open security transactions 100,849 76,430 Net purchases of office properties and equipment (51,553) (70,691) Other 22,175 (12,878) --------- ---------- Net Cash Provided by (Used in) Investing Activities 232,740 (168,281) --------- ---------- FINANCING ACTIVITIES Net deposits for universal life and investment contracts 49,805 156,007 Dividends paid on common and preferred stock (102,887) (102,734) Proceeds from issuance of debt 36,190 182,186 Repayment of debt (193,827) (103,155) Redemption of preferred shares - (199,981) Repurchase of common shares - (102,004) Proceeds from issuance of company-obligated mandatorily redeemable preferred securities of subsidiaries - 98,871 Stock options exercised and other 26,400 18,471 --------- --------- Net Cash Used in Financing Activities (184,319) (52,339) --------- --------- Effect of exchange rate changes on cash - 44 --------- --------- Increase in cash 15,932 18,644 Cash at beginning of period 113,175 109,855 --------- --------- Cash at end of period $129,107 128,499 ========= ========= See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Unaudited June 30, 1998 Note 1 Basis of Presentation - ----------------------------- The financial statements include The St. Paul Companies, Inc. and subsidiaries (The St. Paul), and have been prepared in conformity with generally accepted accounting principles. On April 24, 1998, The St. Paul completed its merger with USF&G Corporation (USF&G) in a tax-free exchange of stock accounted for as a pooling-of-interests. The unaudited consolidated financial statements for all current year and prior year periods in this report reflect the combined accounts and results of operations of The St. Paul and USF&G. The accounting policies employed by The St. Paul and USF&G prior to the merger were consistent in all respects except for the method of accounting for certain workers' compensation loss reserves. See Note 8 on pages 16 and 17 of this report for further information about the adjustment recorded to conform the accounting policies of The St. Paul and USF&G with regard to these reserves. 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. 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 which occurred on May 6, 1998 (See Note 9). In the third quarter of 1998, The St. Paul intends to file with the Securities and Exchange Commission audited financial statements reflecting the combined accounts and results of operations of The St. Paul and USF&G as of Dec. 31, 1997 and 1996, and for the years ended Dec. 31, 1997, 1996 and 1995.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 2 Earnings (Loss) per Share - --------------------------------- Earnings (loss) per common share (EPS) amounts were calculated by dividing net income (loss), as adjusted, by the adjusted average common shares outstanding. Three Months Ended Six Months Ended June 30 June 30 ------------------- ---------------- 1998 1997 1998 1997 ------ ------ ----- ------ (In thousands) BASIC Net income (loss), as reported ($297,281) 288,942 (102,603) 458,360 Dividends on preferred stock, net of taxes (2,120) (2,168) (4,269) (6,012) Premium on preferred shares redeemed (1,361) (651) (2,205) (911) -------- -------- -------- -------- Net income (loss) available to common shares ($300,762) 286,123 (109,077) 451,437 ======== ======== ======== ======== DILUTED Net income (loss), as reported ($297,281) 288,942 (102,603) 458,360 Dividends on preferred stock, net of taxes (2,120) - (4,269) (1,659) Premium on preferred shares redeemed (1,361) (651) (2,205) (911) Dividends on convertible monthly income preferred securities, net of taxes - 2,019 - 4,037 Additional PSOP expense due to assumed conversion of preferred stock, net of taxes - (666) - (1,336) Interest expense on zero coupon bonds,net of taxes - 779 - 1,542 -------- -------- -------- -------- Net income (loss), as adjusted ($300,762) 290,423 (109,077) 460,033 ======== ======== ======== ======== AVERAGE COMMON SHARES OUTSTANDING Basic 235,160 229,611 234,670 230,211 ======== ======== ======== ======== Diluted 235,160 252,362 234,670 252,701 ======== ======== ======== ======== EARNINGS (LOSS) PER SHARE Basic ($1.28) 1.25 (0.46) 1.96 ======== ======== ======== ======== Diluted ($1.28) 1.15 (0.46) 1.82 ======== ======== ======== ========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Diluted EPS is the same as Basic EPS for both periods of 1998 because Diluted EPS calculated in accordance with Statement of Financial Standards (SFAS) No. 128, "Earnings Per Share," for The St. Paul's loss from continuing operations, results in a lesser loss per share than the Basic EPS calculation does. The provisions of SFAS No. 128 prohibit this "anti-dilution" of earnings per share, and require that the larger Basic loss per share also be reported as the Diluted loss per share figure. Average common shares outstanding for diluted EPS in 1997 include the common and common equivalent shares outstanding for the period and common shares that would be issuable upon conversion of preferred stock, the company-obligated mandatorily redeemable preferred securities of St. Paul Capital L.L.C. (monthly income preferred securities) and the zero coupon convertible notes. Note 3 Investments - ------------------- Investment Activity. A summary of investment transactions is presented below. Six Months Ended June 30 -------------------------- 1998 1997 ------ ------ (In thousands) Purchases: Fixed maturities $1,145,945 1,878,844 Equities 820,247 721,728 Real estate 36,124 75,187 Mortgage loans 112,454 94,747 Venture capital 85,702 57,222 Other investments 87,600 59,474 --------- --------- Total purchases 2,288,072 2,887,202 --------- --------- Proceeds from sales and maturities: Fixed maturities: Sales 241,138 1,083,017 Maturities and redemptions 988,904 592,785 Equities 915,194 683,907 Venture capital 42,825 180,973 Real estate 120,306 154,995 Mortgage loans 52,832 12,191 Other investments 71,868 49,772 --------- --------- Total sales and maturities 2,433,067 2,757,640 --------- --------- Net purchases (sales) ($144,995) 129,562 ========= =========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Change in Unrealized Appreciation. The increase (decrease) in unrealized appreciation recorded in common shareholders' equity was as follows: Six Months Ended Twelve Months Ended June 30, 1998 December 31, 1997 ----------------- ------------------ (In thousands) Fixed maturities $33,231 399,832 Equities 12,039 61,969 Venture capital 11,541 (154,826) Life deferred policy acquisition costs and policy benefits (27,798) (50,692) -------- -------- Total change in pretax unrealized appreciation 29,013 256,283 Change in deferred taxes (8,489) (89,853) -------- -------- Total change in unrealized appreciation, net of taxes $20,524 166,430 ======== ======== Note 4 Income Taxes - -------------------- The components of income tax expense (benefit) on continuing operations are as follows: Three Months Ended Six Months Ended June 30 June 30 ----------------- ----------------- 1998 1997 1998 1997 ------ ------ ------ ------ (In thousands) Federal current tax expense (benefit) $(7,025) 102,451 44,468 186,285 Federal deferred tax benefit (147,313) (6,690) (152,588) (24,578) ------- ------- ------- ------- Total federal income tax expense (benefit) (154,338) 95,761 (108,120) 161,707 Foreign income taxes 3,484 4,723 10,382 9,329 State income taxes 1,487 1,494 4,020 3,017 ------- ------- ------- ------- Total income tax expense (benefit) on continuing operations $(149,367) 101,978 (93,718) 174,053 ======= ======= ======= =======
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued 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 The St. Paul's 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. Note 6 Debt - ------------ Debt consists of the following: June 30, December 31, 1998 1997 ------------------- ------------------- Book Fair Book Fair Value Value Value Value ------ ------ ------- ------- (In thousands) Medium-term notes $511,917 531,400 511,920 529,000 Commercial paper 203,963 203,963 168,429 168,429 8 3/8% senior notes 149,650 159,000 149,592 159,060 Zero coupon convertible notes 108,645 126,500 106,838 122,307 7 1/8% senior notes 79,836 83,700 79,824 82,680 Real estate mortgages 19,884 20,100 19,900 20,491 Nuveen debt 2,000 2,000 84,500 84,600 7% senior notes - - 145,225 145,744 Credit facility - - 35,000 35,000 Guaranteed ESOP debt - - 2,780 2,800 --------- --------- --------- --------- Total debt $1,075,895 1,126,663 1,304,008 1,350,111 ========= ========= ========= =========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 7 Segment Information - --------------------------- In connection with the merger with USF&G, The St. Paul performed a reassessment of its reportable segments in accordance with SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information." Based on the merged organizational structure and related operating segment manager responsibilities, The St. Paul has redefined its reportable segments as follows: Three Months Ended Six Months Ended June 30 June 30 ----------------------- --------------------- 1998 1997 1998 1997 ------ ------ ------ ------ Revenues from Continuing Operations (In thousands) Property-Liability Insurance: Worldwide Insurance Operations $1,463,105 1,490,811 2,919,826 2,987,091 Reinsurance 263,071 339,336 563,657 656,574 --------- --------- --------- --------- Total premiums earned 1,726,176 1,830,147 3,483,483 3,643,665 Net investment income 331,130 326,827 662,893 657,334 Realized investment gains 129,621 168,980 177,111 262,943 Other 15,726 11,523 34,452 25,241 --------- --------- --------- --------- Total property- liability insurance 2,202,653 2,337,477 4,357,939 4,589,183 --------- --------- --------- --------- Life insurance 94,094 86,247 183,959 170,865 --------- --------- --------- --------- Asset management- investment banking 76,344 60,279 148,813 121,401 --------- --------- --------- --------- Total reportable segments 2,373,091 2,484,003 4,690,711 4,881,449 Parent company and eliminations 3,725 9,099 10,297 13,904 --------- --------- --------- --------- Total revenues $2,376,816 2,493,102 4,701,008 4,895,353 ========= ========= ========= =========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Three Months Ended Six Months Ended June 30 June 30 -------------------- --------------------- 1998 1997 1998 1997 ------ ------ ------ ------ Income (Loss) from Continuing Operations Before Income Taxes (In thousands) Property-Liability Insurance: Worldwide Insurance Operations ($503,682) (64,398) (611,895) (149,463) Reinsurance 1,867 (1,053) 16,079 1,944 --------- --------- --------- --------- Total GAAP underwriting result (501,815) (65,451) (595,816) (147,519) Net investment income 331,130 326,827 662,893 657,334 Realized investment gains 129,621 168,980 177,111 262,943 Other (223,276) (23,226) (252,051) (44,763) --------- --------- --------- --------- Total property- liability insurance (264,340) 407,130 (7,863) 727,995 --------- --------- --------- --------- Life insurance (33,964) 12,333 (14,946) 25,288 --------- --------- --------- --------- Asset management- investment banking: Pretax income before minority interest 33,077 28,866 64,527 58,060 Minority interest (7,984) (7,436) (15,817) (13,926) --------- --------- --------- --------- Total asset management-investment banking 25,093 21,430 48,710 44,134 --------- --------- --------- --------- Total reportable segments (273,211) 440,893 25,901 797,417 Parent company and eliminations (173,437) (49,973) (222,222) (97,254) --------- --------- --------- --------- Total income (loss) from continuing operations before income taxes $(446,648) 390,920 (196,321) 700,163 ========= ========= ======== ========= The St. Paul recorded a $656 million pretax one-time charge in the second quarter of 1998 resulting from its merger with USF&G (See Note 8). The charge was recorded in the following captions of the above table: $250 million in the property-liability GAAP underwriting result; $199 million in property-liability "other;" $23 million in property-liability realized gains; $57 million in the life segment; and $127 million in "parent company and eliminations."
