UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2003

OR

o 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.

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 o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2).

Yes x   No o

The aggregate market value of the outstanding Common Stock held by non-affiliates of the Registrant on February 24, 2004, was $9,618,402,076.

The number of shares of the Registrant’s Common Stock, without par value, outstanding at February 24, 2004, was 229,105,421.

An Exhibit Index is set forth at page 220 of this report.

DOCUMENTS INCORPORATED BY REFERENCE

None.

 

The St. Paul Companies, Inc.

Annual Report on Form 10-K

For Fiscal Year Ended December 31, 2003

Table of Contents

 

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PART I

Item 1.  Business.

General Description

The St. Paul Companies, Inc. (“The St. Paul” or the “Company”) 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. At February 1, 2004, The St. Paul and its subsidiaries employed approximately 9,300 persons. 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. Our website address is an inactive textual reference only and the contents of the website are not part of this report.

On November 17, 2003, The St. Paul and Travelers Property Casualty Corp. (“Travelers”) announced the signing of a definitive merger agreement that will create The St. Paul Travelers Companies, Inc. (“St. Paul Travelers”), which would be the nation’s second largest property-casualty insurer based on 2002 A.M. Best data concerning direct premiums written. The merger agreement is filed as an exhibit to this report. The Board of Directors of each company unanimously agreed to the tax-free, stock-for-stock merger (the “Proposed Merger” or the “merger”). Under the terms of the merger agreement, Adams Acquisition Corp., a wholly-owned subsidiary of The St. Paul, will merge into Travelers, resulting in Travelers becoming a wholly-owned subsidiary of The St. Paul, and holders of Travelers Class A and Class B common stock will receive 0.4334 common share of The St. Paul for each Travelers share. The St. Paul expects to issue approximately 437 million shares of its common stock in the Proposed Merger. The transaction is subject to customary closing conditions, including the approval by shareholders of both companies as well as certain regulatory approvals. Special shareholder meetings to vote on the Proposed Merger are scheduled for March 19, 2004 in St. Paul, MN and Hartford, CT. The Amended Registration Statement on Form S-4 related to the Proposed Merger was declared effective by the SEC on February 13, 2004. On December 23, 2003, the Federal Trade Commission granted early termination of the waiting period required by the Hart-Scott-Rodino Antitrust Improvements Act of 1976 in connection with the Proposed Merger. The companies are seeking approval of the merger in 11 states and from various foreign regulatory authorities. As of the date of this report, we have received approvals from a number of these regulatory authorities, including the lead domiciliary states of Connecticut and Minnesota, and public hearings have occurred in all states which require hearings to approve the transaction. The transaction is expected to close in the second quarter of 2004.

All information included in the consolidated financial statements and notes to consolidated financial statements in this report reflects only the results of The St. Paul, and does not reflect any impact of the Proposed Merger.

Narrative Description of Business

Property-Liability Insurance

Our property-liability insurance operations underwrite insurance and provide insurance-related products and services to commercial and professional customers throughout the United States and in selected international markets. Our largest insurance underwriting subsidiary is St. Paul Fire and Marine

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Insurance Company (“Fire and Marine”). The primary sources of property-liability revenues are premiums earned from insurance policies, income earned from the investment portfolio and net realized gains from sales of investments. According to the most recent industry statistics published in “Best’s Review” with respect to commercial lines property-liability insurers doing business in the United States, our property-liability underwriting operations ranked as the sixth-largest on the basis of 2002 direct written premiums.

Principal Departments and Products

In general, our property-liability insurance operations underwrite the following types, or “lines,” of insurance coverages.

·  general liability, which provides coverage for liability exposures including personal injury and property damage arising from general business operations, products sold and completed work;

·       liability coverages for corporations and nonprofit organizations, including their directors and officers, and for a variety of professionals such as lawyers, insurance agents and real estate agents;

·       property insurance, which insures tangible property for loss, damage or loss of use;

·       commercial multi-peril, which provides a combination of property coverage (for damages such as those caused by fire, wind, hail, water, theft, and vandalism) and liability coverage (for third-party liability from accidents occurring on the insureds’ premises or arising out of their operations);

·       commercial auto, which provides coverage for businesses against losses resulting from their ownership, maintenance or use of automobiles and trucks, including losses resulting from bodily injury to third parties, physical damage to an insured’s vehicle and property damage to other vehicles and other property;

·       workers’ compensation, which provides coverage for employers for specified benefits payable under state or federal law for workplace injuries, disabilities or death to employees, without regard to fault;

·       inland marine, which provides coverage for property which is generally mobile in nature, such as contractors’ equipment or cargo being shipped by truck or rail, as well as instrumentalities of transportation or communication such as bridges, tunnels and computers, and certain property risks such as builders’ risk;

·       aviation and ocean marine insurance;

·       contract surety bonds and commercial surety bonds; and

·       umbrella coverages, which provide specified layers of coverage on accounts where we do not provide the primary liability coverage.

Further information about these lines of business, including types of coverage that are specific to an operating segment, are included in the segment descriptions that follow this section.

Through one or more lines underwritten by our business segments, including property and general liability, we are exposed to losses from environmental claims and mold claims. Environmental claims include claims of liability for alleged damage from hazardous or toxic materials. The majority of our general liability policies include an absolute pollution exclusion; however, in several business centers, particularly Oil and Gas and Umbrella/Excess & Surplus Lines in our Specialty Commercial segment, we continue to underwrite new business with limited pollution coverage. In addition, most business that we underwrite in the United Kingdom and Ireland do not normally include absolute pollution exclusions. Under certain policies we underwrite, we are exposed to losses from claims of mold and moisture infiltration, which can cause personal injury and damage to property. Certain policyholders have submitted claims to us under their property and general liability polices that include damages related to the presence

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of mold. Predominantly, these mold claims are for property damage submitted under a first-party property policy, or for construction defect third-party liability submitted under a general liability policy. Few personal injury claims related to mold under workers’ compensation or general liability policies have been submitted to us. The cause and type of damage of each property damage or bodily injury incident involving mold determines whether the claim may be a covered loss under a property policy or if there is a duty to defend and/or indemnify an insured in a third-party claim. In addition, we have exposure to claims arising from the use of asbestos in building materials and construction. The “Environmental and Asbestos Claims” section of Management’s Discussion and Analysis included in this report provides additional information regarding our historical exposure to and losses from asbestos and environmental claims.

