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UNITED STATES 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 September 30, 2003
--------------------
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 001-10898
---------
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 Identification
incorporation or organization) 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 at October 24, 2003, was 228,156,507.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION --------
Consolidated Statements of Operations (Unaudited),
Three and Nine Months Ended September 30,
2003 and 2002 3
Consolidated Balance Sheets, September 30, 2003
(Unaudited) and December 31, 2002 4
Consolidated Statements of Shareholders' Equity,
Nine Months Ended September 30, 2003
(Unaudited) and Twelve Months Ended 6
December 31, 2002
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited), Nine Months Ended September 30, 2003
and 2002 7
Consolidated Statements of Cash Flows (Unaudited),
Nine Months Ended September 30, 2003 and 2002 8
Notes to Consolidated Financial Statements
(Unaudited) 9
Forward-Looking Statement Disclosure and Certain Risks 32
Management's Discussion and Analysis of
Financial Condition and Results of
Operations 34
Qualitative and Quantitative Disclosures
about Market Risk 66
Controls and Procedures 66
PART II. OTHER INFORMATION
Item 1 through Item 6 67
Signatures 67
EXHIBIT INDEX 68
Item 1. Financial Statements.
- ------ --------------------
PART I FINANCIAL INFORMATION
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
For the three months and nine months ended September 30, 2003 and 2002
(In millions, except per share data)
Three Months Ended Nine Months Ended
September 30 September 30
------------------ ----------------
2003 2002 2003 2002
------ ------ ------ ------
Revenues:
Premiums earned $ 1,808 $ 1,937 $ 5,237 $ 5,851
Net investment income 279 302 835 881
Asset management 121 102 329 286
Realized investment
gains (losses) 4 (78) 33 (148)
Other 34 34 97 105
------ ------ ------ ------
Total revenues 2,246 2,297 6,531 6,975
------ ------ ------ ------
Expenses:
Insurance losses and
loss adjustment expenses 1,220 1,494 3,548 4,873
Policy acquisition expenses 389 384 1,173 1,258
Operating and
administrative expenses 306 324 920 917
------ ------ ------ ------
Total expenses 1,915 2,202 5,641 7,048
------ ------ ------ ------
Income (loss) from
continuing operations
before income taxes and
cumulative effect of
accounting change 331 95 890 (73)
Income tax expense
(benefit) 94 26 257 (72)
------ ------ ------ ------
Income (loss) before
cumulative effect of
accounting change 237 69 633 (1)
Cumulative effect of
accounting change,
net of taxes (21) - (21) (6)
------ ------ ------ ------
Income (loss) from
continuing operations 216 69 612 (7)
Discontinued operations,
net of taxes (2) (6) (3) (19)
------ ------ ------ ------
Net income (loss) $ 214 $ 63 $ 609 $ (26)
====== ====== ====== ======
Basic earnings (loss)
per share:
Income (loss) before
cumulative effect of
accounting change $ 1.02 $ 0.29 $ 2.72 $ (0.06)
Cumulative effect of
accounting change,
net of taxes (0.09) - (0.09) (0.03)
------ ------ ------ ------
Income (loss) from
continuing operations 0.93 0.29 2.63 (0.09)
Discontinued operations,
net of taxes (0.01) (0.02) (0.01) (0.09)
------ ------ ------ ------
Net income (loss) $ 0.92 $ 0.27 $ 2.62 $ (0.18)
====== ====== ====== ======
Diluted earnings (loss)
per share:
Income (loss) before
cumulative effect of
accounting change $ 0.98 $ 0.29 $ 2.61 $ (0.06)
Cumulative effect of
accounting change,
net of taxes (0.09) - (0.09) (0.03)
------ ------ ------ ------
Income (loss) from
continuing operations 0.89 0.29 2.52 (0.09)
Discontinued operations,
net of taxes (0.01) (0.02) (0.01) (0.09)
------ ------ ------ ------
Net income (loss) $ 0.88 $ 0.27 $ 2.51 $ (0.18)
====== ====== ====== ======
Dividends declared per
common share $ 0.29 $ 0.29 $ 0.87 $ 0.87
====== ====== ====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
September 30, 2003 (unaudited) and December 31, 2002
(In millions)
2003 2002
Assets ------ ------
Investments:
Fixed income $16,689 $17,188
Real estate and mortgage loans 868 874
Venture capital 532 581
Equities 334 394
Securities on loan 982 806
Other investments 859 738
Short-term investments 2,409 2,152
------ ------
Total investments 22,673 22,733
Cash 253 315
Reinsurance recoverables:
Unpaid losses 7,210 7,777
Paid losses 1,088 523
Ceded unearned premiums 703 813
Receivables:
Underwriting premiums 2,574 2,711
Interest and dividends 259 247
Other 231 218
Deferred policy acquisition costs 691 532
Deferred income taxes 1,159 1,267
Office properties and equipment 349 459
Goodwill 906 874
Intangible assets 140 139
Other assets 2,127 1,351
------ ------
Total Assets $40,363 $39,959
====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
September 30, 2003 (unaudited) and December 31, 2002
(In millions)
2003 2002
Liabilities ------ ------
Insurance reserves:
Losses and loss adjustment
expenses $20,899 $22,626
Unearned premiums 4,223 3,802
------ ------
Total insurance reserves 25,122 26,428
Debt 3,573 2,713
Payables:
Reinsurance premiums 894 1,010
Accrued expenses and other 993 963
Securities lending collateral 1,000 822
Other liabilities 2,513 1,388
------ ------
Total Liabilities 34,095 33,324
------ ------
Company-obligated mandatorily
redeemable preferred securities
of trusts holding solely
subordinated debentures of
the company - 889
------ ------
Shareholders' Equity
Preferred:
Stock Ownership Plan -
convertible preferred stock 99 105
Guaranteed obligation -
Stock Ownership Plan (23) (40)
------ ------
Total Preferred
Shareholders' Equity 76 65
------ ------
Common:
Common stock 2,646 2,606
Retained earnings 2,882 2,473
Accumulated other comprehensive
income, net of taxes:
Unrealized appreciation
of investments 689 671
Unrealized loss on foreign
currency translation (23) (68)
Unrealized loss on derivatives (2) (1)
------ ------
Total accumulated other
comprehensive income 664 602
------ ------
Total Common Shareholders'
Equity 6,192 5,681
------ ------
Total Shareholders' Equity 6,268 5,746
------ ------
Total Liabilities, Mandatorily
Redeemable Preferred Securities
and Shareholders' Equity $40,363 $39,959
====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Nine Months Ended September 30, 2003 (unaudited) and
Twelve Months Ended December 31, 2002
(In millions)
2003 2002
------ ------
Preferred Shareholders' Equity
Stock Ownership Plan -
convertible preferred stock:
Beginning of period $ 105 $ 111
Redemptions during the period (6) (6)
------ ------
End of period 99 105
------ ------
Guaranteed obligation - Stock
Ownership Plan:
Beginning of period (40) (53)
Principal payments
17 13
End of period ------ ------
(23) (40)
Total Preferred ------ ------
Shareholders' Equity 76 65
------ ------
Common Shareholders' Equity:
Common stock:
Beginning of period 2,606 2,192
Stock issued:
Stock incentive plans 27 32
Preferred shares redeemed 12 13
Net proceeds from stock offering - 413
Present value of equity unit
forward purchase contracts - (46)
Other 1 2
------ ------
End of period 2,646 2,606
------ ------
Retained earnings:
Beginning of period 2,473 2,500
Net income 609 218
Dividends declared on
common stock (198) (252)
Dividends declared on
preferred stock, net of taxes (6) (9)
Deferred compensation -
restricted stock (4) (5)
Tax benefit on employee
stock options, and other changes 15 28
Premium on preferred shares redeemed (6) (7)
Reacquired shares (1) -
------ ------
End of period 2,882 2,473
------ ------
Unrealized appreciation on
investments, net of taxes:
Beginning of period 671 442
Change during the period 18 229
------ ------
End of period 689 671
------ ------
Unrealized loss on foreign
currency translation, net of taxes:
Beginning of period (68) (76)
Currency translation adjustments 45 8
------ ------
End of period (23) (68)
------ ------
Unrealized loss on
derivatives, net of taxes:
Beginning of period (1) (2)
Change during the period (1) 1
------ ------
End of period (2) (1)
------ ------
Total Common
Sharehoders' Equity 6,192 5,681
------ ------
Total Shareholders' Equity $ 6,268 $ 5,746
====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
For the three months and nine months ended September 30, 2003 and
2002
(In millions)
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
(in millions) 2003 2002 2003 2002
----------- ----- ----- ----- -----
Net income (loss) $ 214 $ 63 $ 609 $ (26)
----- ----- ----- -----
Other comprehensive income
(loss), net of taxes:
Change in unrealized
appreciation of investments (157) 164 18 185
Change in unrealized loss
on foreign currency
translation (13) (8) 45 3
Change in unrealized loss
on derivatives (4) - (1) 2
----- ----- ----- -----
Other comprehensive
income (loss) (174) 156 62 190
----- ----- ----- -----
Comprehensive income $ 40 $ 219 $ 671 $ 164
===== ===== ===== =====
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2003 and 2002
(Unaudited)
(In millions)
2003 2002
------ ------
Operating Activities:
Net income (loss) $ 609 $ (26)
Adjustments:
Loss from discontinued operations 3 19
Change in property-liability
insurance reserves (1,369) 163
Change in reinsurance balances 429 (181)
Change in deferred acquisition costs (160) 2
Change in insurance premiums receivable 140 342
Change in accounts payable and
accrued expenses (99) (72)
Change in income taxes payable /refundable 70 186
Realized investment (gains) losses (33) 148
Provision for federal deferred
tax expense (benefit) 84 (133)
Depreciation and amortization 70 67
Cumulative effect of accounting change 21 6
Other (55) (86)
------ ------
Net Cash Provided (Used)
by Operating Activities (290) 435
------ ------
Investing Activities:
Net purchases of short-term investments (162) (679)
Purchases of other investments (3,613) (6,011)
Proceeds from sales and
maturities of other investments 4,167 5,929
Change in open security transactions 59 111
Venture capital distributions - 77
Purchase of office property and equipment (34) (47)
Sales of office property and equipment 79 10
Acquisitions, net of cash acquired (15) (195)
Other (25) 67
------ ------
Net Cash Provided (Used) by
Continuing Operations 456 (738)
Net Cash Used by
Discontinued Operations (19) (1)
------ ------
Net Cash Provided (Used) by
Investing Activities 437 (739)
------ ------
Financing Activities:
Dividends paid on common and
preferred stock (204) (185)
Proceeds from issuance of debt 300 941
Repayment of debt and preferred securities (346) (534)
Net proceeds from issuance of common shares - 413
Subsidiary's repurchase of common shares (31) (133)
Stock options exercised and other 68 70
------ ------
Net Cash Provided (Used) by
Financing Activities (213) 572
------ ------
Effect of exchange rate changes on cash 4 10
------ ------
Increase (decrease) in cash (62) 278
Cash at beginning of period 315 151
------ ------
Cash at end of period $ 253 $ 429
====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Unaudited
September 30, 2003
Note 1 - Basis of Presentation
- ------------------------------
The financial statements include The St. Paul Companies, Inc. and
subsidiaries ("The St. Paul" or "the Company"), and have been
prepared in conformity with United States generally accepted
accounting principles ("GAAP").
These consolidated financial statements rely, in part, on
estimates. Our most significant estimates are those relating to
our reserves for losses and loss adjustment expenses. We
continually review our estimates and make adjustments as
necessary, but actual results could turn out to be significantly
different from what we expected when we made these estimates.
With respect to those underwriting lines of business that we have
placed in runoff, we believe the process of estimating required
reserves for losses and loss adjustment expenses has an increased
level of risk and uncertainty due to regulatory and other
business considerations. In the opinion of management, all
necessary adjustments, consisting of normal recurring
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" in our annual report to shareholders for the year
ended December 31, 2002. The amounts in those notes have not changed
materially except as a result of transactions in the ordinary
course of business or as otherwise disclosed in these notes.
In 2003, we changed the method by which we recognize premium
revenue at our operations at Lloyd's. Prior to 2003, such
revenue was recognized using the "one-eighths" method, which
reflected the fact that we converted Lloyd's syndicate accounts
to U.S. GAAP on a quarterly basis. Since Lloyd's accounting does
not recognize the concept of earned premium, we calculated earned
premium as part of the conversion to GAAP, assuming business was
written at the middle of each quarter, effectively breaking the
calendar year into earnings periods of eighths. In 2003, we
began recognizing Lloyd's premium revenue in a manner that more
accurately reflects the underlying policy terms and exposures and
is more consistent with the method by which we recognize premium
revenue in our non-Lloyd's business. This change did not have a
material impact on our consolidated financial statements for the
three months or nine months ended September 30, 2003.
In the first quarter of 2003, we eliminated the one-quarter
reporting lag for our operations at Lloyd's, the impact of which
is discussed in more detail in Note 7 of this report.
Some amounts in the 2002 consolidated financial statements have
been reclassified to conform to the 2003 presentation. In
particular, we reclassified certain commissions in our operations
at Lloyd's, which is discussed in more detail in Note 7 of this
report. These reclassifications had no effect on net income,
comprehensive income or shareholders' equity, as previously
reported.
Partial Adoption of FIN 46
- --------------------------
In 2003, we partially adopted the provisions of FASB
Interpretation No. 46, "Consolidation of Variable Interest
Entities" ("FIN 46"), which sets forth accounting and disclosure
rules for "variable interest entities," as defined in the
Interpretation. See Note 14 in this report for further
discussion regarding the impact of our partial adoption of FIN
46.
Adoption of SFAS No. 150
- ------------------------
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity", which generally requires that an issuer
classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). We adopted the
provisions of SFAS 150 in the third quarter of 2003. Our only
financial instruments that fell within the scope of SFAS No. 150
were the "Company-obligated mandatorily redeemable preferred
securities of trusts holding solely subordinated debentures of
the company" that had been classified as a separate line between
liabilities and shareholders' equity on our consolidated balance
sheet.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 1 - Basis of Presentation (continued)
- -----------------------------------------
These securities were issued by five separate trusts which are
included in our consolidated financial statements. In accordance
with SFAS No. 150, we have reclassified these securities to
liabilities on our consolidated balance sheet in 2003, where they
are included in our total debt outstanding. The carrying value
of these securities in total is $897 million, representing the
present value of the expected future payment of these
obligations, discounting at the respective dividend distribution
rates implicit at inception, which were equal to the contract
rates, as prescribed by SFAS No. 150.
Adoption of SFAS No. 142
- ------------------------
In the first quarter of 2002, we began implementing the
provisions of SFAS No. 142, "Goodwill and Other Intangible
Assets," which established financial accounting and reporting for
acquired goodwill and other intangible assets. The statement
changed prior accounting practice in the way intangible assets
with indefinite useful lives, including goodwill, are tested for
impairment on an annual basis. Generally, it also required that
those assets meeting the criteria for classification as
intangible with finite useful lives be amortized to expense over
those lives, while intangible assets with indefinite useful lives
and goodwill are not to be amortized. In the second quarter of
2002, we completed an evaluation for impairment of our recorded
goodwill in accordance with the provisions of SFAS No. 142. That
evaluation concluded that none of our goodwill was impaired. In
connection with our reclassification of certain assets previously
accounted for as goodwill to other intangible assets in 2002, we
established a deferred tax liability of $6 million in the second
quarter of 2002. That provision was classified as a cumulative
effect of accounting change effective as of January 1, 2002. In
accordance with SFAS No. 142, we restated our previously reported
results for the first quarter of 2002, reducing net income for
that period from the originally reported $139 million, or $0.63
per common share (diluted) to $133 million, or $0.60 per common
share (diluted).
We evaluate our goodwill for impairment on an annual basis. If
an event occurs or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its
carrying amount, we will test for impairment between annual
tests. In the second quarter of 2003, we peformed our annual
evaluation for impairment of recorded goodwill in accordance with
provisions of SFAS No. 142. That evaluation concluded that none
of our goodwill was impaired.
Stock Option Accounting
- -----------------------
We follow the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"),
FASB Interpretation 44, "Accounting for Certain Transactions
involving Stock Compensation (an interpretation of APB Opinion
No. 25)," and other related interpretations in accounting for our
stock option plans utilizing the "intrinsic value method"
described in that literature. We also follow the disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation" for our option plans, as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and
Disclosure; an amendment of FASB Statement No. 123". These
require pro forma net income and earnings per share information,
which is calculated assuming we had accounted for our stock
option plans under the "fair value method" described in those
Statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 1 - Basis of Presentation (continued)
- -----------------------------------------
Had we calculated compensation expense on a combined basis for
our stock option grants based on the "fair value method"
described in SFAS No. 123, our net income and earnings per share
would have been reduced to the pro forma amounts as indicated in
the following table.
Three Months Nine Months
Ended September 30 Ended September 30
------------------ ------------------
(in millions, except per share data) 2003 2002 2003 2002
----- ----- ----- -----
Net income (loss):
As reported* $ 214 $ 63 $ 609 $ (26)
Less: Additional stock-
based employee compensation
expense determined under
fair value-based method for
all awards, net of related
tax effects (9) (11) (30) (28)
----- ----- ----- -----
Pro forma $ 205 $ 52 $ 579 $ (54)
===== ===== ===== =====
Basic earnings (loss) per
common share:
As reported $0.92 $ 0.27 $2.62 $(0.18)
===== ===== ===== =====
Pro forma $0.88 $ 0.22 $2.49 $(0.31)
===== ===== ===== =====
Diluted earnings (loss) per
common share:
As reported $0.88 $ 0.27 $2.51 $(0.18)
===== ===== ===== =====
Pro forma $0.86 $ 0.22 $2.38 $(0.31)
===== ===== ===== =====
*As reported net income (loss) included $1 million of stock-based
compensation expenses, net of related tax benefits, in each of
the quarters ended September 30, 2003 and 2002, respectively.
On a year-to-date basis, as reported net income (loss) included
$4 million and $7 million of such expenses, respectively, in
2003 and 2002.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 2 - Earnings Per Common Share
- ----------------------------------
The following table provides the calculation of our earnings per
common share for the three months and nine months ended September 30,
2003 and 2002.
Three Months Ended Nine Months Ended
September 30 September 30
(in millions, except ------------------ -----------------
(per share data) 2003 2002 2003 2002
-------------- ----- ----- ----- -----
Earnings
Basic:
Net income (loss), as reported $ 214 $ 63 $ 609 $ (26)
Preferred stock
dividends, net of taxes (2) (2) (6) (6)
Premium on preferred
shares redeemed (2) (1) (6) (6)
----- ----- ----- -----
Net income (loss)
available to common
shareholders $ 210 $ 60 $ 597 $ (38)
===== ===== ===== =====
Diluted:
Net income (loss)
available to common
shareholders $ 210 $ 60 $ 597 $ (38)
Dilutive effect of affiliates (1) - (3) -
Effect of dilutive securities:
Convertible preferred stock 1 2 5 -
Zero coupon convertible
notes 1 1 2 -
----- ----- ----- -----
Net income (loss)
available to common
shareholders $ 211 $ 63 $ 601 $ (38)
===== ===== ===== =====
Common Shares
Basic:
Weighted average common
shares outstanding 228 221 228 212
===== ===== ===== =====
Diluted:
Weighted average common
shares outstanding 228 221 228 212
Effect of dilutive securities:
Stock options and
other incentive plans 1 1 1 -
Convertible preferred stock 6 6 6 -
Zero coupon convertible notes 2 2 2 -
Equity unit stock
purchase contracts 3 - 2 -
----- ----- ----- -----
Total 240 230 239 212
===== ===== ===== =====
Earnings (Loss) per Common Share
Basic $ 0.92 $ 0.27 $ 2.62 $(0.18)
===== ===== ===== =====
Diluted $ 0.88 $ 0.27 $ 2.51 $(0.18)
===== ===== ===== =====
Diluted EPS is the same as Basic EPS for the nine months
ended September 30, 2002, because Diluted EPS calculated in
accordance with Statement of Financial Accounting Standards
(SFAS) No. 128, "Earnings Per Share," for our 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 amount.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 3 - Investments
- --------------------
Investment Activity. The following table summarizes our
investment purchases, sales and maturities (excluding short-term
investments) for the nine months ended September 30, 2003 and 2002.
Nine Months
Ended September 30
------------------
(in millions) 2003 2002
----- -----
Purchases:
Fixed income $3,022 $4,856
Equities 434 644
Real estate and mortgage loans - 3
Venture capital 84 160
Other investments 73 348
----- -----
Total purchases 3,613 6,011
----- -----
Proceeds from sales and
maturities:
Fixed income 3,514 4,225
Equities 553 1,570
Real estate and mortgage loans 10 76
Venture capital 58 53
Other investments 32 5
----- -----
Total sales and maturities 4,167 5,929
----- -----
Net purchases (sales) $ (554) $ 82
===== =====
Change in Unrealized Appreciation. The change in unrealized
appreciation or depreciation of investments recorded in common
shareholders' equity and other comprehensive income was as
follows:
Nine
Months Ended Year Ended
September 30 December 31
(in millions) 2003 2002
----------- ------------ ------------
Pretax:
Fixed income $ (16) $ 446
Equities 51 (17)
Venture capital (14) (88)
Other 20 8
----- -----
Total increases in pretax
unrealized appreciation 41 349
Increase in deferred taxes (23) (120)
----- -----
Total change in unrealized
appreciation, net of taxes $ 18 $ 229
===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 4 - Income Taxes
- ---------------------
The components of income tax expense (benefit) on income (loss) from continuing
operations before cumulative effect of accounting change were as follows:
Three Months Nine Months
Ended Ended
September 30 September 30
------------- -------------
(in millions) 2003 2002 2003 2002
----------- ----- ----- ----- -----
Income tax expense (benefit):
Federal current $ 2 $ 72 $ 152 $ 43
Federal deferred 83 (51) 84 (133)
----- ----- ----- -----
Total federal income tax
expense (benefit) 85 21 236 (90)
Foreign 5 2 12 10
State 4 3 9 8
----- ----- ----- -----
Total income tax expense
(benefit) on income (loss) from
continuing operations before
cumulative effect of accounting
change $ 94 $ 26 $ 257 $ (72)
===== ===== ===== =====
Note 5 - Commitments, Contingencies and Guarantees
- --------------------------------------------------
Commitments - We have long-term commitments to fund venture
capital investments through one of our subsidiaries, St. Paul
Venture Capital VI, LLC, as well as through new and existing
partnerships and certain other venture capital entities. During
the first nine months of 2003, payments made in the ordinary
course of funding these venture capital investments reduced our
total future estimated obligations by $92 million from year-end
2002. For further information regarding these and other
commitments, refer to Note 17 on pages 82 to 84 of our 2002
Annual Report to Shareholders.