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Note 8 Merger with USF&G Corporation - ------------------------------------- On April 24, 1998, The St. Paul issued 66,468,572 of its common shares (as adjusted for the May 6, 1998 two-for-one stock split) in exchange for all of the outstanding common stock of USF&G Corporation, a holding company for property-liability and life insurance operations. The transaction was valued at approximately $3.7 billion, which included the assumption of USF&G's debt and capital securities. This business combination has been accounted for as a pooling-of-interests; accordingly, the consolidated unaudited financial statements for periods prior to the combination have been restated to include the accounts and results of operations of USF&G Corporation. There were no material intercompany transactions between The St. Paul and USF&G prior to the merger. The following summarizes the results of operations previously reported by The St. Paul and USF&G, and the combined amounts included in the accompanying consolidated financial statements. Three Months Three Months Six Months Ended Ended Ended March 31, 1998 June 30, 1997 June 30, 1997 --------------- ------------- ------------- (In thousands) Total Revenues: The St. Paul Companies, Inc. $1,467,157 1,620,711 3,177,914 USF&G Corporation 857,035 872,391 1,717,439 --------- --------- --------- Combined $2,324,192 2,493,102 4,895,353 ========= ========= ========= Net Income: The St. Paul Companies, Inc. $154,000 230,524 355,073 USF&G Corporation 38,113 47,416 92,403 --------- --------- --------- Combined 192,113 277,940 447,476 Conforming accounting adjustment, net of taxes 2,565 11,002 10,884 --------- --------- --------- Net income included accompanying financial statements $194,678 288,942 458,360 ========= ========= =========
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements, Continued Prior to the merger, USF&G discounted all of its workers' compensation reserves to present value, whereas The St. Paul did not discount any of its loss reserves. Subsequent to the merger, The St. Paul and USF&G on a combined basis discount only tabular workers' compensation reserves using an interest rate of up to 3.5%, a rate which is allowed by all of the states in which The St. Paul is domiciled. These reserves have an ultimate cost and payment pattern that are fixed and determinable, and accordingly, may be discounted in accordance with Staff Accounting Bulletin No. 62, "Discounting by Property-Casualty Insurance Companies." The St. Paul has determined that the discounting of such reserves is the preferable accounting treatment in the circumstances because discounting these reserves more closely matches revenue and expense and more reasonably portrays the economic impact of the time value of money related to these reserves. The conforming accounting adjustment in the preceding table represents the net reduction in insurance losses and loss adjustment expenses to conform the discounting policies of the two companies with regard to these reserves. The conforming accounting adjustment resulted in a net decrease of $94 million and $95 million in the net assets of the combined organization as of June 30, 1998 and Dec. 31, 1997, respectively. The St. Paul recorded a one-time, pretax charge of $656 million ($458 million after-tax) in the second quarter, which consisted of expenses resulting from the merger and other nonrecurring charges. The pretax charge was composed of the following components: $250 million of loss and loss adjustment expenses to reflect the application of The St. Paul's reserving policies to USF&G's property-liability loss reserves; $176 million of severance and other employee-related costs; $70 million of facilities exit costs; $67 million writedown of certain USF&G investments and other assets; $41 million writedown of deferred policy acquisition costs of the life insurance operation acquired in the merger; and $52 million of other costs, primarily transaction fees and other expenses related to the merger. Note 9 2-for-1 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 10 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.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion and Analysis of Financial Condition and Results of Operations June 30, 1998 Consolidated Results On April 24, 1998, The St. Paul Companies, Inc. (The St. Paul) completed its merger with USF&G Corporation (USF&G) in a tax-free exchange of stock accounted for as a pooling-of-interests. The combined organization operates under The St. Paul name and is headquartered in St. Paul, Minn. The following discussion is based on the combined results of The St. Paul and USF&G for all periods presented. The St. Paul incurred a pretax loss from continuing operations of $447 million in the second quarter of 1998, driven by a one-time, pretax charge of $656 million ($458 million after-tax), which consisted of expenses resulting from its merger with USF&G and other nonrecurring charges. Excluding the one-time charge, The St. Paul's second quarter pretax earnings totaled $209 million in 1998, down from comparable pretax earnings from continuing operations of $391 million in the same 1997 period. The decline from 1997 primarily resulted from a significant increase in catastrophe losses and deteriorating loss experience in several segments of The St. Paul's property-liability insurance operations. The following table summarizes The St. Paul's results for the second quarter and year-to-date. Three Months Six Months Ended June 30 Ended June 30 (in millions) ------------- -------------- 1998 1997 1998 