Property-Liability Underwriting Segments

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 managed. Our property-liability underwriting operations consist of two segments constituting our ongoing operations (Specialty Commercial and Commercial Lines), and one segment predominantly comprised of our runoff operations (Other). The composition of those respective segments is described in greater detail in the following discussion. 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. In addition to our participation in voluntary insurance pools, this 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.

In addition, in the fourth quarter of 2003, our Specialty Programs business center, previously reported in our Specialty Commercial segment, was moved to our Commercial Lines segment to more accurately reflect the manner in which this business is underwritten and managed. All data for 2002 and 2001 in this report were restated to be consistent with the changes made to our segment reporting structure in the first and fourth quarters of 2003. The following discussion describes the composition of our three property-liability underwriting segments.

Specialty Commercial.    This segment includes business centers that we have designated specialty commercial operations because each provides dedicated underwriting, claim and risk control services that require specialized expertise, and each focuses exclusively on the respective customers it serves. Insurance coverage in these business centers is often provided on proprietary insurance forms. This segment also includes our ongoing specialty international operations, and our ongoing operations at Lloyd’s. The Specialty Commercial segment collectively generated $4.50 billion of net earned premiums in 2003 (accounting for 64% of our consolidated earned premium volume). The following discussion describes the operations that comprise our Specialty Commercial segment.

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The 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 or legal obligations. The surety is responsible for evaluating the risk to be covered and for determining if the principal meets the underwriting requirements for the bond. The premium charged will reflect the size and type of the obligation. By offering a bond, the surety is offering assurance that its customer will meet its obligations as specified under the bond.

According to data published by the Surety Association of America, our domestic Surety operations were the second-largest in the United States based on 2002 direct premiums written. In addition to its U.S. operations, our Surety business center also includes Afianzadora Insurgentes, the leading surety underwriter in Mexico, and our Canadian operations, St. Paul Guarantee, the largest surety bond underwriter in Canada.

For Contract Surety, we provide bid, performance and payment bonds to a broad spectrum of clients specializing in general contracting, highway and bridge construction, asphalt paving, underground and pipeline construction, manufacturing, civil and heavy engineering, and mechanical and electrical construction. Bid bonds provide financial assurance that bids have been submitted in good faith and that the contractor intends to enter into the contract at the price bid and provide the required performance and payment bonds. Performance bonds require us to fulfill the contractor’s obligations to the obligee should the contractor fail to perform under the contract. Payment bonds guarantee that the contractor will pay certain subcontractor, labor and material bills associated with a project.

For Commercial Surety, which comprises bonds covering obligations often required by law, the bonds that we currently underwrite are as follows.

·       license and permit bonds, which are required by statutes or regulations for a number of purposes, including guaranteeing the payment of certain taxes and fees and providing consumer protection as a condition to granting licenses related to selling real estate, including tax and customs bonds;

·       reclamation bonds, which cover reclamation costs for mining and other industrial companies;

·       fiduciary bonds, which are required by statutes, courts or contracts for the protection of those on whose behalf a fiduciary (such as an executor of an estate or a guardian of a minor) acts, including probate bonds and depository bonds;

·       court bonds, which are bonds that may be required of either a plaintiff or a defendant in a lawsuit;

·       public official bonds, which are required by statutes and regulations to guarantee the lawful and faithful performance of the duties of office by public officials;

·       indemnity bonds, which are obligations to hold a third party harmless of damages related to an underlying obligation to perform, maintain or pay;

·       workers’ compensation self-insurer bonds, which are required by statutes and regulations to guarantee the payment of workers’ compensation benefits to injured workers of companies that wish to self-insure those obligations;

·       transfer agent indemnity bonds, which protect the issuer of securities and the transfer agent against the possibility that a lost share certificate may be presented later by an innocent purchaser for value; and

·       other miscellaneous bonds.

Like contract surety bonds, commercial surety bonds expose us to the risk that the principal (e.g., the fiduciary in a fiduciary bond or the mining company in a reclamation bond) will not perform the duties required by the contract, applicable law or regulation. Accordingly, we underwrite and price these products by analyzing, among other things, the principal’s creditworthiness and ability to perform.

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Certain sectors of our commercial surety business tend to be characterized by low frequency but potentially high severity losses. In October 2000, we made a strategic decision to significantly reduce the exposures in these sectors. Since that time, we had reduced our total commercial surety gross open bond exposure by over 56% by December 31, 2003.

Within these sectors of our commercial surety business, we have exposures related to a small number of accounts, which are 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.

We continue to exit the segments of the commercial surety market that are characterized by low frequency but potentially high severity bonds by ceasing to write new business and, where possible, terminating the outstanding bonds. We 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.

Our Construction business center offers a variety of products and services, including traditional insurance, consisting of workers’ compensation, general liability and commercial auto coverages, and other risk management solutions, to a broad range of contractors and parties responsible for construction projects.

Financial & Professional Services provides property and liability coverages for financial institutions, professional liability and management liability coverages for corporations and nonprofit organizations against losses caused by the negligence or misconduct of named directors and officers, and errors and omissions coverages for a variety of professionals such as lawyers, insurance agents and real estate agents for liability from errors and omissions committed in the course of professional conduct or practice. Although we have not observed any notable increase in directors and officers claims in this business center, in view of recent allegations of corporate malfeasance and professional misconduct, and the Sarbanes-Oxley Act of 2002 (and regulations issued by the Securities and Exchange Commission pursuant to that law), the frequency and severity of such claims could increase.

Technology offers a portfolio of specialty products and services to companies involved in telecommunications, information technology, health sciences and electronics manufacturing.  These products include property, commercial auto, general liability, workers’ compensation, umbrella, Internet liability, and technology errors and omissions coverages. The services provided by this business center include dedicated underwriting, risk control and specialized claim handling.

The Umbrella/Excess and Surplus Lines Group consists of two distinct business units. Specialty Excess and Umbrella focuses on umbrella and excess liability business for retail agents and brokers, where other insurance companies are providing the primary coverage. The coverages underwritten are typically commercial auto, general liability and product liability. Umbrella coverage may also be underwritten over a company that retains risk or has a self-insured retention, instead of a scheduled underlying policy. The Excess & Surplus Lines unit underwrites non-admitted individual risk business for established wholesale distributors. The coverages typically underwritten include commercial auto, general liability and product liability.

The E&S Underwriting Facilities business center underwrites liability and property facilities produced by wholesalers and managing general agents, which are licensed insurance agents that manage all or part of an insurer’s customers with unique requirements—primarily those with moderate to high hazard exposures requiring expertise in the surplus lines marketplace and the ability to use policy forms not subject to regulatory requirements. Coverages include property, commercial auto, general liability and a small amount of umbrella.