Contingencies - In the ordinary course of conducting business, we
(and certain of our subsidiaries) have been named as defendants
in various lawsuits. Some of these lawsuits attempt to establish
liability under insurance contracts issued by our underwriting
operations, including but not limited to liability under
environmental protection laws and for injury caused by exposure
to asbestos products. Plaintiffs in these and other lawsuits are
seeking money damages that in some cases are substantial or extra
contractual in nature or are seeking to have the court direct the
activities of our operations in certain ways.
Although the ultimate outcome of these matters is not presently
determinable, it is possible that the resolution of one or more
matters may be material to our results of operations in the
period during which such resolution occurs. However, we do not
believe that the total amounts that we and our subsidiaries may
ultimately have to pay in all of these lawsuits will have a
material effect on our liquidity or overall financial position.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 5 - Commitments, Contingencies and Guarantees (continued)
- -------------------------------------------------------------
Note 17 on page 83 of our 2002 Annual Report to Shareholders
includes a summary of certain litigation matters with
contingencies, including the following matters for which there
were additional developments in 2003.
Asbestos Settlement Agreement - On June 3, 2002, we
announced that we and certain of our subsidiaries had
entered into an agreement settling all existing and future
claims arising from any insuring relationship of United
States Fidelity and Guaranty Company ("USF&G"), St. Paul
Fire and Marine Insurance Company ("Fire and Marine") and
their affiliates and subsidiaries, including us, with any of
MacArthur Company, Western MacArthur Company, and Western
Asbestos Company (together, the "MacArthur Companies").
There can be no assurance that this agreement will receive
bankruptcy court approval. For a full discussion of the
Western MacArthur settlement agreement, refer to Note 3 to
the financial statements on pages 68 and 69 of our 2002
Annual Report to Shareholders.
In the first quarter of 2003, we made a payment of $747
million, (which included $7 million interest), related to
the Western MacArthur settlement agreement. This amount,
along with $60 million of an initial $235 million payment
made in the second quarter of 2002, is being held in escrow
pending final bankruptcy court approval of the settlement
agreement as part of a broader plan for the reorganization
of the MacArthur Companies (the "Plan"). At least $60
million from the initial payment and the $747 million paid
in 2003 would be returned to us if the Plan is not approved
by the bankruptcy court. Accordingly, as of September 30,
2003, these payments remain recorded in the amounts of $807
million in both "Other Assets" and "Other Liabilities"
pending approval of the Plan.
Purported Class Action Shareholder Suit - In the fourth
quarter of 2002, several purported class action lawsuits
were filed against our chief executive officer, our chief
financial officer, and us. In the first quarter of 2003,
the lawsuits were consolidated into a single action, which
makes various allegations relating to the adequacy of our
previous public disclosures and reserves relating to the
Western MacArthur asbestos litigation, and seeks unspecified
damages and other relief. We view this action as without
merit and are contesting it vigorously.
Boson v. Union Carbide Corp., et al; and Abernathy v. Ace
American Ins. Co., et al - In 2003, lawsuits have been filed
in Texas and Ohio against certain of our subsidiaries, and
other insurers and non-insurer corporate defendants,
asserting liability for failing to warn of the dangers of
asbestos. It is difficult to predict the outcome for
financial exposure represented by this type of litigation in
light of the broad nature of the relief requested and the
novel theories asserted. We believe, however, that the
cases are without merit and we intend to contest them
vigorously. In this regard, we filed special exceptions in
all of the Texas cases. In October 2003, a court ruled on
the special exceptions in 11 of those cases, dismissing the
cases with prejudice. We view this as a significant ruling
in our favor. The special exceptions in the remaining 51
cases have not yet been ruled upon.
World Trade Center Litigation - In 2002, we and certain
other insurers obtained a summary judgment ruling that the
World Trade Center ("WTC") property loss on September 11,
2001 was a single occurence. Certain insureds, including
the WTC's leaseholder, appealed that ruling, asking the
court to determine that the property loss constituted two
separate occurrences rather than one. In September 2003,
the U.S Circuit Court of Appeals for the Second Circuit of
New York ruled that under terms of the policy form we used
to underwrite property coverage for the WTC, the terrorist
attack constituted one occurrence.
Guarantees - In prior periods we provided certain guarantees for
agency loans, issuances of debt securities, third party loans
related to venture capital investments, and certain tax
indemnifications related to our swap agreements. In addition, we
provided various guarantees and indemnifications in the ordinary
course of selling business entities, as well as guarantees and
indemnifications in connection with the transfer of ongoing
reinsurance operations to
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 5 - Commitments, Contingencies and Guarantees (continued)
- -------------------------------------------------------------
Platinum Underwriters Holdings, Ltd. See Note 2 in our Annual
Report to Shareholders for a more detailed description of the
Platinum transfer. During the first nine months of 2003,
guarantee expirations, reductions in outstanding obligations, the
effects of foreign exchange rates, and the adoption of FIN 46,
"Consolidation of Variable Interest Entities" ("FIN 46"),
resulted in a $37 million decrease in potential obligations for
guarantees that were disclosed as of December 31, 2002. For a
full description of the nature and amount of these guarantees and
indemnifications, refer to Note 17 on pages 82 to 84 of our 2002
Annual Report to Shareholders.
In the third quarter of 2003, we sold our subsidiary Botswana
Insurance Company Ltd. for total proceeds of $11 million, and
recorded a pretax loss of less than $1 million. As part of the
sale agreement, we agreed to provide certain indemnifications to
the third party purchaser. While the agreement included an
unlimited indemnification provision in connection with tax
liabilities arising prior to the transfer of ownership, with
survival until the applicable statutes of limitation expire, we
estimate that the fair value of this guarantee is not material to
our consolidated financial statements.
Note 6 - Debt
- -------------
Debt consisted of the following at September 30, 2003 and
December 31, 2002:
September 30, 2003 December 31, 2002
------------------ -----------------
(in millions) Book Fair Book Fair
----------- Value Value Value Value
----- ----- ----- -----
Debt:
----
5.75% senior notes $ 499 $ 538 $ 499 $ 515
Medium-term notes 470 510 523 559
5.25% senior notes 443 467 443 461
Nuveen notes payable 302 302 55 55
7.875% senior notes 249 272 249 274
8.125% senior notes 249 309 249 280
Commercial paper 140 140 379 379
Zero coupon convertible notes 111 113 107 110
7.125% senior notes 80 87 80 87
Variable rate borrowings 64 64 64 64
----- ----- ----- -----
Subtotal-debt 2,607 2,802 2,648 2,784
----- ----- ----- -----
Mandatorily redeemable preferred
securities:
-------------------------------
7.6% securities 575 612 - -
7.625% securities 121 120 - -
8.47% securities 78 82 - -
8.312% securities 70 75 - -
8.5% securities 53 58 - -
----- ----- ----- -----
Subtotal-redeemable preferred
securities 897 947 - -
----- ----- ----- -----
Fair value of interest
rate swap agreements 69 69 65 65
----- ----- ----- -----
Total debt reported
on balance sheet $3,573 $3,818 $2,713 $2,849
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 6 - Debt (continued)
- ------------------------
As described in more detail in Note 1 of this report, in the
third quarter of 2003, we adopted the provisions of SFAS No. 150,
"Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity." As a result,
the "Company-obligated mandatorily preferred securities of trusts
holding solely subordinated debentures of the company"
("Mandatorily redeemable preferred securities" in the foregoing
table) previously reported separately on our consolidated balance
sheet between liabilities and shareholders' equity are now
included in liabilities as a component of debt. These securities
were issued by five separate trusts and are subject to mandatory
redemption on dates ranging from 2027 to 2050, but can be
redeemed earlier in accordance with conditions that vary among
the five trusts. For a complete description of these mandatorily
redeemable preferred securities, refer to Note 13 on pages 76
through 78 in our 2002 Annual Report to Shareholders. In
accordance with provisions of SFAS No. 150, prior periods were
not restated to conform with the 2003 classification of these
securities as liabilities. Accordingly, our consolidated balance
sheet for the year ended December 31, 2002, presents these
securities as a separate line between liabilities and
shareholders' equity.
In September 2003, Nuveen Investments issued $300 million of
4.22% notes in a private placement. The notes mature in 2008. A
portion of the proceeds was used to refinance existing debt and
repay a $105 million loan from The St. Paul. The remainder will
be used for Nuveen Investments' general corporate purposes. The
$302 million carrying value of Nuveen Investments' newly-issued
debt in the foregoing table includes the unamortized gain from
the cancellation of prior interest rate swap transactions entered
into in anticipation of the private placement, as well as
unamortized private placement debt issue costs.
At September 30, 2003, we were party to a number of interest rate
swap agreements related to several of our debt securities
outstanding. The notional amount of these swaps, all of which
qualified for hedge accounting, totaled $880 million. Their
aggregate fair value at September 30, 2003, was recorded as an
asset of $69 million, with the same amount included in the
carrying value of our debt.
Note 7 - Segment Information
- ----------------------------
In the first quarter of 2003, we revised our property-liability
insurance business segment reporting structure to reflect the
manner in which those businesses are now managed. In 2003, our
property-liability underwriting operations consist of two
segments constituting our ongoing operations (Specialty
Commercial and Commercial Lines), and one segment comprising our
runoff operations (Other). All data for 2002 included in this
report has been restated to be consistent with the new reporting
structure in 2003. The following is a summary of changes made to
our segments in the first quarter of 2003.
- Our Surety & Construction operations, previously reported
together as a separate specialty segment, are now separate
components of our Specialty Commercial segment.
- Our ongoing International operations and our ongoing
operations at Lloyd's, previously reported together as a
separate specialty segment, are now separate components of our
Specialty Commercial segment.
- Our Health Care, Reinsurance and Other operations, each
previously reported as a separate runoff business segment,
have been combined into a single Other runoff segment and are
now under common management. "Runoff" means that we have
ceased or plan to cease underwriting business as soon as
possible.
- The results of our participation in voluntary insurance
pools, as well as loss development on business underwritten
prior to 1980 (prior to 1988 for business acquired in our
merger with USF&G Corporation in 1998), previously included in
our Commercial Lines segment, are now included in the Other
segment. That prior year business includes the majority of
our environmental and asbestos liability exposures. The
oversight of these exposures is the responsibility of the same
management team responsible for oversight of the other
components of the Other segment.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
- ---------------------------------------
In accordance with provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," since Surety
& Construction, International & Lloyd's, Health Care, and
Reinsurance were reported as separate segments during 2002 and
are considered to be of continuing significance in analyzing the
results of our operations, we continue to separately present and
discuss (as appropriate) in this note to our consolidated
financial statements information about those businesses in 2003
and the corresponding period of 2002.
In addition to our property-liability business segments, we also
have a property-liability investment operation segment, as well
as an asset management segment, consisting of our majority
ownership in Nuveen Investments.
The accounting policies of these segments are the same as those
described in Note 1 in our 2002 Annual Report to Shareholders.
We evaluate performance based on underwriting results for our
property-liability insurance segments, investment income and
realized gains for our investment operations segment, and on
pretax income for our asset management segment. Property-
liability underwriting assets are reviewed and managed in total
for purposes of decision-making. We do not allocate assets to
specific underwriting segments. Assets are specifically
identified for our asset management segment.
After the revisions to our segment structure described above, our
reportable segments in our property-liability operations
consisted of the following:
The Specialty Commercial segment includes our combined Surety &
Construction operation, our ongoing International & Lloyd's
operations, and the following nine specialty business centers
that in total comprise the "Specialty" component of this segment:
Technology, Financial and Professional Services, Marine, Personal
Catastrophe Risk, Public Sector Services, Discover Re, Excess &
Surplus Lines, Specialty Programs and Oil & Gas. These business
centers are considered specialty operations because each provides
products and services requiring specialty expertise and focuses
on the respective customer group served. Our Surety business
center underwrites surety bonds, which are agreements under which
one party (the surety) guarantees to another party (the owner or
obligee) that a third party (the contractor or principal) will
perform in accordance with contractual obligations. The
Construction business center offers a variety of products and
services, including traditional insurance and risk management
solutions, to a broad range of contractors and parties
responsible for construction projects. Our ongoing International
operations consist of our specialty underwriting operations in
the United Kingdom, Canada (other than Surety) and the Republic
of Ireland, and the international exposures of most U.S.
underwriting business. At Lloyd's, our ongoing operations are
comprised of the following types of insurance coverage we
underwrite mostly through a single wholly-owned syndicate:
Aviation, Marine, Global Property and Personal Lines.
The Commercial Lines segment includes our Small Commercial,
Middle Market Commercial and Property Solutions business centers,
as well as the results of our limited involvement in involuntary
insurance pools. The Small Commercial business center services
commercial firms that typically have between one and fifty
employees through its proprietary St. Paul Mainstreet (SM) and
St. Paul Advantage (SM) products, with a particular focus on
offices, wholesalers, retailers, artisan contractors and other
service risks. The Middle Market Commercial business center
offers comprehensive insurance coverages for a wide variety of
manufacturing, wholesale, service and retail exposures. This
business center also offers loss-sensitive casualty programs,
including significant deductible and self-insured retention
options, for the higher end of the middle market sector. The
Property Solutions business center combines our Large Accounts
Property business with the commercial portion of our catastrophe
risk business and allows us to take a unified approach to large
property risks.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
- ---------------------------------------
The Other segment includes the results of the lines of business
we placed in runoff in late 2001 and early 2002, including our
former Health Care and Reinsurance segments, and the results of
the following international operations: our runoff operations at
Lloyd's, including our participation in the insuring of the
Lloyd's Central Fund; Unionamerica, the London-based underwriting
unit acquired as part of our purchase of MMI in 2000; and
international operations we decided to exit at the end of 2001.
This segment also includes the results of our participation in
voluntary insurance pools, as well as loss development on
business underwritten prior to 1980 (prior to 1988 for business
acquired in our merger with USF&G Corporation in 1998). That
prior year business includes the majority of our environmental
and asbestos liability exposures. Our Health Care operation
historically provided a wide range of medical liability insurance
products and services throughout the entire health care delivery
system. Our Reinsurance operations historically underwrote
treaty and facultative reinsurance for a wide variety of property
and liability exposures. As described in more detail on page 24
of our 2002 Annual Report to Shareholders, in November 2002 we
transferred our ongoing reinsurance operations to Platinum
Underwriters Holdings, Ltd.
The summary below presents revenue and pretax income from
continuing operations for our reportable segments. The revenues
of our asset management segment include investment income and
realized investment gains.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
- ---------------------------------------
Three Months Nine Months
Ended Ended
September 30 September 30
------------- -------------
(in millions) 2003 2002 2003 2002
----------- ----- ----- ----- -----
Revenues from Continuing Operations:
Underwriting:
Ongoing Operations:
Specialty Commercial:
Specialty $ 609 $ 462 $1,662 $1,329
Surety and Construction 323 285 947 851
International and Lloyd's 270 229 816 585
----- ----- ----- -----
Total Specialty Commercial 1,202 976 3,425 2,765
Commercial Lines 523 421 1,461 1,271
----- ----- ----- -----
Total Ongoing
Insurance Operations 1,725 1,397 4,886 4,036
----- ----- ----- -----
Runoff Operations:
Other:
Health Care 20 143 63 443
Reinsurance 46 303 219 985
Other Runoff 17 94 69 387
----- ----- ----- -----
Total Other 83 540 351 1,815
----- ----- ----- -----
Total Underwriting 1,808 1,937 5,237 5,851
----- ----- ----- -----
Investment operations:
Net investment income 279 300 833 873
Realized investment
gains (losses) 5 (74) 43 (151)
----- ----- ----- -----
Total investment operations 284 226 876 722
----- ----- ----- -----
Other 37 30 98 94
----- ----- ----- -----
Total property-
liability insurance 2,129 2,193 6,211 6,667
----- ----- ----- -----
Asset management 121 102 329 286
----- ----- ----- -----
Total reportable segments 2,250 2,295 6,540 6,953
Parent company and other
operations (4) 2 (9) 22
----- ----- ----- -----
Total revenues $2,246 $2,297 $6,531 $6,975
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
- ---------------------------------------
Three Months Nine Months
Ended Ended
September 30 September 30
------------- -------------
(in millions) 2003 2002 2003 2002
----------- ----- ----- ----- -----
Income (Loss) from Continuing
Operations Before Income Taxes and
Cumulative Effect of Accounting Change:
Underwriting result:
Ongoing Operations:
Specialty Commercial:
Specialty $ 107 $ 60 $ 248 $ 121
Surety and Construction (40) (38) (113) (32)
International and Lloyd's 12 34 74 34
----- ----- ----- -----
Total Specialty Commercial 79 56 209 123
Commercial Lines 58 41 132 84
----- ----- ----- -----
Total Ongoing
Insurance Operations 137 97 341 207
----- ----- ----- -----
Runoff Operations:
Other:
Health Care (4) (71) (37) (164)
Reinsurance (1) (25) 2 (14)
Other Runoff (60) (96) (178) (726)
----- ----- ----- -----
Total Other (65) (192) (213) (904)
----- ----- ----- -----
Total Underwriting result 72 (95) 128 (697)
Investment operations:
Net investment income 279 300 833 873
Realized investment
gains (losses) 5 (74) 43 (151)
----- ----- ----- -----
Total investment operations 284 226 876 722
----- ----- ----- -----
Other (9) (18) (61) (55)
----- ----- ----- -----
Total property-
liability insurance 347 113 943 (30)
----- ----- ----- -----
Asset management:
Pretax income, before minority interest 61 53 170 152
Minority interest (12) (11) (35) (33)
----- ----- ----- -----
Total asset management 49 42 135 119
----- ----- ----- -----
Total reportable segments 396 155 1,078 89
Parent company and other
operations (65) (60) (188) (162)
----- ----- ----- -----
Total income (loss) from
continuing operations before
income taxes and cumulative
effect of accounting change $ 331 $ 95 $ 890 $ (73)
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
- ---------------------------------------
Elimination of Reporting Lag - Lloyd's
- --------------------------------------
In the first quarter of 2003, we eliminated the one-quarter
reporting lag for our underwriting operations at Lloyd's to
coincide with the timing of reporting for all of our other
international operations. As a result, our consolidated results
in the first nine months of 2003 included the results of those
operations for the fourth quarter of 2002 and the first nine
months of 2003, whereas our results for the nine months ended
September 30, 2002, included the results of those operations for
the fourth quarter of 2001 and the first six months of 2002. The
year-to-date incremental impact on our property-liability
operations of eliminating the reporting lag, consisting of the
results of these operations for the quarter ended September 30,
2003, was as follows.
(in millions)
----------- Specialty
Commercial Other Total
---------- ------ ------
Net written premiums $ 83 $ 5 $ 88
Decrease in unearned premiums (20) - (20)
----- ----- -----
Net earned premiums 63 5 68
Incurred losses and
underwriting expenses 69 23 92
----- ----- -----
Underwriting result (6) (18) (24)
Net investment income 2 2 4
Other income 6 - 6
----- ----- -----
Total pretax income (loss) $ 2 $ (16) $ (14)
===== ===== =====
Reclassification of Lloyd's Commission Expenses
- -----------------------------------------------
In the first quarter of 2003, we reclassified certain commission
expenses related to our operations at Lloyd's. In prior years,
we determined commission expense based on premiums reported by
the Lloyd's market (net of commissions) using an estimated
average commission rate. Until recently, gross premiums (prior
to reduction for commissions) were not available from the Lloyd's
market. That information is now available for current and prior
periods, and in the first quarter of 2003, we began recording
actual commission expense for our Lloyd's business. We
reclassified prior period results to record actual commission
expense on a basis consistent with that implemented in the first
quarter of 2003. There was no impact to net income or
shareholders' equity as previously reported for any prior
periods, because the reclassification had the impact of
increasing previously reported premiums and commission expense in
equal and offsetting amounts. For the third quarter and first
nine months of 2003, this reclassification had the impact of
increasing both net earned premiums and policy acquisition costs
by $22 million and $61 million, respectively, compared with what
would have been recorded under our prior method of estimation.
In addition, net written premiums increased by $13 million and
$92 million for the third quarter and first nine months of 2003,
respectively (a portion of which was due to the elimination of
the one-quarter reporting lag). For the third quarter and first
nine months of 2002, the impact was an increase to both net
earned premiums and policy acquisition costs of $9 million and
$69 million, respectively, and an increase to net written
premiums of $8 million and $74 million, respectively.
Note 8 - Reinsurance
- --------------------
Our consolidated financial statements reflect the effects of
assumed and ceded reinsurance transactions. Assumed reinsurance
refers to our acceptance of certain insurance risks that other
insurance companies have underwritten. Ceded reinsurance
involves transferring certain insurance risks (along with the
related written and earned premiums) we have underwritten to
other insurance companies who agree to share these risks. The
primary purpose of ceded reinsurance is to protect us against
earnings volatility and from potential losses in excess of the
amount we are prepared to accept.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 8 - Reinsurance (continued)
- -------------------------------
We expect those with whom we have ceded reinsurance to honor
their obligations. In the event these companies are unable to
honor their obligations, we will pay these amounts. We have
established allowances for possible nonpayment of amounts due to
us.