1997 ---- ---- ---- ---- Pretax income (loss): Property-liability insurance: GAAP underwriting result $(502) (65) (596) (148) Net investment income 331 327 663 657 Realized investment gains 130 169 177 263 Other (223) (24) (252) (44) --- --- --- --- Total property- liability insurance (264) 407 (8) 728 Life insurance (34) 12 (15) 25 Asset management- investment banking 25 21 49 44 Parent and other (174) (49) (222) (97) --- --- --- --- Income (loss) from continuing operations before income taxes (447) 391 (196) 700 Income tax expense (benefit) (150) 102 (93) 174 --- --- --- --- Income (loss) from continuing operations (297) 289 (103) 526 Loss from discontinued operations, net of taxes - - - (68) --- --- --- --- Net income (loss) $(297) 289 (103) 458 === === === === Diluted net income (loss) per common share $(1.28) 1.15 (0.46) 1.82 ==== ==== ==== ====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Consolidated Results -------------------- Revenues - -------- Three Months Six Months Ended June 30 Ended June 30 ------------- ------------- (in millions) 1998 1997 1998 1997 ---- ---- ---- ---- Earned premiums $1,752 1,856 3,533 3,697 Net investment income 398 390 795 780 Realized investment gains 133 171 183 267 Asset management- investment banking 75 60 146 118 Other 19 16 44 33 ------- ------ ------- ------- Total revenues $2,377 2,493 4,701 4,895 ======= ====== ======= ======= Premiums earned in The St. Paul's insurance operations for the second quarter and first half of 1998 declined 6% and 4%, respectively, compared with same periods of 1997. The reduction was centered in the General Commercial segment of The St. Paul's property-liability operations, where intensely competitive market conditions over the last 12 months have negatively impacted business volume and pricing. Life insurance premiums earned were level with the second quarter of 1997 and down $3 million for the first half of the year. Realized investment gains for the second quarter and first half of 1998 declined from gains in the same periods of last year; however, the 1997 totals were unusually large due to the sale of one venture capital investment in the second quarter which generated a $129 million gain. One-time Charges - ---------------- The $656 million one-time, pre-tax charge recorded in the second quarter was composed of the following merger-related and other nonrecurring components: - $250 million of loss and loss adjustment expenses, to reflect the application of The St. Paul's reserving policies to USF&G's property-liability loss reserves; - $176 million of severance and other employee-related costs; - $70 million of facilities exit costs, primarily relating to lease buy-outs resulting from the anticipated consolidation of branch office locations; - $67 million writedown of certain USF&G investments and other assets, including a writedown in the carrying value of a portion of the former USF&G headquarters complex in Baltimore, MD; - $41 million writedown of deferred policy acquisition costs of the life insurance operation (F&G Life) acquired in the merger; - $52 million of other costs, primarily composed of transaction fees and other expenses resulting from the merger. These charges were recorded pursuant to management's plan to integrate the operations of The St. Paul and USF&G.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance ---------------------------- The following summarizes key financial results by property- liability underwriting operation: % of Three Months Six Months 1998 Ended June 30 Ended June 30 Written ------------- ------------- ($ in Millions) Premiums 1998 1997 1998 1997 -------- ---- ---- ---- ---- Specialized Commercial: Written Premiums 34% 589 587 1,157 1,146 Underwriting Result ($145) 19 (169) 26 Combined Ratio 127.2 98.7 117.3 99.8 General Commercial Written Premiums 22% $358 459 746 923 Underwriting Result ($228) (49) (275) (97) Combined Ratio 161.9 110.6 136.9 112.0 Personal Insurance: Written Premiums 20% $358 293 692 603 Underwriting Result ($121) (19) (138) (56) Combined Ratio 135.2 104.3 120.0 107.9 ----- ----- ----- ----- ----- Total U.S. Underwriting: Written Premiums 76% $1,305 1,339 2,595 2,672 Underwriting Result ($494) (49) (582) (127) Combined Ratio 139.0 104.1 123.7 105.8 International Underwriting: Written Premiums 7% $122 95 211 148 Underwriting Result ($10) (15) (30) (22) Combined Ratio 107.6 117.6 114.0 116.0 ----- ----- ----- ----- ----- Total Worldwide Insurance Operations: Written Premiums 83% $1,427 1,434 2,806 2,820 Underwriting Result ($504) (64) (612) (149) Combined Ratio 136.9 104.7 123.0 106.3 Reinsurance: Written Premiums 17% $318 393 594 680 Underwriting Result $2 (1) 16 1 Combined Ratio 95.5 96.7 95.9 97.6 ----- ----- ----- ----- ----- Total Property-Liability Underwriting: Written Premiums 100% $1,745 1,827 3,400 3,500 GAAP Underwriting Result ($502) (65) (596) (148) Statutory Combined Ratio: Loss and Loss Expense Ratio 96.3 72.2 84.2 72.6 Underwriting Expense Ratio 34.2 30.8 34.4 32.0 ----- ----- ----- ----- Combined Ratio 130.5 103.0 118.6 104.6 ===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance ---------------------------- Overview - -------- The table on the preceding page reflects the impact of the $250 million pretax provision for losses and loss adjustment expenses recorded in the second quarter to apply The St. Paul's reserving policies to USF&G's loss reserves subsequent to the consummation of the merger. The following table summarizes The St. Paul's consolidated "core" GAAP underwriting results excluding that one- time charge, and the impact of catastrophe losses on core underwriting results. Three Months Six Months Ended June 30 Ended June 30 ------------- ------------- ($ in millions) 1998 1997 1998 1997 ---- ---- ---- ---- Core GAAP underwriting result ($252) (65) (346) (148) Core statutory combined ratio 116.0 103.0 111.4 104.6 Pretax catastrophe losses $157 70 208 84 Impact on combined