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Public Sector Services markets insurance products and services to municipalities, counties, Indian Nation gaming and selected special government districts, including water and sewer utilities, and non-rail transit authorities. The policies written by this business center typically cover property, commercial auto, general liability, workers’ compensation and errors and omissions exposures.

Discover Re, which principally provides commercial auto liability, general liability, workers’ compensation, and property coverages, serves retail brokers and insureds that are committed to the alternative risk transfer market. Alternative risk transfer techniques are typically utilized by sophisticated insureds that are financially able to assume a substantial portion of their own losses. Discover Re is organized in two underwriting units, each of which underwrites primary insurance in connection with arrangements that involve the client or a captive insurer agreeing to bear much of the covered risk. The individual risk unit markets products to individual insureds that are comfortable retaining the more predictable layer of their expected losses through either large deductible or true self-insured retention programs. Under a large deductible structure, we are exposed not only to the risk of loss under the policy but also to the risk of the insured’s inability or unwillingness to pay its obligations under the terms of the agreement. We mitigate the latter risk by collateralizing all or a portion of the expected losses in the insured’s retained layer. The second underwriting unit is the captive/program unit, which focuses on captive business. Similar to the individual risk accounts, the captives retain the more predictable frequency layer of expected losses, with Discover Re providing excess coverage above the captives’ retention. In some instances the captive/program unit may retain little or no risk, but earns revenues primarily from fees collected for providing access to policies from an admitted insurance company.

Oil and Gas provides specialized property and liability products for customers involved in the exploration and production of oil and gas including operators, drillers and servicing contractors. The policies written by this business center insure drilling rigs, natural gas facilities, pipelines, production and gathering platforms, and cover risks including physical damage, liability and business interruption.

Ocean Marine underwrites a diverse portfolio of coverages for all forms of marine transportation and the companies that serve them, as well as other businesses involved in international trade. Our product offerings fall under four main coverage categories:  marine liability; cargo; hull and machinery, protection and indemnity; and marine property-liability.

Personal Catastrophe Risk underwrites personal property coverages in certain states exposed to earthquakes and hurricanes, including principally California, Texas and Florida. As with our commercial catastrophe risk coverages underwritten in our Commercial Lines segment, a single loss event may produce heavy losses under a number of policies. We attempt to manage the risk to which we are exposed through natural catastrophe reinsurance coverage. The “Natural Catastrophe Risk Management” section of Management’s Discussion and Analysis included in this report, which includes a discussion of our natural catastrophe risk management procedures, is incorporated herein by reference.

Our International & Lloyd’s operation consists of the following components: our ongoing operations at Lloyd’s, and our ongoing specialty commercial operations outside of the United States, including our Global Accounts business center (collectively referred to hereafter as “international specialties”).

Lloyd’s is a subscription insurance market in which member individuals and firms participate to provide insurance to customers seeking coverage for a variety of risks. The members of Lloyd’s are organized into “syndicates” consisting of one or more members. The members provide underwriting capacity with which the syndicate makes coverage available to particular customers. Syndicates are operated by managing agencies that receive fees in respect of the services they provide in both underwriting and claims administration. Coverage is placed by insurance brokers acting on behalf of insureds.

In 2003 at Lloyd’s, we underwrote four principal lines of business—aviation, marine, global property and personal lines—through a single syndicate for which we provide 100% of the capital. This syndicate

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was established in 1996 as Syndicate 1211 and re-branded as Syndicate 5000 in November 2002. Aviation underwrites a broad spectrum of international airline, manufacturer, airport and general aviation business. Marine underwrites energy, cargo and hull coverages. Global property underwrites property coverages worldwide. Personal lines provides specialized accident and health coverages for international clients, including personal accident, kidnap and ransom, and payment protection insurance. Prior to 2003, the aviation and personal lines businesses were underwritten through other syndicates that we managed and in which we participated with other members of Lloyd’s. We do not provide Syndicate 5000 with direct capital contributions, but rather obtain bank letters of credit to support the syndicate’s insurance exposure. We are liable, however, if these letters of credit are called upon to cover any losses of the syndicate and must reimburse the banks that issue the letters of credit for any amounts they pay on our behalf.

In addition to the property-liability business we underwrite at Lloyd’s, we also manage, and have made a commitment to provide 13% of the capacity of, Syndicate 779 at Lloyd’s, which underwrites specialty term life insurance to individuals primarily in the United Kingdom and other European countries.

In December 2003, we completed the sale of Camperdown UK Limited, one of our Lloyd’s corporate names and the vehicle for our participation on the 2003 and prior years of account, to Foltus Investments Limited. We recognized a $2 million pretax gain on this transaction. In 2003, Fire and Marine entered into a 100% quota share reinsurance agreement directly with Syndicate 5000 that in effect transferred Syndicate 5000’s underwriting results for the 2003 year of account to Fire and Marine. In order to continue our ongoing operations at Lloyd’s, we activated two corporate names that will be used for 2004 and future years of account to underwrite Syndicate 5000 business.

Our ongoing international specialties are located in the United Kingdom, Canada and the Republic of Ireland, where we offer specialized insurance and risk management services to a variety of industry sectors. Our ongoing international operations primarily underwrite employers’ liability (similar to workers’ compensation coverage in the U.S.), public and product liability (the equivalent of general liability), professional indemnity (similar to directors and officers or errors and omissions coverage), motor (similar to automobile coverage in the United States) and property. The Global Underwriting business center underwrites “home-foreign” business, representing coverage for a U.S. organization’s property-liability exposures in a foreign country, and “reverse-flow” business, which involves coverage of a foreign organization’s property or liability exposures located in the United States, as part of a global program.