The effects of assumed and ceded reinsurance on premiums written,
premiums earned and insurance losses and loss adjustment expenses
were as follows:
Three Months Nine Months
Ended Ended
September 30 September 30
------------- -------------
(in millions) 2003 2002 2003 2002
----------- ---- ---- ---- ----
Premiums written
Direct $2,150 $1,883 $6,189 $5,629
Assumed 314 432 1,312 1,782
Ceded (516) (493) (1,782) (1,628)
----- ----- ----- -----
Net premiums written $1,948 $1,822 $5,719 $5,783
===== ===== ===== =====
Premiums earned
Direct $2,050 $1,942 $5,882 $5,626
Assumed 344 487 1,246 1,752
Ceded (586) (492) (1,891) (1,527)
----- ----- ----- -----
Net premiums earned $1,808 $1,937 $5,237 $5,851
===== ===== ===== =====
Insurance losses and loss
adjustment expenses
Direct $1,379 $1,420 $3,899 $5,136
Assumed 243 288 870 1,064
Ceded (402) (214) (1,221) (1,327)
----- ----- ----- -----
Net insurance losses
and loss adjustment
expenses $1,220 $1,494 $3,548 $4,873
===== ===== ===== =====
In conjunction with the transfer of our continuing reinsurance
business (previously operating under the name "St. Paul Re") to
Platinum Underwriters Holdings, Ltd. ("Platinum") in November
2002, we entered into various agreements with Platinum and its
subsidiaries, including quota share reinsurance agreements by
which Platinum reinsured substantially all of the reinsurance
contracts entered into by St. Paul Re on or after January 1,
2002. This transfer (based on September 30, 2002 balances)
included $125 million of unearned premium reserves (net of ceding
commissions), $200 million of existing loss and loss adjustment
expense reserves and $24 million of other reinsurance-related
liabilities. The transfer of unearned premium reserves to
Platinum was accounted for as prospective reinsurance, while the
transfer of existing loss and loss adjustment expense reserves
was accounted for as retroactive reinsurance.
Data in the foregoing table for 2003 include amounts related to
the quota share reinsurance agreements with Platinum, as detailed
in Note 16 of this report.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 8 - Reinsurance (continued)
- -------------------------------
As noted above, the transfer of reserves to Platinum at the
inception of the quota share reinsurance agreements was based on
the September 30, 2002, balances. In March 2003, we transferred
to Platinum $137 million of additional insurance reserves,
consisting of $72 million in unearned premiums (net of ceding
commissions) and $65 million in existing reserves for losses and
loss adjustment expenses. We also transferred cash and other
assets having a value equal to the additional insurance reserves
transferred. This transfer of additional assets and liabilities
reflected business activity between September 30, 2002, and the
November 2, 2002, inception date of the quota share reinsurance
agreements, and our estimate of amounts due under the adjustment
provisions of the quota share reinsurance agreements. Our
insurance reserves at December 31, 2002, included our estimate,
at that time, of amounts due to Platinum under the quota share
reinsurance agreements, which totaled $54 million. The $83
million increase in our estimate of amounts due to Platinum under
the quota share reinsurance agreements resulted in a pretax
underwriting loss of $6 million in the first quarter of 2003.
During the second quarter of 2003, we reached final agreement
with Platinum regarding the adjustment provisions of the quota
share reinsurance agreements and no further adjustments to the
transferred assets and liabilities will occur.
Note 9 - Restructuring Charges
- ------------------------------
Fourth Quarter 2001 Strategic Review - In December 2001, we
announced the results of a strategic review of all of our
operations, which included a decision to exit a number of
businesses and countries. Note 5 in our 2002 Annual Report to
Shareholders provides more detailed information on this strategic
review. Related to this review, we recorded a pretax charge of
$62 million, including $46 million of employee-related costs
(related to the elimination of approximately 700 positions), $9
million of occupancy-related costs, $4 million of equipment
charges and $3 million of legal costs. Note 18 on pages 84 and
85 of our 2002 Annual Report to Shareholders provides more
information on this charge.
The following presents a rollforward of activity related to
this accrual:
(in millions)
----------- Original Reserve Reserve at
Charges to Pre-tax at Dec. 31, September 30,
earnings: Charge 2002 Payments Adjustments 2003
-------- ---------- -------- ----------- ----------
Employee-
related $ 46 $ 14 $ (2) $ - $ 12
Occupancy-
related 9 8 (2) - 6
Equipment
charges 4 N/A N/A N/A N/A
Legal costs 3 - - - -
----- ----- ----- ----- -----
Total $ 62 $ 22 $ (4) $ - $ 18
===== ===== ===== ===== =====
Other Restructuring Charges - Since 1997, we have recorded
several restructuring and other charges related to acquisitions,
mergers and actions taken to improve our operations. Note 18 in
our 2002 Annual Report to Shareholders also provides more
detailed information regarding these other charges. All actions
have been taken and all obligations had been met regarding these
other restructuring charges, with the exception of certain
remaining lease commitments. The lease commitment charges
related to excess space created by the elimination of employee
positions. We expect to be obligated under certain lease
commitments for approximately seven years.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 9 - Restructuring Charges (continued)
- -----------------------------------------
The following presents a rollforward of activity related to these
lease commitments:
(in millions)
----------- Original Reserve Reserve at
Pre-tax at Dec. 31, September 30,
Charge 2002 Payments Adjustments 2003
-------- ---------- -------- ----------- ----------
Lease
commitments
charged to
earnings: $ 91 $ 24 $ (7) - $ 17
===== ===== ===== ===== =====
Note 10 - Goodwill and Other Intangible Assets
- ----------------------------------------------
In the first quarter of 2002, we implemented the provisions of
SFAS No. 142, "Goodwill and Other Intangible Assets," which
established financial accounting and reporting for acquired
goodwill and other intangible assets. As a result of
implementing the provisions of this statement, we did not record
any goodwill expense in 2002 or 2003. Amortization expense
associated with intangible assets totaled $7 million and $20 million
for the three months and nine months ended September 30, 2003,
respectively, compared with $5 million and $14 million, in the
respective 2002 periods.
The following presents a summary of our acquired intangible
assets.
As of September 30, 2003
(in millions) -------------------------------------------
----------- Gross Foreign
Amortizable Carrying Accumulated Exchange Net
intangible assets: Amount Amortization Effects Amount
-------- ------------ -------- ------
Present value
of future profits $ 70 $ (24) $ 4 $ 50
Customer
relationships 67 (8) - 59
Renewal rights 43 (13) - 30
Internal use software 2 (1) - 1
----- ----- ---- ----
Total $ 182 $ (46) $ 4 $ 140
===== ===== ==== ====
At September 30, 2003, we estimated our amortization expense for
the next five years to be as follows: $24 million in 2004, $20
million in 2005, $16 million in 2006, $13 million in 2007, and
$11 million in 2008.
The changes in the carrying value of goodwill on our balance
sheet were as follows.
(in millions)
-----------
Balance at Balance at
Goodwill by Dec. 31, Goodwill Impairment September 30,
Segment 2002 Acquired Losses 2003
----------- -------- -------- --------- ---------
Specialty Commercial $ 80 $ 2 $ - $ 82
Commercial Lines 33 - - 33
Asset Management 752 29 - 781
Property-Liability
Investment Operations 9 1 - 10
----- ----- ----- -----
Total $ 874 $ 32 $ - $ 906
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 10 - Goodwill and Other Intangible Assets (continued)
- ---------------------------------------------------------
The increase in goodwill in our Specialty Commercial segment was
due to the effects of foreign exchange rates applied to existing
goodwill balances. The increase in goodwill in our Asset
Management segment was a result of Nuveen Investments' purchase
of shares from minority shareholders, as well as additional
payments of $12 million for contingent consideration related to a
prior period acquisition. The increase to goodwill in our
Property-Liability Investment Operations segment was due to the
adoption of FIN 46, "Consolidation of Variable Interest Entities"
("FIN 46"), and the resultant consolidation of certain venture
capital operations. See Note 14 in this report for a description
of the adoption of FIN 46.
In the second quarter of 2003, we performed our annual evaluation
for impairment of recorded goodwill in accordance with provisions
of SFAS No. 142. That evaluation concluded that none of our
goodwill was impaired. For further information regarding our
accounting for goodwill and intangible assets, refer to Note 1 in
this report.
Note 11 - Purchase of Renewal Rights
- ------------------------------------
In May 2003, we purchased the right to seek renewal of several
lines of insurance business previously underwritten by Kemper
Insurance Companies. The initial payment for this right was
recorded as an intangible asset (characterized as renewal rights)
and will be amortized on an accelerated basis over four years.
The portfolio of business involved in this transaction includes
the following lines: technology, small commercial, middle market
commercial, inland and ocean marine, and architects' and
engineers' professional liability. We did not assume any past
liabilities with this purchase; however, we may be obligated to
make an additional payment in June 2004 based on the amount of
premium volume we ultimately renew during the twelve months
subsequent to this purchase. We believe it is unlikely that any
additional payment would exceed $30 million. Our consolidated
gross written premiums for the third quarter and nine months
ended September 30, 2003 included approximately $165 million and
$199 million, respectively, attributable to business underwritten
as a result of this purchase of renewal rights, the majority of
which were included in our Commercial Lines segment.
Note 12 - Discontinued Operations
- ---------------------------------
Standard Personal Insurance - In 1999, we sold our standard
personal insurance operations to Metropolitan Property and
Casualty Insurance Company ("Metropolitan"). Metropolitan
purchased Economy Fire & Casualty Company and subsidiaries
("Economy"), and the rights and interests in those non-Economy
policies constituting the remainder of our standard personal
insurance operations. Those rights and interests were
transferred to Metropolitan by way of a reinsurance and facility
agreement. We guaranteed the adequacy of Economy's loss and loss
expense reserves, and we remain liable for claims on non-Economy
policies that result from losses occurring prior to the September
30, 1999, closing date. Under the reserve-related agreements, we
agreed to pay for any deficiencies in those reserves and would
share in any redundancies that developed by September 30, 2002.
Any losses incurred by us under these agreements were reflected
in discontinued operations in the period during which they were
incurred. In the first nine months of 2003 and 2002, we
recorded pretax losses of $3 and $12 million, respectively, in
discontinued operations, related to claims in respect of pre-sale
losses.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 13 - Derivative Financial Instruments
- ------------------------------------------
We have the following derivative instruments, which have been
designated into one of three categories based on their intended
use:
Fair Value Hedges: We have several pay-floating, receive-fixed
interest rate swaps, with notional amounts totaling $880 million
(including $150 million at Nuveen Investments, as described
below). They are designated as fair value hedges for a portion
of our medium-term and senior notes, as they were entered into
for the purpose of managing the effect of interest rate
fluctuations on this debt. The terms of the swaps match those of
the debt instruments, and the swaps are therefore considered 100%
effective. The balance sheet impact related to the movements in
interest rates for the nine months ended September 30, 2003, and
September 30, 2002, was a $4 million increase and a $42 million
increase, respectively, in the fair value of the swaps and the
related debt on the balance sheet. The impacts within the
statement of operations are offsetting.
During the quarter ended September 30, 2003, Nuveen Investments
entered into a series of interest rate swap transactions with
notional amounts totaling $150 million. All of the interest rate
swap transactions were designated as fair value hedges as they
mitigated the changes in fair value of the hedged portion of the
$300 million of debt Nuveen Investments issued in September 2003
in a private placement (one-half of the total firm commitment of
$300 million). Prior to the close of the private placement debt,
the swap transactions were terminated. The cancellation of these
interest rate swap transactions resulted in a total gain to the
Company of $3 million. In accordance with generally accepted
accounting principles, this gain is being amortized over the term
of the private placement debt.
Cash Flow Hedges: We have entered into forward foreign currency
contracts that are designated as cash flow hedges. They are
utilized to reduce our exposure to foreign exchange rate
fluctuations that may impact our expected foreign currency
payments, or the settlement of our foreign currency payables and
receivables. In the nine months ended September 30, 2003, we
recognized a less than $1 million gain on the cash flow hedges,
which is included in "Other Comprehensive Income." The
comparable amount for the nine months ended September 30, 2002,
was a $1 million gain. The amounts included in Other
Comprehensive Income will be realized in earnings concurrent with
the timing of the hedged cash flows. We anticipate that a $1
million loss will be reclassified into earnings within the next
twelve months. In the nine months ended September 30, 2003, and
September 30, 2002, the ineffective portion of the hedge resulted
in a gain of less than $1 million in both periods.
During the quarter ended September 30, 2003, in anticipation of
its private placement debt issuance, Nuveen Investments entered
into two treasury rate lock transactions with an aggregate
notional amount of $100 million. These treasury rate locks were
designated as cash-flow hedges. The treasury rate locks were
settled for approximately $2 million. We deferred this loss in
"Other Comprehensive Income" as the treasury rate locks were
considered highly effective in eliminating the interest rate risk
on the forecasted debt issuance. Amounts accumulated in other
comprehensive income will be reclassified to earnings
commensurate with the recognition of the interest expense on the
newly issued debt.
Non-Hedge Derivatives: We have entered into a variety of other
financial instruments that are considered to be derivatives, but
which are not designated as hedges. Included in investments are
stock purchase warrants of Platinum Underwriters Holdings, Ltd.,
received as partial consideration from the sale of our
reinsurance business in 2002, stock warrants in our venture
capital business, and foreign currency forwards. We recorded $14
million and $2 million of income in continuing operations for the
nine months ended September 30, 2003, and September 30, 2002,
respectively, relating to the change in the market value of these
derivatives during the period. We also recorded a $21 million
loss in discontinued operations for the nine months ended
September 30, 2002, relating to non-hedge derivatives associated
with the sale of our life business.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 14 - Variable Interest Entities
- ------------------------------------
In January 2003, the Financial Accounting Standards Board
("FASB") issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires
consolidation of all "variable interest entities" ("VIE") by the
"primary beneficiary," as these terms are defined in FIN 46,
effective immediately for VIEs created after January 31, 2003.
Accordingly, we began applying the consolidation requirements for
these new VIEs in the first quarter of 2003. For VIEs created
before January 31, 2003, FIN 46 was originally effective for
reporting periods beginning after June 15, 2003, which for us is
the quarter ended September 30, 2003. However, on October 9,
2003 the FASB issued FASB Staff Position ("FSP") FIN 46-6,
"Effective Date of FASB Interpretation No. 46, Consolidation of
Variable Interest Entities," which deferred the effective date
until the first interim or annual period ending after December
15, 2003, but permitted early and partial adoption.
As a result of our partial adoption of FIN 46, we consolidated
twelve entities (summarized below) that we had not previously
consolidated. As a result, we recorded a loss of $21 million
(net of a deferred tax benefit of $3 million) on our consolidated
statements of operations in the third quarter of 2003, classified
as a "cumulative effect of accounting change" and representing
the cumulative impact of FIN 46 on periods prior to the July 1,
2003 date of adoption. The entities consolidated were as
follows.
- Investment - We hold an investment in an insurance
company that provides insurance coverage to markets in
Baltimore and Washington D.C. Our investment includes a
substantial majority of the company's convertible preferred
stock, but none of its voting common stock. As a result of
our economic interest in the entity, we have the majority
exposure to variability through our preferred stock ownership
and a loan to the company, both of which are considered
variable interests as defined in FIN 46. Accordingly, we
began consolidating this entity in the third quarter. The
carrying value of this investment is approximately $3 million.
- Municipal Trusts - We own interests in various municipal
trusts that were formed for the purpose of allowing us to more
flexibly generate investment income in a manner consistent
with our investment objectives and tax position. As of
September 30, 2003, there were 36 such trusts, which held a
combined total of $450 million in municipal securities, of
which eight had not been included in our consolidated
financial statements prior to our adoption of FIN 46 because
we did not hold majority ownership in them. However, we do
have the majority exposure to variability for these trusts.
Therefore, we began consolidating these eight trusts in the
third quarter of 2003.
- Venture Capital Entities - In our venture capital
investment portfolio, we have numerous investments in small-
to medium-sized companies, in which we have variable interests
through stock ownership and, in some cases, loans. All of
these investments are held for the purpose of generating
investment returns, and the companies in which we invest span
a variety of business sectors, including technology,
telecommunications and healthcare. As a result of our review
of this portfolio, we identified three entities that were
required to be consolidated under the provisions of FIN 46.
The consolidation of the foregoing entities had the net impact of
increasing (decreasing) the balance sheet and statement of
operations' captions by the amounts indicated in the following
table.
Municipal Venture
(in millions) Investment Trusts Capital Total
----------- ---------- --------- ------- -----
Assets $(14) $ 84 $ (1) $ 69
Liabilities 3 84 3 90
---- ---- ---- ----
Cumulative effect of
accounting change $(17) $ - $ (4) $ (21)
==== ==== ==== ====
Other revenue $ - $ 1 $ 1 $ 2
Operating and
administrative expenses $ - $ 1 $ 1 $ 2
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 14 - Variable Interest Entities (continued)
- -----------------------------------------------
In addition to the foregoing entities that were consolidated
pursuant to FIN 46, we also hold significant interests in other
variable interest entities for which we are not considered to be
the primary beneficiary. FIN 46 requires that information about
these entities be disclosed, as follows.
- We have a significant variable interest in two real
estate entities, but we are not considered to be the primary
beneficiary. The total carrying value of these entities was
approximately $57 million as of September 30, 2003, which also
represents our maximum exposure to loss. The purpose of our
involvement in these entities is to generate investment
returns.
Our partial adoption of FIN 46 specifically excluded the
following items.
- Mandatorily redeemable preferred securities of trusts
holding solely subordinated debentures of the company
("Preferred Securities") - These securities have a carrying
value of $897 million and are currently reported in the
liability section of our Consolidated Balance Sheet, as newly
required under SFAS 150 (see further discussion regarding the
adoption of SFAS 150 in Note 1 of this report). These
securities were issued by five separate trusts that were
established for the sole purpose of issuing the securities to
investors and are currently included in our consolidated
financial statements. We are currently evaluating the
implications of FIN 46 with regard to these trusts.
- Lloyd's Syndicates - We participate in various Lloyd's
syndicates at varying levels. These syndicates are
essentially markets where insureds can obtain coverage for a
variety of risks. We continue to evaluate the implications of
FIN 46 with respect to these syndicates.
Note 15 - Health Care Exposures
- -------------------------------
During 2002, we concluded that the impact of settling Health Care
claims in a runoff environment was causing abnormal effects on
our average paid claims, average outstanding claims, and the
amount of average case reserves established for new claims - all
of which are traditional statistics used by our actuaries to
develop indicated ranges of expected loss. Considering these
changing statistics, we developed varying interpretations of the
underlying data, which added more uncertainty to our evaluation
of these reserves. It is our belief that this additional data,
when evaluated in light of the impact of our migration to a
runoff environment, supports our view that we will realize
significant savings on our ultimate Health Care claim costs.
In the fourth quarter of 2002, we established specific tools and
metrics to more explicitly monitor and validate our key
assumptions supporting our Health Care reserve conclusions since
we believe that our traditional statistics and reserving methods
needed to be supplemented in order to provide a more meaningful
analysis. The tools we developed track the three primary
indicators which are influencing our expectations and include:
a) newly reported claims, b) reserve development on known claims
and c) the "redundancy ratio," which compares the cost of
resolving claims to the reserve established for that individual
claim.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 15 - Health Care Exposures (continued)
- ------------------------------------------
In the first quarter of 2003, we evaluated the adequacy of our
previously established medical malpractice reserves in the
context of the three indicators described above. The dollar
amount of newly reported claims in the quarter totaled $118
million, approximately 25% less than we anticipated in our
original estimate of the required level of redundancy at year-end
2002. With regard to development on known claims, loss activity
in the first quarter of 2003 was within our expectations. Case
development on incurred years 2001 and prior was minimal, and
case development on the 2002 incurred year totaled $39 million,
within our year-end 2002 estimate of no more than 3% of
development. For the first quarter of 2003, our redundancy ratio
was within our expected range of between 35% and 40%.
In the second quarter of 2003, the dollar amount of newly
reported claims totaled $127 million, approximately 5% higher
than we anticipated in our original estimate of the required
level of reserves at year-end 2002. Nevertheless, through the
first half of 2003, the dollar amount of newly reported claims
was approximately 12% lower than we anticipated. Loss
development on known claims during the second quarter of 2003 was
negative, but not as negative as we anticipated. Our actual
redundancy ratio continued to improve in the second quarter of
2003; however, since newly reported claims and loss development
on known claims did not improve as much as we expected in the
second quarter, the required reserve redundancy has increased
modestly from the previously estimated range of 35% to 40%.
In the third quarter of 2003, the dollar amount of newly reported
claims totaled $108 million, approximately 10% higher than we
anticipated in our original estimate of the required level of
reserves at year-end 2002. However, through the first nine
months of 2003, the dollar amount of newly reported claims was
approximately 7% lower than we anticipated due to the positive
variance in the first quarter. Loss development on known claims
during the third quarter of 2003 was worse than anticipated. Our
actual redundancy ratio continued to improve in the third quarter
of 2003; however, since newly reported claims and loss
development on known claims again did not improve as much as we
expected in the third quarter, the required reserve redundancy
has increased from the previously estimated range of 35% to 40%
to approximately 45%.
The three indicators described above are related such that if one
deteriorates, additional improvement on another is necessary for
us to conclude that further reserve strengthening is not
necessary. While the results of these indicators support our
current view that we have recorded a reasonable provision for our
medical malpractice exposures as of September 30, 2003, there is
a reasonable possibility that we may incur additional unfavorable
prior year loss development if these indicators significantly
change from our current expectations. If these indicators
deteriorate, we believe that a reasonable estimate of an
additional loss provision could amount to up to $250 million.
However, our analysis as of this point in time continues to
support our belief that we will realize favorable effects in our
ultimate costs and that our current loss reserves will prove to
be a reasonable provision.
As noted above, development on known claims is a key metric in
our evaluation of our Health Care reserves. While we have
experienced adverse development on known claims at year-end 2002,
the magnitude of that development has declined throughout 2003.
If, however, we experience further adverse reserve development on
those claims, and such development is not offset by a favorable
change in our estimate of newly reported claims, and we further
conclude that an increase in the required redundancy ratio to a
level above 45% is necessary, we may determine that additional
reserving actions are necessary.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 16 - Related Party Transaction - Platinum Underwriters Holdings, Ltd.
- --------------------------------------------------------------------------
Under the quota share reinsurance agreements with Platinum
described in more detail in Note 8 of this report, we ceded the
following amounts to Platinum in the first nine months of 2003.