ratio 9.1 3.8 6.0 2.3 ----- ----- ----- ----- Core results excluding catastrophes: GAAP underwriting result ($95) 5 (138) (64) Statutory combined ratio 106.9 99.2 105.4 102.3 ===== ===== ===== ===== Pretax catastrophe losses of $157 million in the second quarter resulted from severe storms in the Midwest and Southeast. Several of these storms occurred in Minnesota, where The St. Paul has a heavy concentration of business, and in Tennessee, which was one of USF&G's largest markets. The deterioration in underwriting results excluding catastrophes was largely due to intensely competitive conditions in several market sectors, particularly the small to midsized commercial segment. The consolidated expense ratio of 34.2 for the second quarter was negatively impacted by an increase in commission expenses resulting from efforts to retain USF&G business during the integration of The St. Paul and USF&G into one organization. Underwriting Results by Segment - ------------------------------- The following discussion focuses on core segment results excluding the impact of the $250 million one-time charge to increase USF&G's loss and loss adjustment expense reserves. Specialized Commercial - ---------------------- Written premiums in this segment totaled $589 million in the second quarter, virtually level with comparable 1997 premiums of $587 million. The St. Paul's Medical Services operation, which is now included in this segment, recorded premiums of $85 million for the quarter, down 5% from last year's second quarter total of $89 million. Medical Services posted a second quarter underwriting loss of $26 million, compared with a profit of $5 million in the same period of 1997. On a year-to-date basis, Medical Services' premium volume of $181 million was down 3%, and underwriting results were $62 million worse than 1997. Accelerating loss costs and a continuing competitive market environment which has negatively impacted pricing accounted for the deterioration in Medical Services' results. During the second quarter, The St. Paul began implementing price increases of 3% to 5% on selected physicians and surgeons' policy renewals.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance ---------------------------- The remainder of the Specialized Commercial segment posted slight premium growth over the second quarter and first six months of 1997. Core underwriting results, however, deteriorated by almost $40 million for both the second quarter and year-to-date in comparison to 1997, primarily due to increased catastrophe losses and adverse loss development on prior years' business. The St. Paul's Surety underwriting operation, which is now the largest in the United States as a result of the USF&G merger, posted strong growth in net premium volume and a $19 million underwriting profit for the quarter. General Commercial - ------------------ Premium volume in this segment declined 22% for the quarter and 19% for the first half of the year. Prices continue to decline in this market, reflecting the continuing intense competition for small to midsized commercial business. The St. Paul does not anticipate that the pricing environment will improve during the remainder of 1998. The second quarter core underwriting loss of $108 million was severely impacted by catastrophe losses of $48 million, and a general deterioration in noncatastrophe prior year loss development across the book of business. The expense ratio for the quarter of 39.6 was over four points worse than last year's second quarter, due to the sharp decline in premium volume, initial merger-related expenses and higher commission expenses. The expense ratio is expected to improve going forward as integration efficiencies are realized. On a year-to-date basis, the core underwriting loss of $155 million was $58 million worse than 1997, with catastrophe losses of $64 million playing a large role in the deterioration. Catastrophe losses in the first half of 1997 totaled $19 million. Personal Insurance - ------------------ Second quarter and year-to-date written premium volume grew 22% and 15%, respectively, over the same periods of 1997. The majority of the increase in 1998 was due to The St. Paul's acquisition in December 1997 of Titan Holdings, Inc., a property- liability company which has a substantial book of nonstandard automobile business. The Personal Insurance segment's core underwriting loss of $86 million for the second quarter was severely impacted by catastrophe losses of $78 million. For the first half of 1998, catastrophe losses accounted for $86 million of the core underwriting loss of $103 million. Two May storms in Minnesota resulted in over 11,000 claims, accounting for nearly $50 million of this segment's catastrophe total. The nonstandard auto business center, a market in which The St. Paul had virtually no presence prior to the merger with USF&G, provides automobile coverage for individuals who are unable to obtain standard coverage due to their inability to meet certain underwriting criteria. Premiums generated by this business center totaled $61 million in the second quarter of 1998, compared with $20 million in the same period of 1997. The core underwriting profit for the quarter was $1 million, compared with a loss of $1 million in 1997's second quarter. International - ------------- The International segment posted premium growth of 29% for the second quarter and 42% for the first half of 1998, when compared to the same periods of 1997. New business in Europe, including business generated through The St. Paul's involvement with Lloyd's of London, was the primary factor contributing to premium growth in 1998. The Emerging Markets sector of the International segment also provided premium growth over 1997, due to new business in Botswana and South Africa. Underwriting results for the second quarter improved $5 million over the same 1997 period, but year-to-date results lag $8 million behind the first half of 1997 due to the impact of severe ice storms in Canada during the first quarter.