Commercial Lines.    This segment generated $2.22 billion of net earned premiums in 2003, accounting for 31% of our consolidated net earned premium volume. 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 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 enterprises for which annual insurance costs typically range from $75,000 to $1 million, as well as programs for selected industries that are national in scope and have similar risk characteristics such as franchises and associations. The majority of these programs were formerly classified as a separate “Specialty Programs” business center in our Specialty Commercial segment but were reclassified in 2003 to our Middle Market Commercial business center in the Commercial Lines segment to more accurately reflect the manner in which this business is underwritten and managed. Specific lines of insurance underwritten through these programs include property, commercial auto, general liability, workers’ compensation, inland marine, errors and omissions, umbrella and fidelity. Underwriting guidelines, premiums and policy forms issued vary by program and by jurisdiction because of local market conditions and legal requirements. Coverage may be on a primary or an excess basis, depending on how the coverage is structured for a particular insured. Because of the

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national scope of the programs underwritten, we may be exposed to unusually large losses if a single industry whose members are insured through an association is adversely affected by a major event or development, to the extent that the event or development causes losses throughout the industry. The Middle Market Commercial 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 Account Property business with the commercial portion of our catastrophe risk business and allows us to take a unified approach to large commercial property risks. Large Accounts are typically those with property premiums greater than $100,000. This business center focuses on underwriting property coverages for real properties exposed to light to moderate hazards, such as hotels and office buildings, rather than high hazard properties such as petrochemical, mining and other basic process industries. Many of the products underwritten by this business center are structured products, in which we write coverage for a specified layer of risk and other insurers underwrite other layers. Some of the policies underwritten by this business center expose us to catastrophe risk, principally earthquake and hurricane, in which a single loss event can produce heavy losses under a number of policies. The structuring, or layering, of risk as described above results in our being less exposed (before the effect of reinsurance) to such catastrophe risk than if we wrote traditional full limits property policies. To further manage our risk, we purchase reinsurance coverage for catastrophe exposures. Our efforts to manage the risk to which we are exposed from natural catastrophe coverage are described in the “Natural Catastrophe Risk Management” section of this report.

Results from our participation in involuntary insurance pools and associations are also included in the Commercial Lines segment. State insurance laws and regulations require us to participate in mandatory property-liability pooling arrangements that provide insurance coverage to individuals or others who otherwise are unable to purchase coverage voluntarily provided by private insurers. We limit our participation in these pools and associations to the extent possible.

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 various 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). In addition to our participation in voluntary insurance pools, this 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 for health care providers throughout the entire health care delivery system, including individual physicians, physician groups, hospitals, managed care organizations and long-term care facilities, as well as certain traditional medical care coverages. Products include coverages for healthcare professionals (physicians and surgeons, dental professionals and nurses); individual healthcare facilities (including hospitals, long-term care facilities and other facilities such as laboratories); and entire systems, such as hospital networks and managed care systems. Typically our Health Care operation underwrote coverages on the basis of an entire clinic, hospital or other organization, so that we are exposed to losses from the malpractice of any one practitioner on the staff of, or with privileges at, the organization. Policies written by this segment are subject to high severity of claims. In the fourth quarter of 2001, we announced our intention to exit the medical liability insurance market, subject to applicable regulatory requirements.

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In the years prior to 2002, our Reinsurance operation (formerly known as “St. Paul Re”) generally underwrote treaty and facultative reinsurance for property, liability, ocean marine, surety, certain specialty classes of coverage, and “nontraditional” reinsurance, which provided limited traditional underwriting risk protection combined with financial risk protection. In late 2001, we announced our intention to cease underwriting certain types of reinsurance coverages and narrow our geographic presence in 2002. 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, as well as all liabilities relating to the flooding in Europe in August 2002.

Our remaining in-force pre-2002 reinsurance exposures are principally in the following areas:

·       North American Casualty, which offered customers with exposures in the United States and Canada the following types of casualty reinsurance coverages: general, workers’ compensation, auto, non-medical professional, directors and officers, employment practices, surplus lines, umbrella and environmental impairment as well as accident and health reinsurance coverages;

·       International, which underwrote property and casualty reinsurance for customers domiciled outside of North America and marine and aerospace reinsurance for customers located throughout the world;

·       Finite Risk, which underwrote non-traditional reinsurance treaties including multi-year excess-of-loss treaties, aggregate stop loss treaties, finite quota share treaties, loss portfolio transfers, and adverse loss development covers; and

·       Certain bond, credit and financial risk coverages.

The Other component of this segment includes the results of the following insurance operations.

·       Runoff operations at Lloyd’s, primarily consisting of the following lines of business written through four syndicates, across which our ownership ranged from 54% to 100% and which ceased underwriting in 2001 or the first quarter of 2002. These syndicates underwrote the following business (both U.S. and non-U.S. coverages): casualty insurance and reinsurance, non-marine reinsurance, professional liability insurance (particularly for financial institutions, and directors’ and officers’ liability insurance) and 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. Unionamerica underwrote liability and property coverages, including medical malpractice and other professional liability and directors’ and officers’ liability, both inside and outside of Lloyd’s, on both an insurance and excess-of-loss reinsurance basis.

·       All other international runoff lines of business we decided to exit at the end of 2001, consisting of health care business in the United Kingdom, Canada and Ireland, as well as our underwriting operations in Germany, France, the Netherlands, Argentina, Mexico (excluding surety business), Spain, Australia, New Zealand, Botswana and South Africa. In late 2002, we sold our operations in Argentina, Mexico and Spain. In 2003, we sold our operations in Botswana.

·       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). In addition to our participation in voluntary insurance pools, this prior year business includes the majority of our environmental and asbestos liability exposures.

We have a management team in place for the operations comprising this category, to ensure that our outstanding claim obligations are settled in an expeditious and economical manner.

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Product Information

The following table summarizes premiums earned by major product line for the years ended December 31, 2003, 2002 and 2001. Our earned premiums related to our foreign operations are presented in total in the table, as those operations do not classify their business using the same product line definitions as our domestic operations.

Years ended December 31				2003			2002			2001
				(In millions)
Other liability				$	1,537		$	1,325		$	1,082
Special property				834			759			600
Commercial auto liability				813			776			624
Workers compensation				792			670			609
Commercial multiple peril				555			542			456
Fidelity and surety				396			353			395
Products liability				386			321			246
Medical malpractice				55			343			600
Reinsurance—nonproportional assumed property				18			250			485
Other				693			656			640
Total earned premium from domestic operations				6,079			5,995			5,737
Earned premium from foreign operations and other				960			1,507			1,672
Total earned premium				$	7,039		$	7,502		$	7,409

 

Principal Markets and Methods of Distribution 

Our insurance operations in the United States are licensed to transact business in all 50 states, the District of Columbia, Puerto Rico, Guam and the Virgin Islands. At least five percent of Fire and Marine’s 2003 direct written premiums were produced in each of California, New York, Texas and Florida.

Our insurance business in the United States is produced primarily through over 5,000 independent insurance agencies and insurance brokers. The needs of agents, brokers and policyholders are addressed through approximately 115 offices located throughout the United States. Discover Re, a component of our Specialty Commercial segment, underwrites alternative risk transfer business from its Farmington, CT headquarters and from regional offices in Atlanta, Pittsburgh, Houston and San Francisco.