(in millions)
-----------
Net written premiums $ 347
Decrease in unearned premiums (74)
----
Net earned premiums 421
Incurred losses and loss
adjustment expenses 209
Underwriting expenses 105
----
Net ceded result $ 107
====
The following Platinum-related balances were included in our
consolidated balance sheet at September 30, 2003.
(in millions)
-----------
Assets:
Reinsurance recoverable-paid losses $ 30
Reinsurance recoverable-unpaid losses $435
Ceded unearned premiums $ 84
Liabilities:
Funds held for reinsurers $ 17
Ceded premiums payable $164
Note 17 - Surety Claim and Exposure
- -----------------------------------
In 2003, we recorded an $89 million pretax loss provision (net of
reinsurance) in our Surety underwriting operation related to one
of our accounts that was in bankruptcy and unable to perform its
bonded obligations. In April 2003, a bankruptcy court approved
the sale of substantially all of the assets of the account.
Following that approval, we received claim notices with respect
to approximately $120 million of bonds securing certain workers'
compensation and retiree health benefit obligations of the
account. The $89 million net pretax loss provision recorded in
2003 represented our estimated loss in this matter.
We have provided surety bond coverage to a construction
contractor that failed to make payments under certain of its debt
obligations during the third quarter of 2003. The contractor has
developed a plan to restructure its operations and financing, and
is negotiating revisions to its credit arrangements. In the
third quarter of 2003, following our detailed review of this
plan, we made collateralized advances to the contractor. Based
on information available to us, we believe that the contractor
will be able to complete projects as contemplated by its plan.
As part of the plan, we may issue bonds for new projects undertaken
by the contractor, subject to our underwriting criteria. We
expect our advances to be fully repaid by cash flow from the
contractor's operations, planned asset sales, reinsurance
recoveries and, if necessary, recovery on collateral. Accordingly,
we do not expect to incur a significant loss with respect to
this account. However, in the unlikely event that the contractor
fails to complete all of its current projects, we estimate that
our aggregate loss, net of estimated collateral, reinsurance
recoveries and participation by co-sureties (one of which has
experienced ratings downgrades and is in runoff), would not
exceed $80 million, on an after-tax basis assuming a 35%
statutory tax rate.
Note 18 - Subsequent Event
- --------------------------
In October 2003, we sold our subsidiary, Octagon Risk Services,
Inc., a claim management and consulting services company, for
proceeds of approximately $30 million.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Forward-Looking Statement Disclosure and Certain Risks
------------------------------------------------------
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 intended to identify forward-looking statements.
Examples of these forward-looking statements include statements
concerning:
- market and other conditions and their effect on future
premiums, pricing, revenues, earnings, cash flow and
investment income;
- price increases, improved loss experience, and expense
savings resulting from the restructuring and other actions
and initiatives announced in recent years;
- statements concerning the anticipated bankruptcy court
approval of the Western MacArthur asbestos litigation
settlement;
- statements concerning our expectations in our Health Care
operation as we settle claims in a runoff environment;
- statements concerning claims made on surety bonds and the
amounts we may ultimately pay with respect to these claims;
and
- statements concerning our estimated maximum exposure in
respect of a contract surety customer.
In light of the risks and uncertainties inherent in future
projections, many of which are beyond our control, actual results
could differ materially from those in forward-looking statements.
These statements should not be regarded as a representation that
anticipated events will occur or that expected objectives will be
achieved. Risks and uncertainties include, but are not limited
to, the following:
- changes in the demand for, pricing of, or supply of our
products;
- our ability to effectively implement price increases;
- general economic conditions, including changes in interest
rates and the performance of financial markets;
- additional statement of operations charges if our loss
reserves are insufficient;
- our exposure to natural catastrophic events, which are
unpredictable, with a frequency or severity exceeding our
estimates, resulting in material losses;
- the possibility that claims cost trends that we anticipate
in our businesses may not develop as we expect;
- the impact of the September 11, 2001 terrorist attack and
the ensuing global war on terrorism on the insurance and
reinsurance industry in general, the implementation of the
Terrorism Risk Insurance Act and potential further
intervention in the insurance and reinsurance markets to
make available insurance coverage for acts of terrorism;
- risks relating to our potential exposure to losses arising
from acts of terrorism and sabotage;
- risks relating to our continuing ability to obtain
reinsurance covering catastrophe, surety and other exposures
at appropriate prices and/or in sufficient amounts;
- risks relating to the collectibility of reinsurance and
adequacy of reinsurance to protect us against losses;
- risks relating to actual and potential credit exposures,
including to derivatives counterparties and related to co-
surety arrangements;
- risks and uncertainties relating to international political
developments, including the possibility of warfare, and
their potential effect on economic conditions;
- changes in domestic and foreign laws, tax laws and changes
in the regulation of our businesses, which affect our
profitability and our growth, including risks relating to
possible Federal legislation regarding asbestos-related
claims;
- the possibility of downgrades in our ratings significantly
adversely affecting us, including, but not limited to,
reducing the number of insurance policies we write,
generally, or causing clients who require an insurer with a
certain rating level to use higher-rated insurers or causing
us to borrow at higher interest rates;
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Forward-Looking Statement Disclosure and Certain Risks (continued)
-----------------------------------------------------------------
- the risk that our investment portfolio suffers reduced
returns or investment losses, which could reduce our
profitability;
- the effect of financial market and interest rate conditions
on pension plan assumptions, asset valuations and
contribution levels;
- the impact of assessments and other surcharges for guaranty
funds and second-injury funds and other mandatory pooling
arrangements;
- risks related to the business underwritten on our policy
forms on behalf of Platinum Underwriters Holdings, Ltd.
("Platinum") and fully reinsured to Platinum pursuant to the
quota share reinsurance agreements entered into in
connection with the transfer of our ongoing reinsurance
operations to Platinum in 2002;
- loss of significant customers;
- risks relating to the decision of the bankruptcy court with
respect to the approval of the settlement of the Western
MacArthur matter;
- changes in our estimate of insurance industry losses
resulting from the September 11, 2001 terrorist attack;
- unfavorable developments in non-Western MacArthur related
asbestos litigation (including claims that certain asbestos-
related insurance policies are not subject to aggregate
limits);
- unfavorable developments in environmental litigation
involving policy coverage and liability issues;
- in the case of a large contract surety exposure, risks
relating to the implementation of the customer's restructuring
plan;
- the effects of emerging claim and coverage issues on our
business, including developments relating to issues such as
mold conditions, construction defects and changes in
interpretation of the named insured provision with respect
to the uninsured/underinsured motorist coverage in
commercial automobile policies;
- the growing trend of plaintiffs targeting property-liability
insurers, including us, in purported class action litigation
relating to claim-handling and other practices;
- the risk that our subsidiaries may be unable to pay
dividends to us in sufficient amounts to enable us to meet
our obligations and pay future dividends;
- the cyclicality of the property-liability insurance
industry causing fluctuations in our results;
- risks relating to our asset management business, including
the risk of material reductions to assets under management
from a significant rise in interest rates, declining equity
markets or poor investment performance;
- our dependence on the business provided to us by agents and
brokers;
- our implementation of new strategies and initiatives;
- and various other matters.
Item 2. Management's Discussion and Analysis of Financial
- ------ Condition and Results of Operations.
-----------------------------------
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
September 30, 2003
The St. Paul Companies, Inc. ("The St. Paul") is incorporated as
a general business corporation under the laws of the State of
Minnesota. The St. Paul and its subsidiaries constitute one of
the oldest insurance organizations in the United States, dating
back to 1853. We are a management company principally engaged,
through our subsidiaries, in providing commercial property-
liability insurance products and services. We also have a
presence in the asset management industry through our 79%
majority ownership of Nuveen Investments, Inc. As a management
company, we oversee the operations of our subsidiaries and
provide them with capital, management and administrative
services. Based on total revenues in 2002, we ranked No. 207 on
the Fortune 500 list of the largest companies in the United
States. Our Internet website address is stpaul.com. We make
available, free of charge, on or through our website, annual
reports on Form 10-K, quarterly reports on Form 10-Q and current
reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the
Securities and Exchange Commission. Annual statements for our
domestic insurance subsidiaries that were filed with state
regulatory authorities in the last two years are also available
through our website. Our website address is an inactive textual
reference only and the contents of the website are not part of
this report.
Consolidated Highlights
-----------------------
The following table summarizes our results for the three months
and nine months ended September 30, 2003 and 2002.
Three Months Nine Months
Ended Ended
September 30 September 30
------------- -------------
(in millions, except 2003 2002 2003 2002
per-share amounts) ---- ---- ---- ----
-----------------
Pretax income (loss) before cumulative
effect of accounting change:
Property-liability insurance:
Underwrit ing result $ 72 $ (95) $ 128 $(697)
Net investment income 279 300 833 873
Realized investment gains (losses) 5 (74) 43 (151)
Other expenses (9) (18) (61) (55)
---- ---- ---- ----
Total property-
liability insurance 347 113 943 (30)
Asset management 49 42 135 119
Parent and other operations (65) (60) (188) (162)
---- ---- ---- ----
Income (loss) from
continuing operations before
income taxes and cumulative
effect of accounting change 331 95 890 (73)
Income tax expense (benefit) 94 26 257 (72)
---- ---- ---- ----
Income (loss) from
continuing operations before
cumulative effect of accounting
change 237 69 633 (1)
Cumulative effect of accounting
change, net of taxes (21) - (21) (6)
---- ---- ---- ----
Income (loss) from
continuing operations 216 69 612 (7)
Discontinued operations,
net of taxes (2) (6) (3) (19)
---- ---- ---- ----
Net income (loss) $ 214 $ 63 $ 609 $ (26)
==== ==== ==== ====
Net income (loss)
per common share (basic) $0.92 $ 0.27 $2.62 $(0.18)
==== ==== ==== ====
Net income (loss)
per common share (diluted) $0.88 $ 0.27 $2.51 $(0.18)
==== ==== ==== ====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Consolidated Results
- --------------------
Our pretax income from continuing operations of $331 million in
the third quarter of 2003 (before the cumulative effect of
accounting change) was significantly better than comparable
pretax income of $95 million in the same period of 2002, driven
by strong improvement in underwriting results and the realization
of net investment gains versus realized net investment losses in
the prior period. Through the first nine months of 2003, our
pretax income from continuing operations totaled $890 million
(before the cumulative effect of accounting change), compared
with a pretax loss of $73 million in the same 2002 period that
included a $585 million pretax loss provision related to a
settlement agreement with respect to certain asbestos litigation
(described in more detail on pages 42 and 43 of this report).
Excluding the impact of that $585 million loss provision in 2002,
our year-to-date 2003 pretax income was over $370 million higher
than the adjusted 2002 income of $512 million, reflecting strong
improvement in underwriting profitability in our two ongoing
underwriting segments - Specialty Commercial and Commercial Lines
- - and a $181 million increase in realized investment gains. Our
asset management subsidiary, Nuveen Investments, Inc., also
contributed to the improvement in our third-quarter and year-to-
date results in 2003. In our "Parent and other operations,"
pretax losses in the first nine months of 2003 exceeded those in
the same periods of 2002 primarily due to an increase in realized
investment losses and a decline in investment income.
Presentation of Certain Information Based on Statutory
Accounting Principles
- ------------------------------------------------------
Our U.S. property-liability insurance operations comprise the
majority of our operations. These operations are required under
applicable state insurance legislation and regulations to
publicly report information on the basis of Statutory Accounting
Principles ("SAP"), including net written premiums, statutory
loss and loss adjustment expense ratio, and statutory
underwriting expense ratio information. We provide in this
report selected SAP information for all of our property-liability
underwriting operations, as well as certain GAAP information for
such operations. The types of SAP information included herein
are common measures of the performance of a property-liability
insurer, and we believe the inclusion of such information will
aid investors in comparing our results with those of our peers in
the industry. In addition, management uses this SAP information
to monitor our financial performance. Definitions of the
statutory information included herein are included under
"Definitions of Certain Statutory Accounting Terms" on page 66 of
this report.
Elimination of Reporting Lag - Lloyd's
- --------------------------------------
In the first quarter of 2003, we eliminated the one-quarter
reporting lag for our underwriting operations at Lloyd's to
coincide with the timing of reporting for all of our other
international operations. As a result, our consolidated results
in the first nine months of 2003 included the results of those
operations for the fourth quarter of 2002 and the first nine
months of 2003, whereas our results for the nine months ended
September 30, 2002 included the results of those operations for
the fourth quarter of 2001 and the first six months of 2002. The
year-to-date incremental impact on our property-liability
operations of eliminating the reporting lag, consisting of the
results of these operations for the quarter ended September 30,
2003, was as follows.
(in millions)
----------- Specialty
Commercial Other Total
---------- ------ ------
Net written premiums $ 83 $ 5 $ 88
Decrease in unearned premiums (20) - (20)
----- ----- -----
Net earned premiums 63 5 68
Incurred losses and
underwriting expenses 69 23 92
----- ----- -----
Underwriting result (6) (18) (24)
Net investment income 2 2 4
Other income 6 - 6
----- ----- -----
Total pretax income (loss) $ 2 $ (16) $ (14)
===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Since the elimination of the one-quarter reporting lag in our
Lloyd's operations makes the information for the first nine
months of 2003 not comparable to the information for the same
period of 2002, we have presented, in certain places herein,
information adjusted to remove the effect of the elimination in
this Management's Discussion and Analysis. We believe that
investors will find it helpful to have this information, as well
as information prepared in accordance with United States
generally accepted accounting principles ("GAAP"), when reviewing
our results for the first nine months of 2003. Such adjusted
information is reconciled to the information reported in
accordance with GAAP whenever it is presented.
Reclassification of Lloyd's Commission Expenses
- -----------------------------------------------
In the first quarter of 2003, we reclassified certain commission
expenses related to our operations at Lloyd's. In prior years,
we determined commission expense based on premiums reported by
the Lloyd's market (net of commissions) using an estimated
average commission rate. Until recently, gross premiums (prior
to reduction for commissions) were not available from the Lloyd's
market. That information is now available for current and prior
periods, and in the first quarter of 2003, we began recording
actual commission expense for our Lloyd's business. We
reclassified prior period results to record actual commission
expense on a basis consistent with that implemented in the first
quarter of 2003. There was no impact to net income or
shareholders' equity as previously reported for any prior
periods, because the reclassification had the impact of
increasing previously reported premiums and commission expense in
equal and offsetting amounts. For the third quarter and first
nine months of 2003, this reclassification had the impact of
increasing both net earned premiums and policy acquisition costs
by $22 million and $61 million, respectively, compared with what
would have been recorded under our prior method of estimation.
In addition, net written premiums increased by $13 million and
$92 million for the third quarter and first nine months of 2003,
respectively (a portion of which was due to the elimination of
the one-quarter reporting lag). For the third quarter and first
nine months of 2002, the impact was an increase to both net
earned premiums and policy acquisition costs of $9 million and
$69 million, respectively, and an increase to net written
premiums of $8 million and $74 million, respectively.
2003 Cumulative Effect of Accounting Change-Partial Adoption of FIN 46
- ----------------------------------------------------------------------
In January 2003, the Financial Accounting Standards Board
("FASB") issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires
consolidation of all "variable interest entities" ("VIE") by the
"primary beneficiary," as these terms are defined in FIN 46,
effective immediately for VIEs created after January 31, 2003.
Accordingly, we began applying the consolidation requirements for
these new VIEs in the first quarter of 2003. For VIEs created
before January 31, 2003, FIN 46 was originally effective for
reporting periods beginning after June 15, 2003, which for us is
the quarter ended September 30, 2003. However, on October 9,
2003 the FASB issued FASB Staff Position ("FSP") FIN 46-6,
"Effective Date of FASB Interpretation No. 46, Consolidation of
Variable Interest Entities," which deferred the effective date
until the first interim or annual period ending after December
15, 2003, but permitted early and partial adoption.
As a result of our partial adoption of FIN 46, we consolidated
twelve entities (summarized below) that we had not previously
consolidated. As a result, we recorded a loss of $21 million
(net of a deferred tax benefit of $3 million) on our consolidated
statements of operations in the third quarter of 2003, classified
as a "cumulative effect of accounting change" and representing
the cumulative impact of FIN 46 on periods prior to the July 1,
2003 date of adoption. The entities consolidated were as
follows.
- Investment - We hold an investment in an insurance
company that provides insurance coverage to markets in
Baltimore and Washington D.C. Our investment includes a
substantial majority of the company's convertible preferred
stock, but none of its voting common stock. As a result of
our economic interest in the entity, we have the majority
exposure to variability through our preferred stock ownership
and a loan to the company, both of which are considered
variable interests as defined in FIN 46. Accordingly, we
began consolidating this entity in the third quarter. The
carrying value of this investment is approximately $3 million.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
- Municipal Trusts - We own interests in various municipal
trusts that were formed for the purpose of allowing us to more
flexibly generate investment income in a manner consistent
with our investment objectives and tax position. As of
September 30, 2003, there were 36 such trusts, which held a
combined total of $450 million in municipal securities, of
which eight had not been included in our consolidated
financial statements prior to our adoption of FIN 46 because
we did not hold majority ownership in them. However, we do
have the majority exposure to variability for these trusts.
Therefore, we began consolidating these eight trusts in the
third quarter of 2003.
- Venture Capital Entities - In our venture capital
investment portfolio, we have numerous investments in small-
to medium-sized companies, in which we have variable interests
through stock ownership and, in some cases, loans. All of
these investments are held for the purpose of generating
investment returns, and the companies in which we invest span
a variety of business sectors, including technology,
telecommunications and healthcare. As a result of our review
of this portfolio, we identified three entities that were
required to be consolidated under the provisions of FIN 46.
The consolidation of the foregoing entities had the net impact of
increasing (decreasing) the balance sheet and statement of
operations' captions by the amounts indicated in the following
table.
Municipal Venture
(in millions) Investment Trusts Capital Total
----------- ---------- --------- ------- -----
Assets $(14) $ 84 $ (1) $ 69
Liabilities 3 84 3 90
---- ---- ---- ----
Cumulative effect of
accounting change $(17) $ - $ (4) $ (21)
==== ==== ==== ====
Other revenue $ - $ 1 $ 1 $ 2
Operating and
administrative expenses $ - $ 1 $ 1 $ 2
In addition to the foregoing entities that were consolidated
pursuant to FIN 46, we also hold significant interests in other
variable interest entities for which we are not considered to be
the primary beneficiary. FIN 46 requires that information about
these entities be disclosed, as follows.
- We have a significant variable interest in two real
estate entities, but we are not considered to be the primary
beneficiary. The total carrying value of these entities was
approximately $57 million as of September 30, 2003, which also
represents our maximum exposure to loss. The purpose of our
involvement in these entities is to generate investment
returns.
Our partial adoption of FIN 46 specifically excluded the
following items.
- Mandatorily redeemable preferred securities of trusts
holding solely subordinated debentures of the company
("Preferred Securities") - These securities have a carrying
value of $897 million and are currently reported in the
liability section of our Consolidated Balance Sheet, as newly
required under SFAS 150 (see further discussion regarding the
adoption of SFAS 150 on page 38 of this report). These
securities were issued by five separate trusts that were
established for the sole purpose of issuing the securities to
investors and are currently included in our consolidated
financial statements. We are currently evaluating the
implications of FIN 46 with regard to these trusts.
- Lloyd's Syndicates - We participate in various Lloyd's
syndicates at varying levels. These syndicates are
essentially markets where insureds can obtain coverage for a
variety of risks. We continue to evaluate the implications of
FIN 46 with respect to these syndicates.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
2002 Cumulative Effect of Accounting Change - Adoption of SFAS No. 142
- ----------------------------------------------------------------------
In the first quarter of 2002, we began implementing the
provisions of Statement of Financial Accounting Standards
("SFAS") No. 142, "Goodwill and Other Intangible Assets," which
established financial accounting and reporting for acquired
goodwill and other intangible assets. The statement changed
prior accounting practice in the way intangible assets with
indefinite useful lives, including goodwill, are tested for
impairment on an annual basis. Generally, it also required that
those assets meeting the criteria for classification as
intangible with finite useful lives be amortized to expense over
those lives, while intangible assets with indefinite useful lives
and goodwill are not to be amortized. In the second quarter of
2002, we completed our initial evaluation for impairment of our
recorded goodwill in accordance with provisions of SFAS No. 142.
That evaluation concluded that none of our goodwill was impaired.
In connection with our reclassification of certain assets
previously accounted for as goodwill to other intangible assets
in 2002, we established a deferred tax liability of $6 million in
the second quarter of 2002. That provision was classified as a
cumulative effect of accounting change effective as of January 1,
2002. In accordance with SFAS No. 142, we restated our
previously reported results for the first quarter of 2002,
reducing net income for that period from the originally reported
$139 million, or $0.63 per common share (diluted) to $133
million, or $0.60 per common share (diluted).
In the second quarter of 2003, we peformed our annual evaluation
for impairment of recorded goodwill in accordance with provisions
of SFAS No. 142. That evaluation concluded that none of our
goodwill was impaired.
As a result of implementing the provisions of SFAS No. 142, we no
longer amortize our goodwill assets. Amortization expense
associated with intangible assets totaled $20 million in the
first nine months of 2003, compared with $14 million in the same
2002 period.
Adoption of SFAS No. 150
- ------------------------
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity", which generally requires that an issuer
classify a financial instrument that is within its scope as a
liability (or an asset in some circumstances). We adopted the
provisions of SFAS 150 in the third quarter of 2003. Our only
financial instruments that fell within the scope of SFAS No. 150
were the "Company-obligated mandatorily redeemable preferred
securities of trusts holding solely subordinated debentures of
the company" that had been classified as a separate line between
liabilities and shareholders' equity on our consolidated balance
sheet. These securities were issued by five separate trusts
which are included in our consolidated financial statements. In
accordance with SFAS No. 150, we have reclassified these
securities to liabilities on our consolidated balance sheet in
2003, where they are included in our total debt outstanding. The
carrying value of these securities in total is $897 million,
representing the present value of the expected future payment of
these obligations, discounting at the respective dividend
distribution rates implicit at inception, which were equal to the
contract rates, as prescribed by SFAS No. 150.