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Property-Liability Insurance ---------------------------- Reinsurance - ----------- St. Paul Re was augmented by the addition of F&G Re and Discover Re as a result of the merger with USF&G. St. Paul Re and F&G Re underwrite both treaty and facultative reinsurance for property, liability, ocean marine, surety and certain specialty classes of business. Discover Re provides products and services to the alternative risk transfer market, and provides products for self- insured companies and insurance pools, as well as ceding to and reinsuring captive insurers. The Reinsurance segment's written premiums of $318 million in the second quarter were down 19% from the same period of 1997. Premium volume of $594 million through the first half of 1998 declined 13% from the first six months of 1997. These sizable declines in 1998 reflect soft global market conditions for this segment, resulting from excess capacity in primary reinsurance markets which has reduced the demand for reinsurance products worldwide. Despite the premium shortfall from 1997, the Reinsurance segment posted a year-to-date underwriting profit of $16 million, compared with a profit of $1 million in the first half of 1997. The lack of catastrophe losses and favorable loss development for prior underwriting years accounted for 1998's strong performance. Year-to-date catastrophe losses totaled $5 million in 1998, compared with $7 million in 1997. Investment Operations - --------------------- Pretax investment income in The St. Paul's property-liability operations for the second quarter and first six months of 1998 was virtually level with the same periods of 1997. 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 on new investments have continued to decline during the first half of 1998. As a result, investment income growth has been negligible for the last several quarters. The merger with USF&G added fixed maturities investments of $5.3 billion (at cost) to The St. Paul's property-liability operations. The combined fixed maturities portfolio on June 30, 1998 of $17.1 billion had a market value on that date of $17.9 billion. Approximately 95% of those investments were rated at investment grade (BBB or above). The weighted average pretax yield on the fixed maturities portfolio was 6.8% at June 30, 1998. The USF&G merger also added lesser amounts of equities, real estate and other investments to The St. Paul's property- liability operations. Pretax realized investment gains totaled $130 million in the second quarter, compared with gains of $169 million in last year's second quarter. Year-to-date pretax gains in 1998 of $177 million were down from last year's six-month gains of $263 million. Sales of equity security investments in favorable market conditions accounted for the majority of 1998's gains. The sale of a single venture capital investment generated pretax gains of $129 million in the second quarter of 1997.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Environmental and Asbestos Claims --------------------------------- The St. Paul's property-liability 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 claims experience, both of which are still developing. The following table represents a reconciliation of total gross and net environmental reserve development for the six months ended June 30, 1998, and the years ended Dec. 31, 1997 and 1996. Amounts in the "net" column are reduced by reinsurance recoverables. Environmental 1998 - ------------- (six months) 1997 1996 ----------- ---- ---- (in millions) Gross Net Gross Net Gross Net ----- --- ----- ---- ----- --- Beginning reserves $867 677 889 676 840 631 Reserves acquired - - - - 18 7 Incurred losses 13 15 44 58 87 92 Paid losses (34) (34) (66) (57) (56) (54) ---- ---- ---- ---- ---- ---- Ending reserves $846 658 867 677 889 676 ==== ==== ==== ==== ==== ==== Many significant environmental claims currently being brought against insurance companies 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 ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Environmental and Asbestos Claims --------------------------------- The following table represents a reconciliation of total gross and net reserve development for asbestos claims for the six months ended June 30, 1998, and the years ended Dec. 31, 1997 and 1996: Asbestos 1998 - -------- (six months) 1997 1996 ----------- ---- ---- (in millions) Gross Net Gross Net Gross Net ----- --- ----- --- ----- --- Beginning reserves $397 279 413 304 421 294 Reserves acquired - - - - 6 6 Incurred losses 5 3 22 (5) 18 25 Paid losses (12) (7) (38) (20) (32) (21) ---- ---- ---- ---- ---- ---- Ending reserves $390 275 397 279 413 304 ==== ==== ==== ==== ==== ==== 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 June 30, 1998 represent its best estimate of its ultimate liability for such losses, based on all information currently available. 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 its results of operations, liquidity or financial position. Total gross environmental and asbestos reserves at June 30, 1998 of $1.24 billion represented approximately 7% of gross consolidated property-liability reserves of $18.65 billion. Life Insurance -------------- The St. Paul's life insurance segment is comprised of Fidelity and Guaranty Life Insurance Company and subsidiaries ("F&G Life"), acquired in the USF&G merger. F&G Life underwrites traditional life insurance and annuities, which are sold throughout the United States through independent agents, managing general agents and specialty brokerage firms. F&G Life recorded a nonrecurring $41 million pretax charge in the second quarter, representing a writedown of deferred policy acquisition costs. The current low interest rate environment prompted a reassessment of assumptions related to future net investment spreads, premium persistency and annuitization rates, primarily related to single premium deferred annuities and tax sheltered annuities. In addition, F&G Life recorded a pretax one-time charge of $16 million as a result of the merger in the second quarter, primarily relating to severance, investment writedowns and facilities exit costs.