Our international operations are headquartered in London and underwrite insurance primarily through domestic operations in the United Kingdom, Canada and the Republic of Ireland. We also underwrite surety business in Mexico.

Through our involvement at Lloyd’s, we have access to insurance markets in virtually every country in the world. At our ongoing operations at Lloyd’s, we underwrite property-liability business through a single syndicate (Syndicate 5000) and specialty life insurance through our 13% participation in Syndicate 779. Our managing agency, operating under the name St. Paul Syndicate Management Ltd., underwrites business for these syndicates, which represent approximately 2% of Lloyd’s total capacity.

Reserves for Losses and Loss Adjustment Expenses

General Information.    When claims are made by or against policyholders, any amounts that our underwriting operations pay or expect to pay to the claimant are referred to as losses. The costs of investigating, resolving and processing these claims are referred to as loss adjustment expenses (“LAE”). Our loss reserves reflect estimates of total losses and LAE we will ultimately have to pay under insurance policies, surety bonds and reinsurance agreements. The reserves for unpaid losses and LAE at December 31, 2003 cover claims that were incurred not only in 2003 but also in prior years. They include estimates of the total cost of claims that have already been reported but not yet settled (“case” reserves),

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and those that have been incurred but not yet reported (“IBNR” reserves). Loss reserves are reduced for estimates of salvage and subrogation.

Loss reserves for tabular workers’ compensation business and certain assumed reinsurance contracts are discounted to present value. Tabular workers’ compensation reserves are indemnity reserves that are calculated using discounts determined with reference to actuarial tables that incorporate interest and contingencies such as mortality, remarriage, inflation or recovery from disability applied to a reasonably determinable payment stream. Reserves for medical costs associated with the work place injury and reserves for loss adjustment expenses are not discounted. Additional information about these discounted liabilities is set forth in Note 1 to our consolidated financial statements included in this report. During 2003, $2 million of discount was amortized and $5 million of additional discount was accrued.

Because many of the coverages we offer involve claims that may not ultimately be settled for many years after they are incurred, subjective judgments as to our ultimate exposure to losses are an integral and necessary component of our loss reserving process. We record our reserves by considering a range of estimates bounded by a high and low point. Within that range, we record our best estimate. We continually review our reserves, using a variety of statistical and actuarial techniques to analyze current claim costs, frequency and severity data, and prevailing economic, social and legal factors. We adjust reserves established in prior years as loss experience develops and new information becomes available. Adjustments to previously estimated reserves are reflected in results in the year in which they are made.

While we believe our reported reserves make a reasonable provision for all of our unpaid loss and loss adjustment expense obligations, it should be noted that the process of estimating required reserves does, by its very nature, involve uncertainty. The level of uncertainty can be influenced by such factors as the existence of long-tail coverages (which we consider to be business in which the majority of coverages involve average loss payment lags of three years or more beyond the expiration of the policy), and changes in claim handling practices. Many of our insurance subsidiaries have underwritten long-tail coverages, and the primary lines of business fitting that criterion are general liability, workers’ compensation and casualty excess reinsurance. In addition, claim handling practices change and evolve over the years. For example, new initiatives are commenced, claim offices are reorganized and relocated, claim handling responsibilities of individual adjusters are changed, use of a call center is increased, use of technology is increased, caseload issues and case reserving practices are monitored more frequently, etc. Furthermore, establishing reserves for our reinsurance and retrocessional business is influenced by our need to rely on the ceding insurers and reinsurers for information regarding reported claims. However, all of the above factors are sources of uncertainty that we have recognized in establishing our reserves.

The “Loss and Loss Adjustment Expense Reserves” section of Management’s Discussion and Analysis included in Item 7 of this report includes more information about our loss reserves, including an analysis of our long-tail exposures.

Ten-year Development.    The table that follows presents a development of net loss and LAE reserve liabilities and payments for the years 1993 through 2003. The top line on the table shows the estimated liability for unpaid losses and LAE, net of reinsurance recoverables, recorded at the balance sheet date for each of the years indicated.

The table excludes the reserves and activity of Economy Fire and Casualty Company and its subsidiaries (“Economy”), which were included in the sale of our standard personal insurance operations to Metropolitan Property and Casualty Insurance Company (“Metropolitan”) in 1999. The table does, however, include reserves and activity for the non-Economy standard personal insurance business that was sold to Metropolitan, since we remain liable for claims on non-Economy standard personal insurance policies that result from losses occurring prior to Sept. 30, 1999 (the closing date of the sale). The “Reconciliation of Loss Reserves” table in Note 8 to our consolidated financial statements in Item 8 of this

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report includes the reserve activity related to the non-Economy claims, as “Activity on reserves of discontinued operations.”

In December 2003, we completed the sale of Camperdown UK Limited, one of our Lloyd’s corporate names and the vehicle for our participation on the 2003 and prior years of account, to Foltus Investments Limited. The $944 million of net reserves transferred as part of the sale are excluded from net reserves for the year ended December 31, 2003 in the following table. Years prior to 2003 in the table include the Camperdown UK Limited reserves, as well as loss development and payments related to those reserves.

When we acquire an insurance underwriting company, we include loss development for the acquired company in the following table beginning with the date of acquisition; however, that development includes activity from periods prior to our acquisition.

The upper portion of the table, which shows the re-estimated amounts relating to the previously recorded liabilities, is based upon experience as of the end of each succeeding year. These estimates are either increased or decreased as further information becomes known about individual claims and as changes in the trend of claim frequency and severity become apparent.

The “Cumulative redundancy (deficiency)” line on the table for any given year represents the aggregate change in the estimates for all years subsequent to the year the reserves were initially established. For example, the 1994 net reserve of $12,997 million developed to $12,227 million, or a $770 million redundancy, by the end of 1996. By the end of 2003, the 1994 reserve had developed a redundancy of $1,812 million. The changes in the estimate of 1994 loss reserves were reflected in operations during the past nine years. Likewise, the deficiency that developed with respect to year-end 2001 reserves (primarily related to our medical liability business) was reflected in our results of operations for 2003 and 2002.

The middle portion of the table represents a reconciliation between the net reserve liability as shown on the top line of the table and the gross reserve liability as shown on our balance sheet. This portion of the table also presents the gross re-estimated reserve liability as of the end of the latest re-estimation period (December 31, 2003) and the related re-estimated reinsurance recoverable.