Sale of Baltimore Office Campus
- -------------------------------
In April 2003, we completed the sale of our 68-acre office campus
in Baltimore, MD. We recorded a pretax impairment writedown of
$14 million in the first quarter of 2003 related to the sale,
which was recorded as an operating expense in our property-
liability operations. On an after-tax basis at the statutory
Federal tax rate of 35%, the writedown totaled $9 million, or
$0.04 per common share (diluted).
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Purchase of Renewal Rights from Kemper Insurance Companies
- ----------------------------------------------------------
In May 2003, we purchased the right to seek renewal of several
lines of insurance business previously underwritten by Kemper
Insurance Companies. The initial payment for this right was
recorded as an intangible asset (characterized as renewal rights)
and will be amortized on an accelerated basis over four years.
The portfolio of business involved in this transaction includes
the following lines: technology, small commercial, middle market
commercial, inland and ocean marine, and architects' and
engineers' professional liability. We did not assume any past
liabilities with this purchase; however, we may be obligated to
make an additional payment in June 2004 based on the amount of
premium volume we ultimately renew during the twelve months
subsequent to this purchase. We believe it is unlikely that any
additional payment would exceed $30 million. Our consolidated
gross written premiums for the third quarter and nine months
ended September 30, 2003 included approximately $165 million and
$199 million, respectively, attributable to business underwritten
as a result of this purchase of renewal rights, the majority of
which were included in our Commercial Lines segment.
Transfer of Ongoing Reinsurance Operations to Platinum
Underwriters Holdings, Ltd.
- ------------------------------------------------------
On November 1, 2002, we completed the transfer of our continuing
reinsurance business (previously operating under the name "St.
Paul Re") and certain related assets, including renewal rights,
to Platinum Underwriters Holdings, Ltd. ("Platinum"), a Bermuda
company formed in 2002 that underwrites property and casualty
reinsurance on a worldwide basis.
As part of this transaction, we contributed $122 million of cash
to Platinum and transferred $349 million in assets relating to
the insurance reserves that we also transferred. In exchange, we
acquired six million common shares, representing a 14% equity
ownership interest in Platinum, and a ten-year option to buy up
to six million additional common shares at an exercise price of
$27 per share, which represents 120% of the initial public
offering price of Platinum's shares.
In conjunction with the transfer of our continuing reinsurance
business to Platinum, we entered into various agreements with
Platinum and its subsidiaries, including quota share reinsurance
agreements by which Platinum reinsured substantially all of the
reinsurance contracts entered into by St. Paul Re on or after
January 1, 2002. This transfer (based on September 30, 2002
balances) included $125 million of unearned premium reserves (net
of ceding commissions), $200 million of existing loss and loss
adjustment expense reserves and $24 million of other reinsurance-
related liabilities. The transfer of unearned premium reserves
to Platinum was accounted for as prospective reinsurance, while
the transfer of existing loss and loss adjustment expense
reserves was accounted for as retroactive reinsurance.
As noted above, the transfer of reserves to Platinum at the
inception of the quota share reinsurance agreements was based on
the September 30, 2002 balances. In March 2003, we transferred
to Platinum $137 million of additional insurance reserves,
consisting of $72 million in unearned premiums (net of ceding
commissions) and $65 million in existing reserves for losses and
loss adjustment expenses. We also transferred cash and other
assets having a value equal to the additional insurance reserves
transferred. This transfer of additional assets and liabilities
reflected business activity between September 30, 2002 and the
November 2, 2002 inception date of the quota share reinsurance
agreements, and our estimate of amounts due under the adjustment
provisions of the quota share reinsurance agreements. Our
insurance reserves at December 31, 2002 included our estimate, at
that time, of amounts due to Platinum under the quota share
reinsurance agreements, which totaled $54 million. The $83 million
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
increase in our estimate of amounts due to Platinum under the
quota share reinsurance agreements resulted in a pretax
underwriting loss of $6 million in the first quarter of 2003.
During the second quarter of 2003, we reached final agreement
with Platinum regarding the adjustment provisions of the quota
share reinsurance agreements and no further adjustments to the
transferred assets and liabilities will occur.
For business underwritten in the United States and the United
Kingdom, until October 31, 2003, Platinum has the right to
underwrite specified reinsurance business on our behalf in cases
where Platinum is unable to underwrite that business because it
has yet to obtain necessary regulatory licenses or approval to do
so, or Platinum has not yet been approved as a reinsurer by the
ceding company. We entered into this agreement solely as a means
to accommodate Platinum through a transition period. Any
business written by Platinum on our policy forms during this
transition period is being fully ceded to Platinum under the
quota share reinsurance agreements.
Our investment in Platinum is included in "Other investments."
The estimated income from our 14% proportionate equity ownership
in Platinum is included in our statement of operations as a
component of "Net investment income." Our option to purchase
additional Platinum shares is carried at market value ($58
million at September 30, 2003), with changes in its fair value
recorded as other realized gains or losses in our statement of
operations. In the first nine months of 2003, we recorded a net
pretax realized loss of $3 million related to this option,
including a $1 million pretax loss in the third quarter.
Revisions to Business Segment Reporting Structure
- -------------------------------------------------
In the first quarter of 2003, we revised our property-liability
insurance business segment reporting structure to reflect the
manner in which those businesses are now managed. Our property-
liability underwriting operations now consist of two segments
constituting our ongoing operations (Specialty Commercial and
Commercial Lines), and one segment comprising our runoff
operations (Other). The composition of those respective segments
is described in greater detail in the analysis of their results
on pages 48 through 59 of this discussion. All data for 2002
included in this report were restated to be consistent with the
new reporting structure in 2003. The following is a summary of
changes made to our segments in the first quarter of 2003.
- Our Surety & Construction operations, previously reported
together as a separate specialty segment, are now separate
components of our Specialty Commercial segment.
- Our ongoing International operations and our ongoing
operations at Lloyd's, previously reported together as a
separate specialty segment, are now separate components of our
Specialty Commercial segment.
- Our Health Care, Reinsurance and Other operations, each
previously reported as a separate runoff business segment,
have been combined into a single Other runoff segment and are
under common management. "Runoff" means that we have ceased
or plan to cease underwriting business as soon as possible.
- The results of our participation in voluntary insurance
pools, as well as loss development on business underwritten
prior to 1980 (prior to 1988 for business acquired in our
merger with USF&G Corporation in 1998), previously included in
our Commercial Lines segment, are now included in the Other
segment. That prior year business included the majority of
our environmental and asbestos liability exposures. The
oversight of these exposures is the responsibility of the same
management team responsible for oversight of the other
components of the Other segment.
In accordance with provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," since Surety
& Construction, International & Lloyd's, Health Care, and
Reinsurance were reported as separate segments during 2002 and
are considered to be of continuing significance in analyzing the
results of our operations, we continue to separately present and
discuss (as appropriate) in Note 7 to our consolidated financial
statements and in Management's Discussion and Analysis,
information about those businesses in 2003 and the corresponding
periods of 2002.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Our operations in runoff do not qualify as "discontinued
operations" for accounting purposes. For the nine months ended
September 30, 2003, these runoff operations collectively
accounted for $351 million, or 7%, of our reported net earned
premiums, and generated underwriting losses totaling $213 million
(an amount that does not include investment income from the
assets maintained to support these operations). For the nine
months ended September 30, 2002, these runoff operations
collectively accounted for $1.82 billion, or 31%, of our net
earned premiums, and generated underwriting losses totaling $904
million, an amount that included the $585 million pretax loss
provision related to the asbestos litigation settlement
agreement.
Terrorism Risk and Legislation
- ------------------------------
On November 26, 2002, President Bush signed into law the
Terrorism Risk Insurance Act of 2002, or TRIA. TRIA establishes
a temporary federal program which requires U.S. and other
insurers to offer coverage in their commercial property and
casualty policies for losses resulting from terrorists' acts
committed by foreign persons or interests in the United States or
with respect to specified U.S. air carriers, vessels or missions
abroad. The coverage offered may not differ materially from the
terms, amounts and other coverage limitations applicable to other
policy coverages. These requirements terminate at the end of
2004 unless the Secretary of the Treasury extends them to 2005.
Under TRIA, the U.S. Secretary of the Treasury determines whether
an act is a covered terrorist act, and if it is covered, losses
resulting from that act ultimately are shared among insurers, the
federal government and policyholders. Generally, insurers pay
all losses to policyholders, retaining a defined "deductible" and
10% of losses above that deductible. The federal government will
reimburse insurers for 90% of losses above the deductible and,
under certain circumstances, the federal government will require
insurers to levy surcharges on policyholders to recoup for the
federal government its reimbursements paid. An insurer's
deductible in 2003 is 7% of the insurer's 2002 direct earned
premiums, and rises to 10% of 2003 direct earned premiums in 2004
and, if the program continues in 2005, 15% of 2004 direct earned
premiums in 2005. Federal reimbursement of the insurance
industry is limited to $100 billion in each of 2003, 2004 and
2005, and no insurer that has met its deductible shall be liable
for the payment of its portion of the aggregate industry insured
loss that exceeds $100 billion, thereby capping the insurance
industry's and each insurer's ultimate exposure to terrorist acts
covered by TRIA.
TRIA voided terrorist exclusions in policies in-force on November
26, 2002 to the extent of the TRIA coverage required to be
offered and imposed requirements on insurers to offer the TRIA
coverage to policyholders at rates chosen by the insurers on
policies in-force on November 26, 2002 and all policies renewed
or newly offered thereafter. Policyholders may accept or decline
coverage at the offered rate and, with respect to policies in-
force on November 26, 2002, TRIA coverage remains in effect until
the policyholder fails to purchase the coverage within a
specified period following the insurer's rate quotation for the
TRIA coverage. We have fully implemented our interim, or in some
cases long-term, rating plans in all states. In states where we
have not implemented long-term rating plans, such long-term
rating plans have been developed to replace the interim plans and
will be filed. Six states have outstanding questions on our
interim TRIA filings, and we continue to work with those states
to resolve their questions about our filings.
We believe it is too early to determine TRIA's impact on the
insurance industry generally or specifically on us. Our domestic
insurance subsidiaries and certain business we underwrite through
Lloyd's are subject to TRIA and, in the event of a terrorist act
covered by TRIA, coverage would attach after losses of
approximately $430 million (calculated based on 7% of our TRIA-
qualifying calendar year 2002 direct earned premium total)
Accordingly, TRIA's federal reimbursement provisions alone do not
protect us from losses from foreign terrorist acts that could be
material to our results of operations or financial condition.
Furthermore, there is substantial uncertainty in determining the
appropriate rates for offering TRIA coverage (and coverage for
terrorist acts generally), and our quoted rates could be too low
and attract poor risks or, alternatively, could be higher than
our competitors and result in the loss of business. There are
numerous interpretive issues in connection with TRIA's
implementation by the Secretary of the Treasury that remain to be
resolved, including the timing of federal reimbursement for TRIA losses,
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
the standards for obtaining the federal reimbursement and the
mechanisms for allocating losses exceeding insurers' deductibles.
We currently have property reinsurance that would cover only a
portion of our deductible. In April 2003, we renewed our
terrorism reinsurance coverage, as described in the following
discussion. There can be no assurance TRIA will achieve its
objective of creating a viable private insurance market for
terrorism coverage prior to TRIA's expiration, and rates and
forms used by us and our competitors may vary widely in the
future.
Regardless of TRIA, some state insurance regulators do not permit
terrorism exclusions in various coverages we write, and
currently, we have not excluded coverage for terrorist acts by
domestic terrorists (e.g., the Oklahoma bombing) in our domestic
coverages, or resulting from terrorist acts occurring outside the
United States from our international coverages. Accordingly, our
exposure to losses from terrorist acts is not limited to TRIA
coverages. Losses from terrorists' acts, whether arising under
TRIA coverages or otherwise, could be material to our results of
operations and financial condition.
Purchase of Terrorism Coverage and Exposure to Future Terrorist Events
- ----------------------------------------------------------------------
After the terrorist attacks in September 2001, reinsurers, in
general, specifically excluded terrorism coverage from property
reinsurance treaties that subsequently renewed. As a result, in
the second quarter of 2002, we purchased limited specific
terrorism coverage in the form of two separate property
reinsurance treaties. Those treaties expired on April 1, 2003,
on which date we renewed our coverage in the form of a combined
per-risk and catastrophe terrorism occurrence treaty. The treaty
provides both certified and non-certified TRIA coverage. (To be
TRIA certified, the terrorist act must be sponsored by an
international group or state and damage caused must exceed a
financial threshold, whereas non-certified coverage refers to
acts of domestic terrorism). In addition, we secured non-
certified TRIA terrorism coverage in our standard property
reinsurance treaty renewals in April 2003 as part of our overall
ceded reinsurance program. We renewed the majority of our
reinsurance treaties covering workers' compensation in July 2003,
and the majority of treaties covering general liability business
in August 2003; those renewals included both certified and non-
certified TRIA coverage. Generally, our reinsurance treaties do
not cover acts of terrorism involving nuclear, biological or
chemical events. There can be no assurance that we will be able
to secure terrorism reinsurance coverage on expiring treaties
each year.
Asbestos Settlement Agreement
- -----------------------------
On June 3, 2002, we announced that we and certain of our
subsidiaries had entered into an agreement settling all existing
and future claims arising from any insuring relationship of
United States Fidelity and Guaranty Company ("USF&G"), St. Paul
Fire and Marine Insurance Company and their affiliates and
subsidiaries, including us (collectively, the "USF&G Parties")
with any of MacArthur Company, Western MacArthur Company
("Western MacArthur"), and Western Asbestos Company ("Western
Asbestos") (together, the "MacArthur Companies"). For a full
description of the circumstances leading up to the agreement,
refer to Note 3 on pages 68 and 69 of our 2002 Annual Report to
Shareholders.
Pursuant to the provisions of the settlement agreement, on
November 22, 2002, the MacArthur Companies filed voluntary
petitions under Chapter 11 of the Bankruptcy Code to permit the
channeling of all current and future asbestos-related claims
solely to a trust to be established pursuant to Section 524(g) of
the Bankruptcy Code. Consummation of most elements of the
settlement agreement is contingent upon bankruptcy court approval
of the settlement agreement as part of a broader plan for the
reorganization of the MacArthur Companies (the "Plan"). Approval
of the Plan involves substantial uncertainties that include the
need to obtain agreement among existing asbestos plaintiffs, a
person who has been appointed to represent the interests of
unknown, future asbestos plaintiffs, the MacArthur Companies and
the USF&G Parties as to the terms of such Plan. Accordingly,
there can be no assurance that bankruptcy court approval of the
Plan will be obtained.
Upon final approval of the Plan, the MacArthur Companies will
release the USF&G Parties from any and all asbestos-related
claims for personal injury, and all other claims in excess of $1
million in the aggregate, that may be asserted relating to or
arising from, directly or indirectly, any alleged coverage
provided by any of the USF&G Parties to any of the MacArthur
Companies, including any claim for extra contractual relief.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
The after-tax impact on our net income for the three months and
six months ended June 30, 2002, net of expected reinsurance
recoveries and the re-evaluation and application of asbestos and
environmental reserves, was a loss of approximately $380 million.
In the fourth quarter of 2002, we revised upward our estimated
reinsurance recoverables related to this settlement, reducing the
after-tax impact of the settlement on calendar year 2002 net
income to a loss of $307 million. This calculation reflected
payments of $235 million during the second quarter of 2002, and
$747 million on January 16, 2003 (including interest). The $747
million payment, together with at least $60 million of the
original $235 million, shall be returned to USF&G Parties if the
Plan is not finally approved. Accordingly, as of September 30,
2003 we had recorded those payments of $807 million in both
"Other Assets" and "Other Liabilities," since the Plan had not
yet been approved. The settlement agreement also provided for
the USF&G Parties to pay $13 million (which was paid in the
second quarter of 2002) and to advance certain fees and expenses
incurred in connection with the settlement, bankruptcy
proceedings, finalization of the Plan and efforts to achieve
approval of the Plan, subject to a right of reimbursement in
certain circumstances of amounts advanced.
As a result of the settlement, pending litigation with the
MacArthur Companies has been stayed pending final approval of the
Plan. Whether or not the Plan is approved, up to $175 million of
the $235 million will be paid to counsel for the MacArthur
Companies, and persons holding judgments against the MacArthur
Companies as of June 3, 2002 and their counsel, and the USF&G
Parties will be released from claims by such holders to the
extent of $110 million paid to such holders.
Possible Asbestos Legislation
- -----------------------------
From time to time asbestos reform bills have been introduced in
the U.S. Congress. Some of these proposed laws seek to reduce or
eliminate current personal injury litigation by replacing it with
a statutory compensation program funded by contributions from a
variety of sources which may include companies that formerly
manufactured, distributed or sold asbestos products and insurers
that underwrote certain asbestos risks. Many of these reform
efforts would not cover asbestos property damage claims and other
categories of asbestos exposure including future personal injury
claims if the compensation fund ultimately proves insufficient.
The prospects for the passage of an asbestos reform bill remain
uncertain and the effect of any such future asbestos legislative
reform on us would depend upon a variety of factors including the
total size of any compensation fund, the portions allocated to
various commercial groups and the formula for allocating
contributions among insurers. If any asbestos litigation reform
is enacted in the future, our contribution allocation could be
significantly larger than our current asbestos reserve.
September 11, 2001 Terrorist Attack
- -----------------------------------
In 2001, we recorded estimated net pretax losses totaling $941
million related to the September 11, 2001 terrorist attack in the
United States. We regularly evaluate the adequacy of our
estimated net losses related to the attack, weighing all factors
that may impact the total net losses we will ultimately incur.
During 2002, we recorded an additional loss provision of $20
million, and a $33 million reduction in our estimated provision
for uncollectible reinsurance related to the attack. In the
second quarter of 2003, we recorded a $24 million reduction in
losses related to the attack, virtually all of which was recorded
in our reinsurance operations, the results of which are reported
in our runoff "Other" segment. No additional major adjustments
were recorded in the third quarter of 2003. Through September
30, 2003, we have made net loss payments totaling $471 million
related to the attack since it occurred, of which $164 million
were made in the first nine months of 2003. For further
information regarding the impact of the terrorist attack on our
operations, refer to Note 4 on page 69 of our 2002 Annual Report
to Shareholders.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Discontinued Operations
- -----------------------
Standard Personal Insurance - In 1999, we sold our standard
personal insurance operations to Metropolitan Property and
Casualty Insurance Company ("Metropolitan"). Metropolitan
purchased Economy Fire & Casualty Company and subsidiaries
("Economy"), and the rights and interests in those non-Economy
policies constituting the remainder of our standard personal
insurance operations. Those rights and interests were
transferred to Metropolitan by way of a reinsurance and facility
agreement. We guaranteed the adequacy of Economy's loss and loss
expense reserves, and we remain liable for claims on non-Economy
policies that result from losses occurring prior to the September
30, 1999 closing date. Under the reserve-related agreements, we
agreed to pay for any deficiencies in those reserves and would
share in any redundancies that developed by September 30, 2002.
Any losses incurred by us under these agreements were reflected
in discontinued operations in the period during which they were
incurred. At December 31, 2002, our analysis indicated that we
owed Metropolitan $13 million related to the reserve agreements,
which was paid in April 2003. In the first nine months of 2003
and 2002, we recorded pretax losses of $3 and $12 million,
respectively, in discontinued operations, related to claims in
respect of pre-sale losses.
Critical Accounting Policies
- ----------------------------
Overview - On pages 30 through 32 of our 2002 Annual Report to
Shareholders, we identified and described the critical accounting
policies related to accounting estimates that 1) require us to
make assumptions about highly uncertain matters and 2) could
materially impact our consolidated financial statements if we
made different assumptions. Those policies were unchanged at
September 30, 2003, except for a change related to the recognition of
premium revenue as described below.
In 2003, we changed the method by which we recognize premium
revenue at our operations at Lloyd's. Prior to 2003, such
revenue was recognized using the "one-eighths" method, which
reflected the fact that we converted Lloyd's syndicate accounts
to U.S. GAAP on a quarterly basis. Since Lloyd's accounting does
not recognize the concept of earned premium, we calculated earned
premium as part of the conversion to GAAP, assuming business was
written at the middle of each quarter, effectively breaking the
calendar year into earnings periods of eighths. In 2003, we
began recognizing Lloyd's premium revenue in a manner that more
accurately reflects the underlying policy terms and exposures and
is more consistent with the method by which we recognize premium
revenue in our non-Lloyd's business. This change did not have a
material impact on our consolidated financial statements for the
three months or nine months ended September 30, 2003.
The following discussion provides an update to various financial
disclosures related to critical accounting policies pertaining to
our investments.
We continually monitor the difference between our cost and the
estimated fair value of our investments, which involves
uncertainty as to whether declines in value are temporary in
nature. If we believe a decline in the value of a particular
investment is temporary, we record the decline as an unrealized
loss in our common shareholders' equity. If we believe the
decline is "other than temporary," we write down the carrying
value of the investment and record a realized loss on our
statement of operations. Our assessment of a decline in value
includes our current judgment as to the financial position and
future prospects of the entity that issued the investment
security. If that judgment changes in the future we may
ultimately record a realized loss after having originally
concluded that the decline in value was temporary. The following
table summarizes the total pretax gross unrealized loss recorded
in our common shareholders' equity at September 30, 2003 and Dec.
31, 2002, by invested asset class.
(in millions)
----------- Sept. 30, Dec. 31,
2003 2002
------- -------
Fixed income (including
securities on loan) $ 40 $ 52
Equities 10 37
Venture capital 95 119
----- -----
Total unrealized loss $145 $208
===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
At September 30, 2003 and December 31, 2002, the carrying value
of our consolidated invested asset portfolio included $1.07
billion and $1.03 billion of net pretax unrealized gains,
respectively.
The following table summarizes, for all securities in an
unrealized loss position at September 30, 2003 and Dec. 31, 2002,
the aggregate fair value and gross unrealized loss by length of
time those securities have been continuously in an unrealized
loss position.