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Life Insurance -------------- Highlights of F&G Life's financial performance for the second quarter and six months of 1998 and 1997 were as follows (core earnings exclude the impact of the $57 million one-time charge): Three Months Six Months Ended June 30 Ended June 30 ------------- ------------- (in millions) 1998 1997 1998 1997 ---- ---- ---- ---- Sales (annualized premiums) $71 121 151 235 Premiums earned $26 26 50 53 Policy surrenders $62 42 114 81 Net investment income $67 63 132 121 Core pretax earnings (including realized gains) $23 12 42 25 The decline in sales for the second quarter and first half of 1998 was primarily due to the significantly lower level of interest rates and its negative impact on fixed interest rate annuities. The demand for annuity products is affected by fluctuating interest rates and the relative attractiveness of alternative investment, annuity or insurance products. In an effort to balance its portfolio of fixed interest rate annuity products, F&G Life introduced an equity-indexed annuity in June 1998. The decline in premiums earned for the first six months of 1998 was largely due to a reduction in sales of structured settlement annuities, which are sold primarily to property-liability insurers to settle insurance claims. Sales of these annuities in the second quarter were adversely impacted by disruptions caused by the merger with The St. Paul; however, sales are expected to grow in the second half of 1998 as F&G Life expands these products into The St. Paul's claim organization. Deferred annuities and universal life products are subject to surrender by policyholders. Nearly all of F&G Life's surrenderable annuity policies allow a refund of the cash value balance less a surrender charge. Surrender activity increased in 1998 due to an increase in the size and maturity of the annuity book of business and from competition from alternative investments, primarily equity-based products. Net investment income grew in 1998 as a result of an increasing asset base generated by positive cash flow. Despite the decline in premiums earned, core pretax earnings for the second quarter and six months of 1998 were higher than the same periods of 1997 due to improved investment spread management on annuity and universal life products and strong expense controls. Total life insurance in force at June 30, 1998 was $10.74 billion, compared with $10.49 billion at June 30, 1997.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Asset Management-Investment Banking ----------------------------------- The St. Paul's portion of The John Nuveen Company's second quarter 1998 pretax earnings was $25 million, $4 million higher than the same period of 1997. For the first half of 1998, the company's portion of such earnings was $49 million, compared with $44 million for the first half of 1997. The company currently owns 77% of Nuveen. Nuveen's asset management fee revenue of $67 million for the second quarter was $16 million, or 32% 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. Year-to-date management fee revenues totaled $132 million in 1998, compared with $102 million through the first six months of 1997. Nuveen's assets under management grew to $52.2 billion at June 30, 1998, an increase of 5% since year-end 1997. Capital Resources ----------------- The St. Paul's capitalization (debt, redeemable preferred securities and equity) stood at $8.07 billion at June 30, 1998, down 4% from the year-end 1997 total of $8.41 billion. Common shareholders' equity declined by $118 million in the first half of 1998 as a result of the net loss incurred during that period. The merger with USF&G Corporation consummated in April 1998 was a tax-free exchange of stock accounted for as a pooling-of- interests. The St. Paul issued 66.5 million shares of its common stock in exchange for all of the outstanding common stock of USF&G. The transaction was valued at approximately $3.7 billion, which included the assumption of USF&G's debt and capital securities. Total debt outstanding at the end of June was $1.08 billion, a decline of $228 million, or 17%, from the Dec. 31, 1997 total of $1.30 billion. The reduction was driven by the maturity of $145 million of 7% senior notes in May 1998, which was funded with a combination of internal funds and commercial paper issuances. In addition, Nuveen's short-term debt outstanding declined by $83 million from year-end 1997. Approximately 48% of The St. Paul's debt outstanding at June 30, 1998 consisted of medium- term notes bearing a weighted average rate of 7.1%. Commercial paper comprised 19% of The St. Paul's total debt at the mid- point of 1998. Debt as a percentage of total capitalization at June 30, 1998, was 13%, down from 15% at year-end 1997. The St. Paul has no plans for major capital expenditures during the remainder of 1998. The company's year-to-date pretax loss from continuing operations was inadequate to cover "fixed charges" by $196 million and "combined fixed charges and preferred stock dividends" by $224 million. For the first six months of 1997, the company's ratio of earnings to fixed charges was 12.05, and the ratio of earnings to combined fixed charges and preferred stock dividends was 8.81. Fixed charges consist of interest expense before reduction for capitalized interest 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 cash requirements of its business operations. Net cash used in operations was $19 million in the first six months of 1998, compared with cash provided by operations of $260 million in 1997. The significant decline in operational cash flows compared with 1997 was the result of an increase in insurance loss payments due to deteriorating loss experience and severe catastrophes, a decline in property-liability written premiums, and expenses paid relating to the merger with USF&G. Despite the negative operational cash flows in the first half of 1998, The St. Paul's ability to meet its short-term and long- term liquidity requirements remains intact due to the high level of readily marketable investment securities in its portfolio which generate strong levels of investment income, and the prospects for future profitable growth afforded by the merger with USF&G. 