The lower portion of the table presents the cumulative amounts paid with respect to the previously recorded liability as of the end of each succeeding year. For example, as of December 31, 2003, $9,640 million of the currently estimated $11,185 million of net losses and LAE that have been incurred for the years up to and including 1994 have been paid. Thus, as of December 31, 2003, it is estimated that $1,545 million of net incurred losses and LAE have yet to be paid for the years up to and including 1994.

Caution should be exercised in evaluating the information shown in this table. It should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, the portion of the development shown for year-end 1999 reserves that relates to 1994 losses is included in the cumulative redundancy (deficiency) for the years 1994 through 1999.

In addition, the table presents calendar year data. It does not present accident or policy year development data, which some readers may be more accustomed to analyzing. The social, economic and legal conditions and other trends which have had an impact on the changes in the estimated liability in the past are not necessarily indicative of the future. Accordingly, readers are cautioned against extrapolating any conclusions about future results from the information presented in this table.

For additional information regarding our loss reserve liabilities, see Note 8 to our consolidated financial statements included in Item 8 of this report, which includes a reconciliation of beginning and ending loss reserve liabilities for each of the years 2003, 2002 and 2001. In addition, see the “Loss and Loss Adjustment Expense Reserves,” “Environmental and Asbestos Claims” and “Other” sections of Management’s Discussion and Analysis included in Item 7 of this report.

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Analysis of Loss and Loss Adjustment Expense (LAE) Development
(In millions)

Year ended December 31				1993			1994		1995		1996		1997		1998		1999		2000		2001		2002		2003
Net liability for unpaid losses and LAE				$	12,970		12,997		13,464		14,689		14,704		14,813		14,042		13,545		15,253		14,849		13,275
Liability re-estimated as of:
One year later				12,601			12,665		12,995		13,929		14,534		14,822		13,315		14,139		16,252		15,495
Two years later				12,227			12,227		12,289		13,703		14,534		14,097		13,183		15,050		17,347
Three years later				11,929			11,770		12,141		13,791		13,917		13,821		13,805		15,713
Four years later				11,567			11,621		12,195		13,395		13,502		14,165		14,154
Five years later				11,454			11,580		11,683		12,967		13,787		14,472
Six years later				11,404			11,197		11,316		13,224		13,984
Seven years later				11,112			10,876		11,547		13,405
Eight years later				10,843			11,104		11,662
Nine years later				11,087			11,185
Ten years later				11,066
Cumulative redundancy (deficiency)				$	1,904		1,812		1,802		1,284		720		341		(112	)	(2,168	)	(2,094	)	(646	)
Net liability for unpaid losses and LAE				$	12,970		12,997		13,464		14,689		14,704		14,813		14,042		13,545		15,253		14,849		13,275
Reinsurance recoverable on unpaid losses				2,581			2,533		2,824		2,864		3,051		3,199		3,678		4,651		6,848		7,777		6,151
Gross liability				15,551			15,530		16,288		17,553		17,755		18,012		17,720		18,196		22,101		22,626		19,426
Gross re-estimated liability:
One year later				15,157			15,620		15,844		17,024		17,725		17,840		17,011		19,576		24,536		23,399
Two years later				15,181			15,257		15,105		16,787		17,466		16,813		17,111		21,988		25,601
Three years later				14,968			14,666		14,985		16,669		16,559		16,777		18,795		22,738
Four years later				14,500			14,675		14,743		15,881		16,259		17,956		19,292
Five years later				14,530			14,350		13,883		15,583		17,321		18,309
Six years later				14,234			13,688		13,576		16,610		17,628
Seven years later				13,813			13,375		14,781		16,845
Eight years later				13,501			14,570		14,960
Nine years later				14,711			14,683
Ten years later				14,673
Gross cumulative redundancy (deficiency)				$	878		847		1,328		708		127		(297	)	(1,572	)	(4,542	)	(3,500	)	(773	)
Cumulative amount of net liability paid through:
One year later				$	2,723		2,641		2,893		3,335		3,518		3,950		3,769		4,574		5,416		5,146
Two years later				4,506			4,491		4,827		5,657		6,144		6,476		6,589		8,282		9,605
Three years later				5,778			5,817		6,309		7,444		7,906		8,354		8,941		11,127
Four years later				6,693			6,851		7,390		8,698		9,147		9,852		10,967
Five years later				7,423			7,648		7,857		9,465		10,205		11,560
Six years later				8,020			7,940		8,360		10,244		11,545
Seven years later				8,247			8,305		8,949		11,355
Eight years later				8,540			8,793		9,931
Nine years later				8,976			9,640
Ten years later				9,761
Cumulative amount of gross liability paid through:
One year later				3,316			3,241		3,408		3,702		3,943		4,392		4,297		5,619		7,029		6,711
Two years later				5,489			5,491		5,386		6,310		6,796		7,170		7,632		10,235		12,806
Three years later				7,054			6,842		7,074		8,316		8,657		9,428		10,573		14,267
Four years later				7,989			8,034		8,289		9,559		10,168		11,329		13,603
Five years later				8,831			8,942		8,870		10,486		11,509		13,718
Six years later				9,540			9,311		9,478		11,519		13,487
Seven years later				9,866			9,758		10,290		13,199
Eight years later				10,231			10,454		11,826
Nine years later				10,871			11,783
Ten years later				12,119

 

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NATURAL CATASTROPHE RISK MANAGEMENT

Our property-liability insurance operations expose us to claims arising out of natural catastrophes, as well as terrorism. Natural catastrophes can be caused by various events, but losses are principally driven by hurricanes and earthquakes. The incidence and severity of natural catastrophes and terrorist attacks are inherently unpredictable and may materially reduce our profitability in a given period or even harm our financial condition. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the affected area and the severity of the event.

Most catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage, especially in areas that are heavily populated. Most of the catastrophe-related claims in our ongoing businesses in the past five years have related to commercial property coverages in the United States. The geographic distribution of our business subjects us to natural catastrophe exposure principally from hurricanes in Florida and the Mid-Atlantic, Northeast, and Gulf coast regions, as well as earthquakes in California, along the New Madrid fault line and in the Pacific Northwest region.

We attempt to estimate the impact of certain catastrophic events using catastrophe models developed by outside vendors. Models are applied to evaluate our exposure to losses arising from individual contracts and in the aggregate. Underwriting controls and systems exist to ensure that individual contracts conform to our risk tolerance, fit within our existing exposure portfolio, and are priced at appropriate levels.