September 30, 2003 December 31, 2002
------------------- -------------------
(in millions) Gross Gross
----------- Fair Unrealized Fair Unrealized
Value Loss Value Loss
----- ---------- ----- ----------
Fixed income
(including securities
on loan):
0 - 6 months $1,298 $ 24 $ 673 $ 27
7 - 12 months 126 4 198 9
Greater than
12 months 137 12 198 16
----- ----- ----- -----
Total 1,561 40 1,069 52
----- ----- ----- -----
Equities:
0 - 6 months 77 7 144 15
7 - 12 months 9 1 80 20
Greater than
12 months 8 2 4 2
----- ----- ----- -----
Total 94 10 228 37
----- ----- ----- -----
Venture capital:
0 - 6 months 55 21 60 49
7 - 12 months 6 6 39 25
Greater than
12 months 85 68 44 45
----- ----- ----- -----
Total 146 95 143 119
----- ----- ----- -----
Total $1,801 $ 145 $1,440 $ 208
===== ===== ===== =====
At September 30, 2003, non-investment grade securities comprised
less than 2% of our consolidated fixed income investment
portfolio, and nonrated securities comprised less than one half
of one percent of that portfolio. Included in those categories
at that date were securities in an unrealized loss position that,
in the aggregate, had an amortized cost of $99 million and a fair
value of $92 million, resulting in a net pretax unrealized loss
of $7 million. These securities represented 1% of the total
amortized cost and fair value of the fixed income portfolio at
September 30, 2003, and accounted for 18% of the total pretax
unrealized loss in the fixed income portfolio. Included in those
categories at Dec. 31, 2002 were securities in an unrealized loss
position that, in the aggregate, had an amortized cost of $160
million and a fair value of $140 million, resulting in a net
pretax unrealized loss of $20 million. These securities
represented 1% of the total amortized cost and fair value of the
fixed income portfolio at Dec. 31, 2002, and accounted for 38% of
the total pretax unrealized loss in the fixed income portfolio.
The following table presents information regarding fixed income
investments that were in an unrealized loss position at September
30, 2003, by remaining period to maturity date.
(in millions) Amortized Estimated
----------- Cost Fair Value
--------- ----------
Remaining period to maturity date:
One year or less $ 130 $ 128
Over one year through five years 305 301
Over five years through ten years 477 464
Over ten years 287 279
Asset/mortgage-backed securities
with various maturities 402 389
------ ------
Total $1,601 $1,561
====== ======
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance
----------------------------
Overview
- --------
Our total net written premiums of $1.95 billion in the third
quarter of 2003 were 7% higher than comparable 2002 premiums of
$1.82 billion, driven by price increases and new business
throughout our ongoing operations, which more than offset an 81%
decline in volume in our runoff "Other" segment. In our ongoing
Specialty Commercial and Commercial Lines segments, total net
written premium volume of $1.89 billion in the third quarter was
24% ahead of the comparable 2002 total of $1.52 billion. In the
first nine months of 2003, reported premium volume of $5.72
billion was slightly below reported 2002 nine-month volume of
$5.78 billion. Strong growth in our ongoing segments was offset
by a $1.1 billion decline in the "Other" segment that was
primarily due to our November 2002 transfer of our ongoing
reinsurance operations to Platinum. Our year-to-date ongoing
operations' premium volume of $5.46 billion was 23% higher than
the 2002 nine-month total of $4.43 billion. The year-to-date
2003 ongoing operations' total included $83 million of
incremental premium volume resulting from the elimination of the
one-quarter reporting lag at our operations at Lloyd's, and also
benefited from incremental premiums resulting from our purchase
of the right to renew certain business previously underwritten by
Kemper Insurance Companies (discussed in more detail on page 39
of this report).
Our consolidated statutory loss ratio, which measures insurance
losses and loss adjustment expenses as a percentage of earned
premiums, was 66.3 in the third quarter of 2003, compared with a
loss ratio of 77.1 in the same 2002 period. In our ongoing
operations, the third-quarter 2003 loss ratio of 62.7 was over
one point better than the comparable 2002 loss ratio of 63.9,
primarily due to continued improvement in our current-year loss
experience. Through the first nine months of 2003, our ongoing
segments' loss ratio was 63.4, which included a 1.8 point impact
from an $89 million loss provision recorded in our Surety
business center related to one of our accounts (discussed in more
detail on page 50 of this report). The nine-month ongoing
segments' 2002 loss ratio of 65.3 included a 0.9 point impact
from a $34 million loss provision recorded in the Surety business
center for a claim related to the construction of two oil rigs.
Excluding those factors in both years, our ongoing segments'
adjusted nine-month 2003 loss ratio of 61.6 was nearly three
points better than the comparable adjusted 2002 loss ratio of
64.4. That improvement reflected the impact of price increases
in recent years and our efforts to upgrade the quality of our
business, both of which have resulted in a significant
improvement in current-year loss experience throughout the
majority of our ongoing operations.
Effective January 1, 2003, we changed our disclosure regarding
catastrophe losses. We no longer classify all losses from
Insurance Services Office (ISO)-defined catastrophes as
"catastrophe losses." We revised our definition of losses
reported as "catastrophes" to include only those events that we
believe generate losses beyond a level normally expected in our
business. This revised definition has no impact on recorded
results for either the current or prior period. Catastrophe
losses reported in prior periods have been reclassified to
conform to our new definition. In the first nine months of 2003,
we recorded a net $26 million reduction in the provision for
catastrophes incurred in prior years, nearly all of which was
recorded in our runoff Reinsurance operations and was related to
the September 11, 2001 terrorist attack. In the first nine
months of 2002, we recorded a net $40 million provision for
catastrophe losses incurred in prior years, the majority of which
was recorded in our Reinsurance operations and was related to
flooding in Europe.
Our consolidated statutory expense ratio, measuring underwriting
expenses as a percentage of net written premiums, was 27.7 in the
third quarter of 2003, nearly one point better than the 2002
third-quarter ratio of 28.6. In our ongoing operations, the
third-quarter 2003 expense ratio of 28.2 was level with the
comparable 2002 expense ratio. Through the first nine months of
2003, our ongoing operations' expense ratio of 29.0 was slightly
higher than the 2002 nine-month expense ratio of 28.8, primarily
due to the impact of the reclassification of Lloyd's commission
expense, and the impact on that commission expense of eliminating
the one-quarter reporting lag.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Prior-Year Loss Development
- ---------------------------
"Prior-year loss development" refers to the calendar year income
statement impact of changes in the provision for losses and loss
adjustment expenses for claims incurred in prior accident years.
The following table summarizes net loss and loss adjustment
expense ("LAE") reserves at December 31, 2002 and September 30,
2003 for each of our property-liability segments (and the material
components thereof), and the amount of unfavorable (favorable)
prior-year loss development recorded in those respective
operations in the first nine months of 2003.
Net Loss and LAE Reserves
-------------------------
Year-to-date
Dec. 31, Sept. 30, Prior-Year Loss
(in millions) 2002 2003 Development
----------- ------- ------- ----------------
Ongoing operations:
Specialty Commercial:
Specialty $ 2,043 $ 2,284 $ 11
Surety & Construction 1,369 1,608 -
International & Lloyd's 987 1,200 -
------ ------ ----
Total Specialty
Commercial 4,399 5,092 11
------ ------ ----
Commercial Lines 2,495 2,543 4
------ ------ ----
Total Ongoing
Operations 6,894 7,635 15
------ ------ ----
Runoff Operations:
Other:
Health Care 1,970 1,411 (1)
Reinsurance 3,043 2,454 (22)
Other Runoff 2,942 2,189 109
------ ------ ----
Total Other 7,955 6,054 86
------ ------ ----
Total Underwriting $14,849 $13,689 $101
====== ====== ====
Specific circumstances leading to the reserve development
recorded in the first nine months of 2003 are discussed in more
detail in the respective segment discussions that follow.
The table on the following page summarizes key financial results
(from continuing operations) by property-liability underwriting
business segment (underwriting results are presented using GAAP
measures; combined ratios are presented on a statutory accounting
basis). In the first quarter of 2003, we implemented a new
segment reporting structure for our property-liability
underwriting operations. Data for 2002 in the table have been
reclassified to be consistent with the new segment reporting
structure.
Following the table is a detailed discussion of the results for
each segment for the three months and nine months ended September
30, 2003 and 2002. In addition to "prior-year loss development,"
we sometimes refer to "current-year loss development" or "current
accident year loss activity," which refers to the calendar year
income statement impact of recording the provision for losses and
LAE for losses incurred in the current accident year.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
% of Total Three Months Ended Nine Months Ended
Premiums September 30 September 30
---------- ------------------ -----------------
($ in millions) 2003 2002 2003 2002
------------- ------ ------ ------ ------
Specialty Commercial
Net written premiums 67% $1,269 $1,064 $3,815 $3,097
Underwriting result $79 $56 $209 $123
Combined ratio 92.5 93.7 93.5 94.7
Commercial Lines
Net written premiums 29% $620 $453 $1,649 $1,336
Underwriting result $58 $41 $132 $84
Combined ratio 87.2 88.5 89.7 92.9
Other*
Net written premiums 4% $59 $305 $255 $1,350
Underwriting result $(65) $(192) $(213) $(904)
--- ------ ------ ------ ------
Total Property-
Liability Insurance
Net written premiums 100% $1,948 $1,822 $5,719 $5,783
==== ====== ====== ====== ======
Underwriting result $72 $ (95) $128 $(697)
====== ====== ====== ======
Statutory Combined Ratio
Loss and loss adjustment
expense ratio 66.3 77.1 67.0 83.3
Underwriting expense
ratio 27.7 28.6 29.3 29.2
------ ------ ------ ------
Combined Ratio 94.0 105.7 96.3 112.5
====== ====== ====== ======
*The table excludes statutory combined ratios for the "Other"
segment, as they are less meaningful in a runoff environment
because of the significant decline in net written and earned
premiums.
Specialty Commercial
- --------------------
The Specialty Commercial segment includes our combined Surety &
Construction operation, our ongoing International & Lloyd's
operations, and the following nine specialty business centers
that in total comprise the "Specialty" component of this segment:
Technology, Financial and Professional Services, Marine, Personal
Catastrophe Risk, Public Sector Services, Discover Re, Excess &
Surplus Lines, Specialty Programs and Oil & Gas. These business
centers are considered specialty operations because each provides
products and services requiring specialty expertise and focuses
on the respective customer group served. Our Surety business
center underwrites surety bonds, which are agreements under which
one party (the surety) guarantees to another party (the owner or
obligee) that a third party (the contractor or principal) will
perform in accordance with contractual obligations. The
Construction business center offers a variety of products and
services, including traditional insurance and risk management
solutions, to a broad range of contractors and parties
responsible for construction projects. Our ongoing International
operations consist of our specialty underwriting operations in
the United Kingdom, Canada (other than surety) and the Republic
of Ireland, and the international exposures of most U.S.
underwriting business. At Lloyd's, our ongoing operations are
comprised of the following types of insurance coverage we
underwrite mostly through a single wholly-owned syndicate:
Aviation, Marine, Global Property and Personal Lines. The
following table provides supplemental information for this
segment for the three months and nine months ended September 30,
2003 and 2002.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
($ in millions) 2003 2002 2003 2002
------------- ------ ------ ------ ------
SPECIALTY
Net written premiums $701 $523 $1,865 $1,434
Percentage increase over 2002 34% 30%
Underwriting result $107 $60 $248 $121
Statutory combined ratio:
Loss and loss adjustment
expense ratio 58.6 64.1 60.3 66.6
Underwriting expense ratio 23.4 22.6 23.9 23.6
------ ------ ------ ------
Combined ratio 82.0 86.7 84.2 90.2
====== ====== ====== ======
SURETY & CONSTRUCTION
Net written premiums $280 $280 $953 $953
Percentage increase over 2002 -% -%
Underwriting result $(40) $(38) $(113) $(32)
Statutory combined ratio:
Loss and loss adjustment
expense ratio 76.2 78.2 76.6 68.2
Underwriting expense ratio 38.9 37.5 34.9 34.3
------ ------ ------ ------
Combined ratio 115.1 115.7 111.5 102.5
====== ====== ====== ======
INTERNATIONAL & LLOYD'S
Net written premiums $288 $261 $997 $710
Percentage change from 2002 10% 40%
Underwriting result $12 $34 $74 $34
Statutory combined ratio:
Loss and loss adjustment
expense ratio 62.3 56.6 59.0 65.0
Underwriting expense ratio 29.9 25.3 32.9 28.6
------ ------ ------ ------
Combined ratio 92.2 81.9 91.9 93.6
====== ====== ====== ======
TOTAL SPECIALTY
COMMERCIAL SEGMENT
Net written premiums $1,269 $1,064 $3,815 $3,097
Percentage increase over 2002 19% 23%
Underwriting result $79 $56 $209 $123
Statutory combined ratio:
Loss and loss adjustment
expense ratio 64.2 66.5 64.5 66.7
Underwriting expense ratio 28.3 27.2 29.0 28.0
------ ------ ------ ------
Combined ratio 92.5 93.7 93.5 94.7
====== ====== ====== ======
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Specialty
- ---------
Almost all business centers in the Specialty category contributed
to the strong premium growth over the third quarter and first
nine months of 2002. Financial and Professional Services' third-
quarter 2003 premiums of $177 million were 75% higher than in the
same period of 2002, driven by price increases and new business
principally generated by our December 2002 acquisition of the
right to seek to renew the professional and financial risk
practice business of Royal & SunAlliance, and the May 2003
acquisition of the right to seek to renew architects' and
engineers' professional liability business from Kemper Insurance
Companies. Through the first nine months of 2003, Financial and
Professional Services written premiums totaled $455 million,
compared with $288 million in the same period of 2002.
Technology's written premiums of $107 million in the third
quarter were 27% higher than the comparable 2002 total of $84
million, primarily due to price increases and new business.
Personal Catastrophe Risk third-quarter net premiums of $40
million were more than double those in the same 2002 period, due
to a change in our reinsurance program related to this business
that has resulted in less business being ceded to reinsurers.
The improvements in third-quarter and year-to-date 2003
underwriting results compared with the same periods of 2002
occurred throughout the business centers in the Specialty
category, reflecting the impact of price increases and the
addition of profitable new business. The Technology and
Financial and Professional Services business centers recorded the
most notable improvements over the third quarter of 2002, posting
underwriting profits of $32 million and $26 million,
respectively. We recorded an $11 million provision for prior-
year losses in the Specialty category in 2003, the majority of
which was concentrated in our Discover Re operation, due to the
recognition of uncollectible reinsurance and an increase in
estimated losses related to a single large account.
Surety & Construction
- ---------------------
Net written premiums generated by our Surety business center
totaled $133 million in the third quarter of 2003, compared with
$136 million in the same 2002 period. Through the first nine
months of 2003, Surety's written premium volume of $373 million
was 3% below the comparable 2002 total of $383 million, primarily
due to the closing of certain field offices, the impact of
underwriting actions to improve the risk profile of our book of
business, and increased reinsurance costs.
The Surety underwriting loss totaled $6 million in the third
quarter of 2003, compared with an underwriting loss of $45
million in the same 2002 period. The 2002 loss was driven by a
$34 million loss provision recorded after a judicial decision
regarding surety bonds issued in connection with the construction
of two large Brazilian oil rigs. Through the first nine months
of 2003, Surety's underwriting loss of $104 million included an
$89 million pretax loss provision (net of reinsurance) related to
one of our accounts that was in bankruptcy and unable to perform
its bonded obligations. In April 2003, a bankruptcy court
approved the sale of substantially all of the assets of the
account. Following that approval, we received claim notices with
respect to approximately $120 million of bonds securing certain
workers' compensation and retiree health benefit obligations of
the account. The $89 million net pretax loss provision recorded
in 2003 represented our estimated loss in this matter. Surety's
year-to-date 2002 underwriting loss totaled $46 million.
In our Surety operation, we continue to experience an increase in
the frequency of reported losses, primarily resulting from the
continuing economic downturn in North America. Certain segments
of our surety business tend to be characterized by low frequency
but potentially high severity losses.
Within our commercial surety segments, we have exposures related
to a small number of accounts, which are now in various stages of
bankruptcy proceedings. In addition, certain other accounts have
experienced deterioration in creditworthiness since we issued
bonds to them. Given the current economic climate and its impact
on these companies, we may experience an increase in claims and,
possibly, incur high severity losses. Such losses would be
recognized in the period in which the claims are filed and
determined to be a valid loss under the provisions of the surety
bond issued.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
With regard to commercial surety bonds issued on behalf of
companies operating in the energy trading sector, our aggregate
pretax exposure, net of facultative reinsurance, is with five
companies for a total of approximately $385 million ($318 million
of which is from gas supply bonds), an amount that will decline
over the contract periods. The largest individual exposure
approximates $186 million (pretax). These companies all continue
to perform their bonded obligations and, therefore, no claims
have been filed.
In addition to our largest exposure discussed above with respect
to energy trading companies, our commercial surety business as of
September 30, 2003 included seven accounts with gross pretax bond
exposures greater than $100 million each, before reinsurance.
The majority of these accounts have investment grade ratings, and
all accounts continue to perform their bonded obligations.
In 2003, we secured excess of loss reinsurance coverage for our
commercial surety exposures in the form of two new treaties
providing $500 million of aggregate loss limits over a five-year
period, with a maximum recovery of $100 million per principal for
gas supply bonds and $150 million per principal for other bonds.
The reinsurance program does not extend coverage to the small
number of commercial surety accounts which were in bankruptcy at
the inception of the reinsurance treaties.
We continue with our intention to exit the segments of the
commercial surety market discussed above by ceasing to write new
business and, where possible, terminating the outstanding bonds.
Since October 2000, when we made a strategic decision to
significantly reduce the exposures in these segments, our total
commercial surety gross open bond exposure has decreased by over
54% as of September 30, 2003. We will continue to be a market for
traditional commercial surety business, which includes low-limit
business such as license and permit, probate, public official,
and customs bonds.
In the contract surety business, creditworthiness is a primary
underwriting consideration and the underwriting process involves
a number of factors, including consideration of a contractor's
financial condition, business prospects, experience and
management. The risk in respect of a contract surety bond
changes over time. Such risk tends to decrease as the related
construction project is completed, but may increase to the extent
the financial condition of the contractor deteriorates or
difficulties arise during the course of the project. Losses in
the contract surety business can occur as a result of a
contractor's failure to complete its bonded obligations in
accordance with the contract terms. Such losses, if any, would
be estimated by estimating the cost to complete the remaining
work (which may include amounts advanced to the contractor by the
surety) and the contractor's unpaid bills, offset by monies due
to the contractor, reinsurance and the estimated net realizable
value of collateral. While our contract surety business
typically has not been characterized by high severity losses, it
is possible, given the current economic climate, that significant
losses could occur.
Some of our contract surety business, particularly with respect
to larger accounts, is written on a co-surety basis with other
surety underwriters in order to manage and limit our aggregate
exposure. Certain of these sureties have experienced, and may
continue to experience, deterioration in their financial
condition and financial strength ratings. If a loss is incurred
and one of our co-sureties fails to meet its obligations under a
bond, we and any other co-surety or co-sureties on the bond
typically are jointly and severally liable for such obligations.
As a result, our losses could significantly increase to the
extent such an event or events occur.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
We have provided surety bond coverage to a construction
contractor that failed to make payments under certain of its debt
obligations during the third quarter of 2003. The contractor has
developed a plan to restructure its operations and financing, and
is negotiating revisions to its credit arrangements. In the
third quarter of 2003, following our detailed review of this
plan, we made collateralized advances to the contractor. Based
on information available to us, we believe that the contractor
will be able to complete projects as contemplated by its plan.
As part of the plan, we may issue bonds for new projects undertaken
by the contractor, subject to our underwriting criteria. We
expect our advances to be fully repaid by cash flow from the
contractor's operations, planned asset sales, reinsurance
recoveries and, if necessary, recovery on collateral. Accordingly,
we do not expect to incur a significant loss with respect to
this account. However, in the unlikely event that the contractor
fails to complete all of its current projects, we estimate that
our aggregate loss, net of estimated collateral, reinsurance
recoveries and participation by co-sureties (one of which has
experienced ratings downgrades and is in runoff), would not
exceed $80 million, on an after-tax basis assuming a 35%
statutory tax rate.
In our Construction business center, third-quarter net written
premiums of $147 million were slightly higher than net written
premium volume of $144 million in the third quarter of 2002,
while year-to-date premiums of $580 million were 2% higher than
premiums of $570 million in the same 2002 period. The impact on
written premiums from higher prices during 2003 was largely
offset by a reduction in new business. Construction's third-
quarter 2003 underwriting loss of $35 million was driven by an
increased provision for current accident year losses.
International & Lloyd's
- -----------------------
Net written premiums of $288 million in the third quarter were
10% higher than comparable 2002 premiums of $261 million. For
the nine months ended September 30, 2003, written premium volume
of $997 million for the International & Lloyd's category included
$83 million of incremental premiums from the elimination of the
one-quarter reporting lag at Lloyd's (the remaining $5 million of
incremental premiums described on page 35 of this report were
recorded in our runoff Other segment). Excluding that additional
$83 million, premium volume in 2003 of $914 million was 29%
higher than 2002 nine-month written premiums of $710 million. We
experienced strong growth in our operations at Lloyd's, due to
price increases, new business and our increased participation in
Lloyd's following the consolidation of most of our Lloyd's
operations into one wholly-owned syndicate in 2002. In our
International operations, premiums of $414 million for the nine
months ended September 30, 2003, were 15% higher than comparable
premiums of $360 million in the same 2002 period. Price
increases, new business and favorable foreign currency
translation effects were all factors contributing to the growth
in premiums in the first nine months of 2003.