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 is coordinating with financial institutions, vendors and other entities with which it does business to identify and resolve any year 2000 issues. 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 believes that, although payments of such claims could possibly have an adverse effect on its results of operations and/or cash flows, they would not have a material adverse effect on its consolidated financial position. Impact of Accounting Pronouncements to be Adopted in the Future - --------------------------------------------------------------- In December 1997, the American Institute of Certified Public Accountants issued Statement of Position (SOP) No. 97-3, "Accounting by Insurance and Other Enterprises for Insurance- Related Assessments." The SOP provides guidance for determining when a liability should be recognized for guaranty fund and other insurance-related assessments and on the measurement of that liability. It also provides guidance on when an asset should be recognized for a portion or all
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES Management's Discussion, Continued Impact of Accounting Pronouncements to be Adopted in the Future - --------------------------------------------------------------- of the liability or paid assessment that can be recovered through premium tax offsets of policy surcharges. The SOP is effective for fiscal years beginning after December 31, 1998. The St. Paul currently intends to adopt the provisions of the SOP in the first quarter of 1999. The cumulative effect of adopting the SOP may be material to The St. Paul's results of operations in the period it is adopted; however, The St. Paul cannot at this time reasonably estimate the amount of that cumulative effect. In February 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits," which standardizes the disclosure requirements for pensions and other postretirement benefits to the extent practicable, requires additional information on changes in benefits obligations and fair values of plan assets, and eliminates certain disclosures currently required. SFAS No. 132 is effective for fiscal years beginning after December 15, 1997. The St. Paul will adopt the provisions of SFAS No. 132 for its 1998 annual financial statements. This adoption is not expected to materially change The St. Paul's current pension and postretirement disclosures, and will have no impact on net income in 1998 and succeeding years. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the balance sheet, and measure those instruments at fair value. SFAS No. 133 is effective for all quarters of fiscal years beginning after June 15, 1999, and prohibits retroactive application to financial statements of prior periods. The St. Paul currently intends to implement the provisions of SFAS No. 133 in the first quarter of the year 2000. The St. Paul currently has limited involvement with derivative instruments, primarily for purposes of hedging against fluctuations in interest rates. The St. Paul cannot at this time reasonably estimate the potential impact of this adoption on its financial position or results of operations for future periods. 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 it 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. Not applicable. 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 April 24, 1998, relating to the consummation of its merger with USF&G Corporation. 2) 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. 3) 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. 4) The St. Paul filed a Form 8-K Current Report dated May 14, 1998, relating to the anticipated cost savings to be realized from the USF&G merger, and the anticipated second- quarter charge to earnings resulting from the merger. 5) The St. Paul filed a Form 8-K Current Report dated May 22, 1998, relating to the expected pretax catastrophe losses of between $35 million and $40 million resulting from a May 15, 1998 storm in Minnesota.
6) The St. Paul filed a Form 8-K Current Report dated June 8, 1998, relating to the expected pretax catastrophe losses of between $25 million and $30 million resulting from a May 30, 1998 storm in Minnesota and the Midwest. 7) The St. Paul filed a Form 8-K Current Report dated July 8, 1998, relating to the anticipated total of approximately $155 million in pretax catastrophe losses for the second quarter of 1998. 8) The St. Paul filed a Form 8-K Current Report dated August 3, 1998, relating to the announcement of its financial results for the quarter ended June 30, 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: August 14, 1998 By /s/ Bruce A. Backberg --------------------- Bruce A. Backberg Senior Vice President and Chief Legal Counsel (Authorized Signatory) Date: August 14, 1998 By /s/ Thomas A. Bradley --------------------- Thomas A. Bradley Senior Vice President and Corporate Controller (Principal 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*.......................................... (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**..................(1) (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 Legal Services, The St. Paul Companies, 385 Washington Street, Saint Paul, MN 55102. (1) Filed electronically herewith.