We rely significantly on reinsurance to limit our exposure to natural catastrophes. Reinsurance exists both at an account level and at the portfolio level, where we purchase a specific natural catastrophe reinsurance treaty. In the event that reinsurance capacity providing natural catastrophe protection becomes limited, we would adjust our direct exposures accordingly.

There can be no assurance that our underwriting risk management procedures and our reinsurance programs will limit actual losses to a level consistent with our risk tolerance. Losses from an individual catastrophe, or a series of catastrophes, may materially exceed such amount. Actual results may vary from the expectations developed in our catastrophe modeling, and such variances could negatively impact our reinsurers and the related reinsurance recoverables.

CEDED REINSURANCE

Purpose.   When we purchase reinsurance or “cede” insurance premiums and risks, other insurers or reinsurers agree to share certain risks that we have underwritten. The primary purpose of reinsurance is to limit a ceding insurer’s maximum net loss from individually large or aggregate risks as well as to provide protection against catastrophes. Our reinsurance program is generally managed from a corporate risk-tolerance perspective. Reinsurance contracts addressing specific business center risks are utilized on a limited basis to cover unique exposures as necessary. Our reinsurance program addresses risk through a combination of per-risk reinsurance and reinsurance contracts protecting against the aggregation of risk exposures. Facultative reinsurance, which covers specific risks, is also used to supplement our reinsurance program. Until the transfer of our ongoing reinsurance operations to Platinum in November 2002, we underwrote assumed reinsurance coverages on a worldwide basis.

Price increases and pressures on contract terms and conditions continue in the reinsurance market. Despite these constraints, our reinsurance program continues to support our primary underwriting reinsurance needs, particularly as increases in rates and reductions in limits also continue in the reinsurance market.

Creditworthiness of Reinsurers.   Approximately 94% of our reinsurance recoverable balances at December 31, 2003 were with reinsurance companies having financial strength ratings of A- or higher by A.M Best or Standard & Poors, were from state sponsored facilities or reinsurance pools, or were collateralized reinsurance programs associated with certain of our insurance operations. We have an

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internal credit security committee, which uses a comprehensive credit risk review process in selecting our reinsurers. This process considers such factors as ratings by major ratings agencies, financial condition, parental support, operating practices, and market news and developments. The credit security committee convenes quarterly to evaluate these factors and take action on our approved list of reinsurers, as necessary.

We maintain an allowance for uncollectible reinsurance, which is evaluated and adjusted on a regular basis to reflect disputed coverages and changing market and credit conditions. Our allowance for uncollectible reinsurance as a percentage of total reinsurance recoverable balances was 1.9% and 1.5% as of December 31, 2003 and 2002, respectively.

In 2001, we entered into two aggregate excess-of-loss reinsurance treaties. One of these treaties was corporate-wide, with coverage triggered when our insurance losses and LAE across all lines of business reached a certain level, as prescribed by terms of the treaty (the “corporate program”). We did not enter into such a treaty in 2002 or 2003. Additionally, our Reinsurance operation was impacted by cessions made under a separate treaty in 2001 and 2002 unrelated to the corporate treaty. The combined impact of these treaties (together, the “reinsurance treaties”) is included in the table that follows.

Years Ended December 31				2003			2002			2001
				(In millions)
Ceded written premiums				$	—		$	(1	)	$	128
Ceded losses and loss adjustment expenses				—			(35		)	253
Ceded earned premiums				—			(1		)	128
Net pretax benefit (detriment)				$	—		$	(34	)	$	125

 

The $35 million of negative losses and loss adjustment expenses ceded in 2002 was related to the reinsurance segment treaty and primarily resulted from a commutation of a portion of that treaty. Note 15 to our consolidated financial statements in Item 8 of this report provides a schedule of ceded reinsurance and additional information about the reinsurance treaties.

Until the transfer of our ongoing reinsurance operations to Platinum Underwriters Holdings, Ltd. (“Platinum”) in November 2002, we underwrote assumed reinsurance coverages on a worldwide basis. We remain liable on all reinsurance contracts with inception dates prior to January 1, 2002, as well as on certain 2002 contracts that were not transferred to Platinum. Note 19 to our consolidated financial statements in Item 8 of this report provides more information about the transfer of operations to Platinum.

TERRORISM RISK AND LEGISLATION

On November 26, 2002, President Bush signed into law the Terrorism Risk Insurance Act of 2002 (“TRIA”). TRIA established 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.

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An insurer’s deductible in 2003 was 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 long-term rating plans in all states.

We continue to monitor TRIA’s impact on the insurance industry generally and on us specifically. 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 $690 million (calculated based on 10% of our TRIA-qualifying calendar year 2003 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 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’

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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.

PROPERTY-LIABILITY INVESTMENT OPERATIONS SEGMENT

Our board of directors approves the overall investment plan for the companies within The St. Paul’s property-liability operations. Each subsidiary develops its own specific investment policy tailored to comply with domestic laws and regulations and the overall corporate investment plan. The primary objectives of those plans are to ensure our ability to meet our liabilities, primarily consisting of insurance claim payments, and, having done that, to increase our shareholders’ equity. The funds we invest are generated by underwriting cash flows, consisting of the premiums collected less losses and expenses paid, and by investment cash flows, consisting of income received on existing investments and proceeds from sales, redemptions and maturities of investments.

The majority of funds available for investment are deployed in a widely diversified portfolio of high-quality, intermediate-term taxable U.S. government, corporate and mortgage-backed bonds, and tax-exempt U.S. municipal bonds. We also invest much smaller amounts in equity securities, venture capital and real estate. The latter three investment classes have the potential for higher returns but also involve varying degrees of risk, including less stable rates of return and less liquidity.

The following discussion provides more information on each of our invested asset classes.

Fixed Income Securities.   Our portfolio of fixed income securities constituted 71% (at cost) of our property-liability insurance operations’ investment portfolio at December 31, 2003. The portfolio is primarily composed of high-quality, intermediate-term taxable U.S. government, corporate and mortgage-backed bonds, and tax-exempt U.S. municipal bonds. The following table presents information about the fixed maturity portfolio for the years 2001 through 2003 (dollars in millions).