The International & Lloyd's underwriting profit of $12 million in
the third quarter of 2003 declined $22 million from the same
period of 2002, due to losses in the personal lines business unit
at Lloyd's. For the first nine months of 2003, however, the
underwriting profit of $74 million, which included $6 million in
losses attributable to the elimination of the one-quarter
reporting lag, was significantly improved over the $34 million
underwriting profit in the same period of 2002. The improvement
in 2003 results was largely due to strong results from our
operations in Canada and the United Kingdom, as well as from our
overall Lloyd's operations, compared with the same period of
2002.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Commercial Lines
- ----------------
The Commercial Lines segment includes our Small Commercial,
Middle Market Commercial and Property Solutions business centers,
as well as the results of our limited involvement in involuntary
insurance pools. The Small Commercial business center services
commercial firms that typically have between one and fifty
employees through its proprietary St. Paul Mainstreet (SM) and
St. Paul Advantage (SM) products, with a particular focus on
offices, wholesalers, retailers, artisan contractors and other
service risks. The Middle Market Commercial business center
offers comprehensive insurance coverages for a wide variety of
manufacturing, wholesale, service and retail exposures. This
business center also offers loss-sensitive casualty programs,
including significant deductible and self-insured retention
options, for the higher end of the middle market sector. The
Property Solutions business center combines our Large Accounts
Property business with the commercial portion of our catastrophe
risk business and allows us to take a unified approach to large
property risks. The following table summarizes key financial
data for this segment for the three months and nine months ended
September 30, 2003 and 2002.
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
($ in millions) 2003 2002 2003 2002
------------- ------ ------ ------ ------
Net written premiums $620 $453 $1,649 $1,336
Percentage increase over 2002 37% 23%
Underwriting result $58 $41 $132 $84
Statutory combined ratio:
Loss and loss adjustment
expense ratio 59.2 57.9 60.8 62.1
Underwriting expense ratio 28.0 30.6 28.9 30.8
------ ------ ------ ------
Combined ratio 87.2 88.5 89.7 92.9
====== ====== ====== ======
The strong premium growth in the third quarter and first nine
months of 2003 over the comparable periods of 2002 was primarily
due to new business volume, including that resulting from our
purchase of the right to renew certain business previously
underwritten by Kemper Insurance Companies (described in more
detail on page 39 of this report). Price increases and strong
business retention levels have also played a role in premium
growth in 2003. Written premiums of $224 million in the Small
Commercial business center were 36% higher than comparable third-
quarter 2002 volume of $164 million. In the Middle Market
business center, third-quarter written premiums of $369 million
increased 42% over the same period of 2002. Through the first
nine months of 2003, Middle Market premium volume totaled $1
billion, compared with $788 in the same period of 2002.
Throughout our Commercial Lines segment, we continue to nonrenew
underperforming classes of business, pursue further rate
increases where appropriate and leverage our distribution network
to capitalize on new business opportunities.
Strong improvement in current accident year loss experience in
2003 was the primary factor contributing to the significant
increase in underwriting profitability in the third quarter and
first nine months of 2003 over the same periods of 2002. That
improvement occurred despite a significant increase in weather-
related losses in 2003. We have been successful in adding new
business in the first nine months of 2003 that meets our pricing
and underwriting criteria while maintaining strict control over
expense growth. The nearly two-point improvement in the expense
ratio compared with the first nine months of 2002 reflected the
success of our expense control efforts.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Other
- ----
This segment includes the results of the lines of business we
placed in runoff in late 2001 and early 2002, including our
former Health Care and Reinsurance segments, and the results of
the following international operations: our runoff operations at
Lloyd's, including our participation in the insuring of the
Lloyd's Central Fund; Unionamerica, the London-based underwriting
unit acquired as part of our purchase of MMI in 2000; and
international operations we decided to exit at the end of 2001.
We have a management team in place for these operations, seeking
to ensure that our outstanding claim obligations are settled in
an expeditious and economical manner. This segment also includes
the results of our participation in voluntary insurance pools, as
well as loss development on business underwritten prior to 1980
(prior to 1988 for business acquired in our merger with USF&G
Corporation in 1998). That prior year business includes the
majority of our environmental and asbestos liability exposures.
The oversight of these exposures is the responsibility of the
same management team responsible for oversight of the other
components of the Other segment. Our Health Care operation
historically provided a wide range of medical liability insurance
products and services throughout the entire health care delivery
system. Our Reinsurance operations historically underwrote
treaty and facultative reinsurance for a wide variety of property
and liability exposures.
As described in more detail on pages 42 and 43 of this report, in
November 2002 we transferred our ongoing reinsurance operations
to Platinum Underwriters Holdings, Ltd. The following table
summarizes key financial data for the Other segment for the three
months and nine months ended September 30, 2003 and 2002. The
table excludes statutory ratios, as they are less meaningful in a
runoff environment because of the significant decline in net
written and earned premiums.
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
($ in millions) 2003 2002 2003 2002
------------- ------ ------ ------ ------
HEALTH CARE
Net written premiums $1 $37 $27 $179
Percentage decline from 2002 (97%) (85%)
Underwriting result $(4) $(71) $(37) $(164)
REINSURANCE
Net written premiums $40 $230 $168 $893
Percentage decline from 2002 (83%) (81%)
Underwriting result $(1) $(25) $2 $(14)
OTHER RUNOFF
Net written premiums $18 $38 $60 $278
Percentage decline from 2002 (53%) (78%)
Underwriting result $(60) $(96) $(178) $(726)
----- ----- ----- -----
TOTAL OTHER SEGMENT
Net written premiums $59 $305 $255 $1,350
===== ===== ===== =====
Percentage decline from 2002 (81%) (81%)
Underwriting result $(65) $(192) $(213) $(904)
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Other Segment Overview
- ----------------------
The Other segment in total generated a $65 million underwriting
loss in the third quarter of 2003, compared with a loss of $192
million in the same 2002 period. As described in more detail in
the following discussion, the year-to-date segment underwriting
loss of $213 million included $86 million of net unfavorable
prior-period loss development, including $39 million that emerged
in the third quarter of the year. The year-to-date total also
included $18 million in losses attributable to the elimination of
the one-quarter reporting lag. The remainder of the nine-month
underwriting loss primarily resulted from provisions for losses
on current accident year business, and expenses associated with
the runoff lines of business in this segment.
Health Care
- -----------
We announced our decision to exit the medical liability insurance
market at the end of 2001. Written premiums for all periods
presented in the foregoing table primarily consisted of premiums
generated by extended reporting endorsements and professional
liability coverages underwritten prior to our nonrenewal
notifications becoming effective in several states. We were
required to offer reporting endorsements to claims-made
policyholders at the time their policies were nonrenewed. These
endorsements cover losses incurred in prior periods that have not
yet been reported. Unlike typical policies, premiums on these
endorsements are fully earned, and the expected losses are
recorded, at the time the endorsement is written. Effective in
the third quarter of 2003, our obligation to offer reporting
endorsements was substantially satisfied.
In 2000 and 2001, we recorded cumulative prior-year reserve
charges of $225 million and $735 million, respectively, in our
Health Care operations, ultimately leading to our decision at the
end of 2001 to exit this market. In general, the reserve
increases primarily resulted from claim payments being greater
than anticipated due to the recent escalation of large jury
awards, which included substantially higher than expected pain
and suffering awards. This affected our view of not only those
cases going to trial, but also our view of all cases where
settlements are negotiated and the threat of a large jury verdict
aids the plaintiff bar in the negotiation process. The recent
escalation in claim costs that resulted from these developments
was significantly higher than originally projected trends (which
had not forecasted the change in the judicial environment), and
has now been considered in our actuarial analysis and the
projection of ultimate loss costs. In addition, a portion of the
reserve increase in the fourth quarter of 2001 resulted from
information obtained from the work of a Health Care Claims Task
Force, created during the first half of 2001, which focused
resolution efforts on our largest claims with the intent of
lowering our ultimate loss costs.
The following presents a summary of trends we observed within our
Health Care operation for each quarter of 2002 and the first two
quarters of 2003. For a discussion of quarterly trends observed
in 2000 and 2001, refer to page 40 of our 2002 Annual Report to
Shareholders.
2002
- ----
Following the cumulative prior-year reserve charges of $735
million in 2001, activity in the first quarter of 2002 developed
according to projections. Average paid claims for the full year
of 2001 for medical malpractice lines had been $117,000,
including a fourth quarter average of $124,000. The phrase
"average paid claims" as used herein excludes claims which were
settled or closed for which no loss or loss expense was paid. In
the first quarter of 2002, the average paid loss was down to
$111,000. We interpreted this as a positive sign that prior year
reserve charges up to this point had been adequate. The average
outstanding case reserve increased slightly from $141,000 in the
fourth quarter of 2001 to $144,000 in the first quarter of 2002,
but this was interpreted as a relatively benign change, given
inflation and the promising decrease in average payment amounts.
No additional reserve action was taken.
In the second quarter of 2002, average paid claims for medical
malpractice lines were somewhat above expectations, rising to
$130,000 for the quarter. This, coupled with an additional
increase in the average outstanding case reserve to $148,000,
prompted management to reflect these new increased averages in
its reserve analysis and record a reserve increase of $97
million.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Throughout 2002, we initiated significant changes to our Health
Care claims organization and resolution process. During the
third quarter of 2002, we began to see the results of executing
this strategy. Specifically, caseloads per adjuster had begun to
decline substantially and the process for providing oversight on
high exposure cases had been streamlined, enabling a more
expeditious approach to our handling of these medical malpractice
claims - including the establishment of stronger case reserves.
We also added staff with expertise in high exposure litigation
management to assist claim handlers in aggressively pursuing
appropriate resolutions on a file-by-file basis. This allowed us
to establish more effective resolution strategies to either
resolve claims prior to going to trial or, for those claims
deemed as non-meritorious, maintain an aggressive defense. We
have also become more selective in determining which cases are
taken to trial and more willing to make use of our right to
select defense counsel in those instances that we decide to
litigate. This has caused our ratio of defense verdicts to
plaintiff verdicts to improve over prior years. We began to more
effectively manage our claim disposition strategies to limit the
number of catastrophic verdicts. We believe that executing this
strategy has increased our ability to reduce our ultimate
indemnity losses.
As noted above, as part of our focus on claim resolution, we have
increased our emphasis on routinely reviewing our case reserves
and have put in place a process where managers actively review
each adjuster's entire inventory of pending files to assure,
among other things, that case reserves are adequate to support
settlement values. In addition, as we have moved further into
runoff, our mix of paid and outstanding claims has changed and we
expect that our statistical data will reflect fewer new claims.
We expect our claim counts will go down and the average size of
our outstanding and paid claims will go up since newly reported
claims are often settled at minimal loss or loss expense cost.
In the third quarter of 2002, although our average paid claim
decreased slightly to $126,000, our average outstanding claim
reserve increased to $166,000. We believed that increases in the
average outstanding claim reserve were due to both the claim mix
and case strengthening as described above and were not unexpected
in a runoff environment. Accordingly, we did not record any
reserve charge given the favorable effects we anticipate
realizing in future ultimate payments.
In the fourth quarter of 2002, the average paid claim increased
to $153,000 and the average outstanding case reserve increased to
$181,000, which we believe was attributable to the previously
described observations and was reasonable relative to our
expectations. Also during the fourth quarter, we determined that
our claim inventory had been reduced considerably and had matured
to a level at which we appropriately began to consider other more
relevant data and statistics suitable for evaluating reserves in
a runoff environment.
During 2002, and as described above, we concluded that the impact
of settling claims in a runoff environment was causing abnormal
effects on our average paid claims, average outstanding claims,
and the amount of average case reserves established for new
claims - all of which are traditional statistics used by our
actuaries to develop indicated ranges of expected loss. Taking
these changing statistics into account, we developed varying
interpretations of our data, which implied added uncertainty to
our evaluation of these reserves. It is our belief that this
data, when appropriately evaluated in light of the impact of our
migration to a runoff environment, supports our view that we will
realize significant savings on our ultimate claim costs.
In the fourth quarter of 2002, we established specific tools and
metrics to more explicitly monitor and validate our key
assumptions supporting our reserve conclusions since we believe
that our traditional statistics and reserving methods needed to
be supplemented in order to provide a more meaningful analysis.
The tools we developed track the three primary indicators which
are influencing our expectations and include: a) newly reported
claims, b) reserve development on known claims and c) the
"redundancy ratio," comparing the cost of resolving claims to the
reserve established for that individual claim.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Emergence of newly reported claims - Our Health Care book of
business was put into runoff at the end of 2001, and our
outstanding exposure has rapidly dropped, as expected. Since
the majority of coverage we offered was on a claims-made
basis and notification of the claim must be made within the
policy period, the potential for unreported claims has
decreased significantly. We expected that the emergence of
newly reported medical malpractice claims, with incurred
years of 2002 or prior, would not exceed 40% of our year-end
2002 outstanding case reserve amount.
Development on known claims - As part of executing our runoff
claims strategy, the inventory of claim-specific case
reserves was reviewed during 2002 in an effort to reserve
each claim as appropriately as possible. This effort is in
its advanced stages, and our expectations for additional
reserve strengthening on known claims is considered to be
minimal. We expected additional case development on medical
malpractice claims would not exceed 3% of year-end 2002 case
reserves.
Case redundancy - While there were claims settlements which
exceeded the claim-specific reserve that had been
established, on the whole, claims are being settled at a
level significantly less than the individual case reserve
previously carried. During 2001, the amount of excess
reserves above settled amounts as a percentage of previously
established reserves (referred to as a redundancy ratio) were
in the range of 25% to 30%. By the end of 2002, the
redundancy ratio had increased to between 35% and 40%. We
expect this ratio to stay within this range to support our
best estimate of a reasonable provision for our loss
reserves.
2003
- ----
In 2003, we evaluated the adequacy of our previously established
medical malpractice reserves in the context of the three
indicators described above. The dollar amount of newly reported
claims in the first quarter totaled $118 million, approximately
25% less than we anticipated in our original estimate of the
required level of redundancy at year-end 2002. With regard to
development on known claims, loss activity in the first quarter
of 2003 was within our expectations. Case development on
incurred years 2001 and prior was minimal, and case development
on the 2002 incurred year totaled $39 million, within our year-
end 2002 estimate of no more than 3% of development. For the
first quarter of 2003, our redundancy ratio was within our
expected range of between 35% and 40%.
In the second quarter of 2003, the dollar amount of newly
reported claims totaled $127 million, approximately 5% higher
than we anticipated in our original estimate of the required
level of reserves at year-end 2002. Nevertheless, through the
first half of 2003, the dollar amount of newly reported claims
was approximately 12% lower than we anticipated. Loss
development on known claims during the second quarter of 2003 was
negative, but not as negative as we anticipated. Our actual
redundancy ratio continued to improve in the second quarter of
2003; however, since newly reported claims and loss development
on known claims did not improve as much as we expected in the
second quarter, the required reserve redundancy has increased
modestly from the previously estimated range of 35% to 40%.
In the third quarter of 2003, the dollar amount of newly reported
claims totaled $108 million, approximately 10% higher than we
anticipated in our original estimate of the required level of
reserves at year-end 2002. However, through the first nine
months of 2003, the dollar amount of newly reported claims was
approximately 7% lower than we anticipated due to the positive
variance in the first quarter. Loss development on known claims
during the third quarter of 2003 was worse than anticipated. Our
actual redundancy ratio continued to improve in the third quarter
of 2003; however, since newly reported claims and loss
development on known claims again did not improve as much as we
expected in the third quarter, the required reserve redundancy
has increased from the previously estimated range of 35% to 40%
to approximately 45%.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
The three indicators described above are related such that if one
deteriorates, additional improvement on another is necessary for
us to conclude that further reserve strengthening is not
necessary. While the results of these indicators support our
current view that we have recorded a reasonable provision for our
medical malpractice exposures as of September 30, 2003, there is
a reasonable possibility that we may incur additional unfavorable
prior year loss development if these indicators significantly
change from our current expectations. If these indicators
deteriorate, we believe that a reasonable estimate of an
additional loss provision could amount to up to $250 million.
However, our analysis as of this point in time continues to
support our belief that we will realize favorable effects in our
ultimate costs and that our current loss reserves will prove to
be a reasonable provision.
As noted above, development on known claims is a key metric in
our evaluation of our Health Care reserves. While we have
experienced adverse development on known claims at year-end 2002,
the magnitude of that development has declined throughout 2003.
If, however, we experience further adverse reserve development on
those claims, and such development is not offset by a favorable
change in our estimate of newly reported claims, and we further
conclude that an increase in the required redundancy ratio to a
level above 45% is necessary, we may determine that additional
reserving actions are necessary.
Reinsurance
- -----------
In November 2002, we transferred our ongoing reinsurance
operations to Platinum Underwriters Holdings, Ltd. ("Platinum")
while retaining liabilities generally for reinsurance contracts
incepting prior to January 1, 2002. Written premium volume
recorded in the third quarter and first nine months of 2003
consisted entirely of premium adjustments relating to reinsurance
business underwritten in prior years. The year-to-date 2003
underwriting profit of $2 million included the impact of $23
million of favorable development related to the September 11,
2001, terrorist attack, which was substantially offset by
unfavorable development in other coverages in the Reinsurance
category of the Other segment and expenses associated with
operating in a runoff environment. Results for the first nine
months of 2003 also included a $6 million underwriting loss
related to the transfer of additional assets and reserves to
Platinum pursuant to an adjustment mechanism (as described in
more detail on pages 39 and 40 of this report). Underwriting
losses for the three months and nine months ended September 30,
2002, were driven by $21 million of losses related to the
September 11, 2001, terrorist attack that were reallocated from
our primary insurance operations to our Reinsurance operations.
Other Runoff
- ------------
This category includes the results of the following operations:
our runoff operations at Lloyd's; Unionamerica, the London-based
underwriting unit acquired as part of our purchase of MMI in
2000; and international operations we decided to exit at the end
of 2001. The $178 million underwriting loss in the first nine
months of 2003 in this category included $109 million of loss
provisions to increase prior-year reserves, of which $39 million
was recorded in the third quarter. In our runoff syndicates at
Lloyd's, which accounted for $47 million of the year-to-date
prior-year provision, the unfavorable development was
concentrated in North American casualty coverages, as well as
specific lines associated with Financial Institutions and
Professional coverages. We experienced deterioration in those
same syndicates throughout 2002, leading us to increase reserve
levels. In the first quarter of 2003, further analysis
undertaken by an independent party on our behalf in connection
with Lloyds' compliance with annual regulatory requirements
provided us with additional information and analyses, which led
us to record a $35 million prior-year loss provision. An
analysis completed during the third quarter of 2003 indicated
that reported losses had been in excess of those projected, and
an additional $12 million provision was recorded.
Our Unionamerica business accounted for $38 million of the year-
to-date provision to increase prior-year reserves, all of which
was recorded in the third quarter. We performed a comprehensive
review of Unionamerica loss reserves in the third quarter that
included a thorough analysis of individual claims and case
reserves, and compared our conclusions regarding their adequacy
with conclusions reached after a similar review in 2002. The
primary factor contributing to the decision to record the
additional loss provision was an increase in the expected future
level of newly reported losses, based on higher than expected
levels of actual newly reported losses in recent quarters.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Also contributing to the underwriting loss in the first nine
months of 2003 was $25 million of unfavorable prior-year
development primarily related to several specific large losses in
a number of countries within our exited international operations
where we have ceased underwriting business. The remainder of the
year-to-date underwriting loss was the result of provisions for
losses on current accident year business, and expenses associated
with the runoff lines of business in this segment.
The significant underwriting losses in this category in the first
nine months of 2002 were driven by the $585 million loss
provision related to the Western MacArthur asbestos litigation
settlement agreement, described in more detail on pages 42 and 43
of this report.
Investment Operations
- ---------------------
Pretax net investment income in our property-liability insurance
operations totaled $279 million in the third quarter of 2003, 7%
below pretax investment income of $300 million in the same period
of 2002. Through the first nine months of 2003, pretax
investment income of $833 million was 5% lower than the
comparable 2002 total of $873 million. Our investment income in
2003 has been negatively impacted by declining yields on new
investments and a reduction in funds available for investment due
to significant cash payments for insurance losses and loss
adjustment expenses, including payments related to our runoff
operations. In addition, we made a planned payment of $747
million (including interest) in mid-January 2003 related to the
settlement of the Western MacArthur asbestos litigation, further
reducing our invested asset base in 2003. Since the end of 1999,
average new money rates on taxable and tax-exempt fixed-income
securities have fallen from 7.2% and 5.4%, respectively, to 4.4%
and 3.9%, respectively, at September 30, 2003.
The market value of our $15.7 billion fixed income portfolio
exceeded its cost by $992 million at September 30, 2003.
Approximately 98% of that portfolio is rated at investment grade
(BBB or above). The weighted average pretax yield on those
investments was 5.9% at September 30, 2003, down from 6.4% a year
earlier.
Net pretax realized investment gains in our property-liability
insurance operations totaled $5 million in the third quarter of
2003, compared with realized losses of $74 million in the same
2002 period. In the third quarter of 2002, realized investment
losses were concentrated in our venture capital portfolio, where
we sold the majority of our partnership investments, which
generated a pretax loss of approximately $56 million. On a year-
to-date basis, net pretax realized investment gains totaled $43
million in 2003, compared with realized losses of $151 million in
the same 2002 period. The gains in 2003 were concentrated in
venture capital and were almost entirely the result of the sale
of a large portion of our investment in Select Comfort
Corporation, a manufacturer of adjustable air-supported beds,
which generated a pretax gain of $109 million. The year-to-date
losses in 2002 included the losses from the sale of venture
capital partnerships discussed above and losses from the sale of
equity investments totaling $41 million.
In the first nine months of 2003, we sold fixed income securities
with a cumulative amortized cost of $617 million, generating
gross pretax gains of $34 million. Those gains were partially
offset by impairment writedowns totaling $17 million. Net pretax
realized gains generated by sales from our equity portfolio
totaled $12 million in the first nine months of 2003. In our
venture capital portfolio, pretax realized gains from the sale of
securities totaled $137 million in the first nine months of 2003
(primarily resulting from the Select Comfort sale), an amount
that was partially offset by impairment writedowns totaling $99
million.
In the first nine months of 2002, we sold fixed income securities
with a cumulative amortized cost of $2 billion, generating gross
pretax gains of $131 million. Those gains were partially offset
by impairment writedowns totaling $39 million. In our venture
capital portfolio, impairment writedowns totaled $55 million in
the first nine months of 2002.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Environmental and Asbestos Claims
---------------------------------
We continue to receive claims, including through lawsuits,
alleging injury or damage from environmental pollution or seeking
payment for the cost to clean up polluted sites. We also receive
asbestos injury claims, including through lawsuits, arising out
of coverages under general liability policies. Most of these
claims arise from policies written many years ago. Significant
legal issues, primarily pertaining to the scope of coverage,
complicate the determination of our alleged liability for both
environmental and asbestos claims. In our opinion, court
decisions in certain jurisdictions have tended to broaden
insurance coverage for both environmental and asbestos matters
beyond the intent of the original insurance policies.
Our ultimate liability for environmental claims is difficult to
estimate because of these legal issues. Insured parties have
submitted claims for losses that in our view are not covered in
their respective insurance policies, and the final resolution of
these claims may be subject to lengthy litigation, making it
difficult to estimate our 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 our ultimate liability for asbestos claims is also
very difficult. The primary factors influencing our estimate of
the total cost of these claims are case law and a history of
prior claim development, both of which continue to evolve and are
complicated by aggressive litigation against insurers, including
us. Estimating ultimate liability is also complicated by the
difficulty of assessing what rights, if any, we may have to seek
contribution from other insurers of any policyholder.
Late in 2001, we hired a new Executive Vice President of Claims,
with extensive experience with environmental and asbestos claims
handling and environmental and asbestos reserves, who conducted a
summary level review of our environmental and asbestos reserves.
As a result of observations made in this review, we undertook
more detailed actuarial and claims analyses of environmental
reserves. No adjustment to reserves was made in the fourth
quarter of 2001, since management did not have a sufficient basis
for making an adjustment until such supplemental analyses were
completed, and we believed our environmental and asbestos
reserves were adequate as of December 31, 2001.
Our historical methodology (through first quarter 2002) for
reviewing the adequacy of environmental and asbestos reserves
utilized a survival ratio method, which considers ending reserves
in relation to calendar year paid losses. When the environmental
reserve analyses were completed in the second quarter of 2002, we
supplemented our survival ratio analysis with the detailed
additional analyses referred to above, and concluded that our
environmental reserves were redundant by approximately $150
million. Based on our additional analyses, we released
approximately $150 million of environmental reserves in the
second quarter of 2002. Had we continued to rely solely on our
survival ratio analysis, we would have recorded no adjustment to
our environmental reserves through the six months ended June 30,
2002.
In the second quarter of 2002, we also supplemented our survival
ratio analysis of asbestos reserves with a detailed claims
analysis. We determined that, excluding the impact of the
Western MacArthur settlement, our asbestos reserves were
adequate; however, including that impact, we determined that our
asbestos reserves were inadequate.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Environmental and Asbestos Claims (continued)
--------------------------------------------
As a result of developments in the asbestos litigation
environment generally, we determined in the first quarter of 2002
that it would be desirable to seek earlier and ultimately less
costly resolutions of certain pending asbestos-related
litigations. As a result, we have decided where possible to seek
to resolve these matters while continuing to vigorously assert
defenses in pending litigations. We are taking a similar
approach to environmental litigations. As discussed in more
detail on pages 42 and 43 of this report, in the second quarter
of 2002 we entered into a definitive agreement to settle asbestos
claims for a total gross cost of $995 million arising from any
insuring relationship we and certain of our subsidiaries may have
had with MacArthur Company, Western MacArthur Company or Western
Asbestos Company.
The table below represents a reconciliation of total gross and
net environmental reserve development for the nine months ended
September 30, 2003, and the years ended December 31, 2002 and
2001. Amounts in the "net" column are reduced by reinsurance
recoverables. The disclosure of environmental reserve
development includes all claims related to environmental
exposures. Additional disclosure has been provided to separately
identify loss payments and reserve amounts related to policies
that were specifically underwritten to cover environmental
exposures, referred to as "Underwritten," as well as amounts
related to environmental exposures that were not specifically
underwritten, referred to as "Not Underwritten." In 1988, we
completed our implementation of a pollution exclusion in our
commercial general liability policies; therefore, activity
related to accident years after 1988 generally relates to
policies underwritten to include environmental exposures.
The amounts presented for paid losses in the following table as
"Underwritten" include primarily exposures related to accident
years after 1988 for policies which the underwriter contemplated
providing environmental coverage. In addition, certain pre-1988
exposures, primarily first party losses, are included since they
too were contemplated by the underwriter to include environmental
coverage. "Not Underwritten" primarily represents exposures
related to accident years 1988 and prior for policies which were
not contemplated by the underwriter to include environmental
coverage.
Nine Months Ended
Environmental September 30, 2003 2002 2001
------------- ------------------ ----------- -----------
(in millions) Gross Net Gross Net Gross Net
----------- ----- ---- ----- ---- ----- ----
Beginning reserves $370 $298 $604 $519 $684 $573
Incurred losses 22 (1) (2) (3) 6 21
Reserve reduction - - (150) (150) - -
Paid losses:
Not underwritten (88) (59) (70) (56) (74) (63)
Underwritten (6) (6) (12) (12) (12) (12)
----- ---- ----- ---- ----- ----
Ending reserves $298 $232 $370 $298 $604 $519
===== ==== ===== ==== ===== ====
The $150 million reduction of environmental reserves in 2002
discussed previously was included in the gross and net incurred
losses for 2002.
For 2001, the year-end gross and net environmental "underwritten"
reserves were both $28 million, at December 31, 2002 such gross
and net reserves were both $36 million, and at September 30,
2003, such gross and net reserves were $38 million and $37
million, respectively. These reserves relate to policies, which
were specifically underwritten to include environmental
exposures. These "underwritten" reserve amounts are included in
the total reserve amounts in the preceding table.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Environmental and Asbestos Claims (continued)
--------------------------------------------
The following table represents a reconciliation of total gross
and net reserve development for asbestos claims for the nine
months ended September 30, 2003 and the years ended December 31, 2002
and 2001. No policies have been underwritten to specifically
include asbestos exposure.
Nine Months Ended
Asbestos September 30, 2003 2002 2001
------------- ------------------ ----------- -----------
(in millions) Gross Net Gross Net Gross Net
----------- ----- ---- ----- ---- ----- ----
Beginning reserves $1,245 $778 $577 $387 $471 $315
Incurred losses 23 2 846 482 167 116
Reserve increase - - 150 150 - -
Paid losses (861) (516) (328) (241) (61) (44)
----- ---- ----- ---- ----- ----
Ending reserves $407 $264 $1,245 $778 $577 $387
===== ==== ===== ==== ===== ====
Paid losses in 2003 include $740 million related to the Western
MacArthur litigation settlement. Included in gross incurred
losses in 2002 were $995 million of losses related to the Western
MacArthur settlement. Also included in the gross and net
incurred losses for the year ended December 31, 2002, but
reported separately in the above table, was a $150 million
increase in asbestos reserves. Gross paid losses in 2002 include
the $248 million Western MacArthur payment made in June 2002.
In 2001, we completed a periodic analysis of environmental and
asbestos reserves at one of our subsidiaries in the United
Kingdom. The analysis was based on a policy-by-policy review of
our known and unknown exposure to damages arising from
environmental pollution and asbestos litigation. The analysis
concluded that loss experience for environmental exposures was
developing more favorably than anticipated, while loss experience
for asbestos exposures was developing less favorably than
anticipated. The divergence in loss experience had an offsetting
impact on respective reserves for environmental and asbestos
exposures; as a result, we recorded a $48 million reduction in
net incurred environmental losses in 2001, and an increase in net
incurred asbestos losses for the same amount.
For a discussion of potential Federal asbestos legislation, refer
to the "Possible Asbestos Legislation" section on page 43 of this
report.
Our reserves for environmental and asbestos losses at September
30, 2003 represent our best estimate of our ultimate liability
for such losses, based on all information currently available.
Because of the inherent difficulty in estimating such losses,
however, we cannot give assurances that our ultimate liability
for environmental and asbestos losses will, in fact, match
current reserves. We continue to evaluate new information and
developing loss patterns, as well as the potential impact of our
determination to seek earlier and, we believe, ultimately less
costly resolutions of certain pending asbestos and environmental
related litigations. Future changes in our estimates of our
ultimate liability for environmental and asbestos claims may be
material to our results of operations, but we do not believe they
will materially impact our liquidity or overall financial
position.
Total gross environmental and asbestos reserves of $705 million
at September 30, 2003 represented approximately 3% of gross
consolidated loss reserves of $20.9 billion.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Asset Management
----------------
Our asset management segment consists of our 79% majority
ownership interest in Nuveen Investments, Inc. ("Nuveen
Investments," formerly The John Nuveen Company). Nuveen
Investments provides individually managed accounts, closed-end
exchange-traded funds and mutual funds to the affluent and high-
net-worth market segments through unaffiliated intermediary
firms. Nuveen Investments also provides managed account services
to several institutional market segments and channels.
Highlights of Nuveen Investments' performance for the three
months and nine months ended September 30, 2003 and 2002 were as
follows.
Three Months Ended Nine Months Ended
September 30 September 30
------------------ -----------------
(in millions) 2003 2002 2003 2002
----------- ------ ------ ------ ------
Revenues $ 121 $ 102 $ 329 $ 286
Expenses 60 49 159 134
------ ------ ------ ------
Pretax earnings 61 53 170 152
Minority interest (12) (11) (35) (33)
------ ------ ------ ------
The St. Paul's share
of pretax earnings $ 49 $ 42 $ 135 $ 119
====== ====== ====== ======
Assets under management $90,059 $76,928
====== ======
Nuveen Investments' strong revenue and earnings growth in the
third quarter was driven by continuing momentum in retail managed
accounts, and the introduction of new closed-end, exchange-traded
funds over the last 12 months. Managed account sales totaled
$2.8 billion in the third quarter of 2003, compared with $1.9
billion in the same 2002 period. The increase reflected strong
demand for value equity portfolios and municipal accounts. In
the third quarter, Nuveen Investments raised approximately $300
million with the introduction of its first exchange-traded fund
that blends debt and equity investment strategies. Also in the
third quarter, Nuveen Investments raised $945 million in exchange-
traded fund assets through the issuance of preferred shares that
leveraged the convertible and preferred income fund first offered
in June. Through the first nine months of 2003, gross investment
product sales totaled $14.0 billion, compared with $11.3 billion
in the same 2002 period. Nuveen Investments' net flows (equal to
the sum of sales, reinvestments and exchanges, less redemptions
and withdrawals) during the first nine months of 2003 totaled
$7.3 billion, 42% higher than comparable 2002 net flows of $5.1
billion.
Assets under management at the end of the third quarter consisted
of $46.1 billion of closed-end exchange-traded funds, $23.0
billion of retail managed accounts, $12.1 billion of mutual funds
and $8.9 billion of institutional managed accounts. The 17%
increase in managed assets over the same time a year ago was
driven by $9.5 billion in positive net flows and $3.6 billion of
equity market appreciation. Assets under management at the end
of 2002 totaled $79.7 billion.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Capital Resources
-----------------
Common shareholders' equity of $6.19 billion at September 30,
2003 grew $511 million over the year-end 2002 total of $5.68
billion, driven by our net income of $609 million in the first
nine months of 2003. Common dividends declared through the first
nine months of 2003 totaled $198 million.
Our reported debt outstanding at September 30, 2003 of $3.57
billion grew significantly over our reported debt of $2.71
billion at December 31, 2002, entirely due to our adoption of
SFAS No. 150. The "Company-obligated mandatorily preferred
securities of trusts holding solely subordinated debentures of
the company" previously reported separately on our consolidated
balance sheet between liabilities and shareholders' equity are
now included in liabilities as a component of debt. These
securities were issued by five separate trusts and are subject to
mandatory redemption on dates ranging from 2027 to 2050, but can
be redeemed earlier in accordance with conditions that vary among
the five trusts. In accordance with provisions of SFAS No. 150,
prior periods were not restated to conform with the 2003
classification of these securities as liabilities. Excluding the
$897 million impact of the balance sheet reclassification, debt
outstanding at September 30, 2003 of $2.68 billion declined
slightly from the year-end 2002 total of $2.71 billion, largely
due to a net $239 million reduction in commercial paper
outstanding. A significant portion of that reduction in
commercial paper was funded by Nuveen Investments' repayment of
an intercompany loan from The. St. Paul. Debt outstanding also
declined as a result of maturities of medium-term notes totaling
$53 million in the first nine months of 2003, which were funded
with internally generated funds.
These reductions in debt were largely offset by a $247 million
increase in Nuveen Investments' debt over year-end 2002. In the
third quarter, Nuveen Investments issued $300 million of 4.22%
notes due in September 2008 in a private placement. A portion
of the proceeds was used to refinance existing debt and repay a
$105 million loan from The St. Paul. The remainder will be used
for Nuveen Investments' general corporate purposes. Our ratio of
total debt and mandatorily redeemable preferred securities to
total capitalization (defined as the sum of debt obligations,
shareholders' equity and mandatorily redeemable preferred
securities) was 36% at the end of the third quarter, down from
the comparable year-end 2002 ratio of 39%. Net interest and
dividend distribution expense related to debt and preferred
securities totaled $138 million in the first nine months of 2003,
compared with $133 million in the same 2002 period. The increase
was primarily due to our issuance in March 2002 of $500 million
of 5.75% Senior Notes and our issuance in July 2002 of $443
million of 5.25% Senior Notes, the impact of which more than
offset a decline in interest expense related to our floating rate
debt.
We made no major capital improvements in the first nine months of
2003, and none are anticipated during the remainder of the year.
Our ratio of earnings to fixed charges was 6.32 for the first
nine months of 2003, compared with 0.54 in the same period of
2002. Our ratio of earnings to combined fixed charges and
preferred stock dividend requirements was 5.98, compared with
0.51 in the same period of 2002. Fixed charges consist of
interest expense, distributions on preferred securities and that
portion of rental expense deemed to be representative of an
interest factor.
Liquidity
---------
Liquidity is a measure of our ability to generate sufficient cash
flows to meet the short- and long-term cash requirements of our
business operations. In our insurance operations, short-term
cash needs primarily consist of funds to pay insurance losses and
loss adjustment expenses and day-to-day operating expenses.
Those needs are generally met through cash provided from
operations, which primarily consists of insurance premiums
collected and investment income. As necessary, additional
liquidity is provided by net sales from our investment portfolio
and access to the debt and equity markets.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Liquidity (continued)
--------------------
Net cash flows used by continuing operations totaled $290 million
in the first nine months of 2003, compared with cash provided by
continuing operations of $435 million in the same period of 2002.
Operational cash outflows in the first nine months of 2003 were
dominated by our January 2003 payment of $747 million related to
the Western MacArthur asbestos litigation settlement. In the
same period of 2002, operational cash flows were negatively
impacted by a $248 million payment related to the Western
MacArthur settlement. In the third quarter of 2003, however, our
consolidated cash flows provided by operations totaled $543
million, driven by favorable underwriting results from our
ongoing underwriting business segments and a decline in the
negative cash flow impact of our operations in runoff, where we
are no longer underwriting new business but continue to pay
insurance losses and loss adjustment expenses. We expect
consolidated operational cash flows during the final quarter of
2003 to continue to grow, due to continuing price increases and
improvement in the quality of our book of business in our ongoing
business segments.
Net loss payments related to the September 11, 2001 terrorist
attack totaled $164 million in the first nine months of 2003,
compared with payments of $208 million in the same 2002 period.
In April 2003, Moody's Investors Services, Inc. lowered certain
of our financial ratings and those of our insurance underwriting
subsidiaries and established a stable outlook on the ratings
going forward. In June 2003, A.M. Best Co. also lowered certain
of our financial ratings while affirming those of our insurance
underwriting subsidiaries and maintaining stable outlooks for
both sets of ratings going forward. We believe our financial
strength continues to provide us with the flexibility and
capacity to obtain funds externally through debt or equity
financings on both a short-term and long-term basis. We continue
to maintain an $800 million commercial paper program with $600
million of back-up liquidity, now consisting entirely of bank
credit agreements.
Impact of Accounting Pronouncements to be Adopted in the Future
- ---------------------------------------------------------------
As discussed in more detail on page 36 of this report, on October
9, 2003, the FASB issued FASB Staff Position ("FSP") FIN 46-6,
"Effective Date of FASB Interpretation No. 46, Consolidation of
Variable Interest Entities," which deferred the effective date of
FIN 46 until the first interim or annual period ending after
December 15, 2003, which for us would be the period ended
December 31, 2003. Under the partial adoption provisions of the
FSP, we early-adopted the consolidation and disclosure provisions
of this interpretation on July 1, 2003. Our partial adoption
specifically excluded the following items.
- Mandatorily redeemable preferred securities of trusts
holding solely subordinated debentures of the company - These
securities were issued by five separate trusts that were
established for the sole purpose of issuing the securities to
investors and are currently included in our consolidated
financial statements. We are currently evaluating the
implications of FIN 46 with regard to these trusts. It is
possible that evaluation will conclude that the trusts should
be "deconsolidated" from our financial statements. We
continue to monitor developments at the FASB regarding this
issue. Should we conclude that FIN 46 requires such
deconsolidation, we have determined that there would be no
"cumulative effect of accounting change" recorded upon
deconsolidation; however, our consolidated assets and
liabilities would each increase by approximately $31 million.
- Lloyd's Syndicates - We participate in various Lloyd's
syndicates at varying levels. We continue to evaluate the
implications of FIN 46 with respect to these syndicates, and
at this time we are not able to quantify the impact of
adoption on our consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Definitions of Certain Statutory Accounting Terms
-------------------------------------------------
Expense Ratio - We use the statutory definition of expenses in
calculating expense ratios disclosed in this report. Expenses
are divided by net written premiums to arrive at the expense
ratio. "Statutory" expenses differ from "GAAP" expenses
primarily with regard to policy acquisition costs, which are not
deferred and amortized for statutory purposes, but rather
recognized as incurred.
Written and Earned Premiums - Net "written" premiums are a
statutory measure of premium volume that differs from the net
"earned" premiums reported in our GAAP statement of operations.
Written premiums for a period can be reconciled to earned
premiums by adding or subtracting the change in unearned premium
reserves in the period.
Loss Ratio - We use the statutory definition of loss ratio. This
ratio is calculated by dividing losses and loss adjustment
expenses incurred by net earned premiums. Net earned premiums,
and losses and loss adjustment expenses, are GAAP measures.
Combined Ratio - This ratio is the sum of the statutory expense
ratio and the statutory loss ratio.
Underwriting Result - We calculate underwriting results using
statutory financial information adjusted for certain items (such
as the amortization of deferred policy acquisition costs) to
arrive at an underwriting result as calculated with GAAP
measures. Our reported GAAP underwriting result is calculated by
subtracting incurred losses and loss adjustment expenses and
underwriting expenses (as adjusted for items such as the impact
of deferred policy acquisition costs) from net earned premiums.
The GAAP underwriting result represents our best measure of
profitability for our property-liability underwriting segments.
We do not allocate net investment income to our respective
underwriting segments. A reconciliation of statutory
underwriting results to our reported underwriting results can be
found in the statistical supplement available on our web site.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
- ------ ----------------------------------------------------------
For a description of our risk management policies and procedures,
see the "Exposures to Market Risk" section of Management's
Discussion and Analysis on pages 54 and 55 of our 2002 Annual
Report to Shareholders.
Item 4. Controls and Procedures.
- ------ -----------------------
An evaluation was carried out under the supervision and with the
participation of the Company's management, including our Chief
Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-15(e) under the
Securities Exchange Act of 1934), as of September 30, 2003.
Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the design and operation of
these disclosure controls and procedures were effective.
Since filing its Quarterly Report on Form 10-Q for the period
ended June 30, 2003 on July 31, 2003, the Company has completed
its investigation of instances of noncompliance with existing
internal controls and possibly with the Foreign Corrupt Practices
Act relating to its Mexican subsidiary. The Company has not
identified that any material adjustment to its financial
statements is necessary as a result of its investigation. The
Company has submitted the results of its investigation to the
U.S. Securities and Exchange Commission, the U.S. Department of
Justice and the Mexican Bonding and Insurance Commission. This
matter does not affect the conclusions expressed in the preceding
paragraph.
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
The information set forth in the "Contingencies"
section (which updates information in our Annual
Report on Form 10-K for the year ended December 31,
2002 pertaining to the Western MacArthur settlement
agreement and certain purported class action
shareholder lawsuits) of 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 furnished in a Form 8-K Current Report dated
July 25, 2003 a press release related to the announcement of
the anticipated impact on second-quarter 2003 financial
results of losses recorded for a surety exposure.
2) The St. Paul furnished in a Form 8-K Current Report dated
July 30, 2003 a press release related to the announcement of
the company's financial results for the quarter and six
months ended June 30, 2003.
3) The St. Paul furnished in a Form 8-K Current Report dated
October 29, 2003 a press release related to the announcement of
the company's financial results for the quarter and nine
months ended September 30, 2003.
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: October 30, 2003 By Bruce A. Backberg
--------------- -----------------
Bruce A. Backberg
Senior Vice President
(Authorized Signatory)
Date: October 30, 2003 By John C. Treacy
---------------- --------------
John C. Treacy
Vice President and
Corporate Controller
(Principal Accounting Officer)
EXHIBIT INDEX
-------------
Exhibit
- -------
(2) Plan of acquisition, reorganization, arrangement,
liquidation or succession*.................................
(3) (i) Articles of incorporation*................................
(ii) By-laws..................................................(1)
(4) Instruments defining the rights of security holders,
including indentures*......................................
(10) Material contracts*...........................................
(11) Statement re computation of per share earnings................(1)
(12) Statement re computation of ratios............................(1)
(15) Letter re unaudited interim financial information*............
(18) Letter re change in accounting principles*....................
(19) Report furnished to security holders*.........................
(22) Published report regarding matters submitted to
vote of security holders*..................................
(23) Consents of experts and counsel*..............................
(24) Power of attorney*............................................
(31) Rule 13a-14(a)/15d-14(a) Certifications
(a) Certification by Jay S. Fishman.....................(1)
(b) Certification by Thomas A. Bradley..................(1)
(32) Section 1350 Certifications
(a) Certification by Jay S. Fishman.....................(1)
(b) Certification by Thomas A. Bradley..................(1)
(99) Additional exhibits*..........................................
* These items are not applicable.
(1) Filed herewith.