Year				Amortized Cost at Year-end					Estimated Fair Value at Year-end					Weighted Average Pre-tax Yield				Weighted Average After-tax Yield
2003					$	15,585				$	16,447				5.7	%			4.1	%
2002					$	16,126				$	17,135				6.2	%			4.5	%
2001					$	15,194				$	15,756				6.6	%			4.8	%

 

We participate in a securities lending program whereby certain securities from our fixed income portfolio are loaned to other institutions. We require collateral equal to 102 percent of the fair value of the loaned securities. We maintain full ownership rights to the securities loaned, and continue to earn interest on them. In addition, we have the ability to sell the securities while they are on loan. We have an indemnification agreement with the lending agents in the event a borrower becomes insolvent or fails to return securities. We record securities lending collateral as a liability and pay the borrower an agreed upon interest rate. The proceeds from the collateral are invested in short-term investments and are reported as “Securities on Loan” on the balance sheet. We share a portion of the interest earned on these short-term investments with the lending agent. The fair value of the securities on loan is removed from fixed income securities on the balance sheet and shown as a separate investment asset.

We manage our bond portfolio conservatively to provide reasonable returns while limiting exposure to risks. At December 31, 2003, approximately 96% of our fixed income portfolio (comprised of fixed income securities, the fixed income portion of our securities on loan and short-term investments), was rated investment grade. Approximately 3% consisted of non-investment grade securities and 1% were non-rated securities.

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Real Estate and Mortgage Loans.   Our real estate holdings consist of a diversified portfolio of commercial office and warehouse properties that we own directly or have partial interest in through joint ventures. The properties are geographically distributed throughout the United States and had an overall occupancy rate of 89.7% at December 31, 2003. We also have a portfolio of real estate mortgage loans acquired in our merger with USF&G Corporation in 1998. The real estate and mortgage loan portfolio produced $67 million of pretax investment income in 2003 and generated $4 million of pretax realized gains.

Venture Capital.   Securities of small- to medium-sized companies spanning a variety of industries comprise our venture capital holdings, which accounted for 2% of property-liability investments (at cost) at December 31, 2003. The $535 million carrying value of venture capital investments at December 31, 2003 included $24 million of pretax unrealized appreciation. Venture capital investments generated pretax realized investment gains of$51 million in 2003 and losses of $200 million in 2002.

In our venture capital portfolio, the sale of a large portion of one of our investment holdings generated a pretax gain of $171 million in 2003, which was largely offset by impairment realized losses totaling $143 million related to 38 of our investment holdings. Fourteen of those holdings were impaired due to a merger or sale at a value less than our cost. Eleven holdings experienced fundamental economic deterioration (characterized by gross margins being less than expected, product pricing not meeting initial projections due to market conditions, and greater than expected manufacturing expenses). Six holdings were written down because the entities’ progress was substantially less than planned and additional financing was required at values less than our cost. An additional six holdings were impaired due to cessation of operations of the entity. Finally, one holding was impaired because market demand for its product was less than expected.

In 2002, realized losses in our venture capital portfolio included $56 million of losses resulting from the sale of the majority of our partnership investment holdings, and impairment write-downs in 25 of our holdings totaling $122 million. These holdings were impaired for the same general reasons noted above for the 2003 impairments: seven holdings were impaired because market demand for their products was less than expected; seven holdings were written down because the entities’ progress was less than planned and additional financing would be required; five holdings were impaired due to fundamental economic deterioration (as defined above); four holdings were impaired due to a merger or sale at less than our cost; and two holdings were impaired due to cessation of operations.

Equities.   Our equity holdings consist of a diversified portfolio of public common stock, comprising less than 1% of total property-liability investments (at cost) at year-end 2003. In mid-2002, we began reducing our equity investments. Our decision to reduce our public equity holdings was prompted by several factors, including our opinion as to the near-term direction of equity prices, a comprehensive evaluation of our aggregate equity exposure (including venture capital and equities held by our pension fund), and a change in our opinion as to the level of public equity investments that is appropriate for publicly held insurance companies in light of increasing equity market volatility. By the end of 2003, we had reduced our equity investments by $953 million (at cost) since year-end 2001.

Short-Term and Other Investments.   Our portfolio also includes short-term securities and other miscellaneous investments (including our 14% equity ownership stake in Platinum and our warrants to purchase up to six million additional common shares of Platinum), which in the aggregate comprised 15% of property-liability investments at December 31, 2003. Also included in “Other investments” at December 31, 2003 and 2002 was a long-term interest-bearing security from a highly rated entity, supporting a series of insurance transactions. The carrying value of that security on those dates was $359 million and $386 million, respectively.

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Derivatives.   Our property-liability investment operations have had limited involvement with derivative financial instruments, primarily for purposes of hedging against fluctuations in foreign currency exchange rates and interest rates. Effective January. 1, 2001, we adopted the provisions of Statement of Financial Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, which required the recognition of all derivative instruments as either assets or liabilities on the balance sheet. See Note 7 to our consolidated financial statements in Item 8 of this report, which provides more information regarding the impact of adopting SFAS No. 133.

In addition to Note 7, see Notes 1, 5 and 6 to our consolidated financial statements included in Item 8 of this report, which provide additional information about our investment portfolio.

Asset Management

Nuveen Investments, Inc. (“Nuveen Investments,” formerly The John Nuveen Company) is our asset management subsidiary. The St. Paul and its largest property-liability insurance subsidiary, Fire and Marine) hold a combined 79% interest in Nuveen Investments.

Nuveen Investments’ core businesses are asset management and related research, as well as the development, marketing and distribution of investment products and services for the affluent, high net worth and institutional market segments. Nuveen Investments distributes its investment products and services, including individually managed accounts, closed-end exchange-traded funds and mutual funds, to the affluent and high net worth market segments through unaffiliated intermediary firms including broker/dealers, commercial banks, affiliates of insurance providers, financial planners, accountants, consultants and investment advisors. Nuveen Investments also provides managed account services, including privately offered partnerships, to several institutional market segments and channels.

Nuveen Investments’ primary business activities generate three principal sources of revenue: (1) advisory fees earned on assets under management, including exchange-traded funds, separately managed accounts and mutual funds; (2) underwriting and distribution revenues earned upon the sale of certain investment products and (3) performance fees earned on certain institutional accounts based on the performance of such accounts. Advisory fees accounted for 90% of Nuveen Investments’ total revenues in 2003.

Operations of Nuveen Investments are organized around its principle advisory subsidiaries, which are registered investment advisors under The Investment Advisors Act of 1940:  Nuveen Advisory Corp. (“NAC”) and Nuveen Institutional Advisory Corp (“NIAC”) manage various Nuveen mutual funds and exchange-traded funds; Nuveen Asset Management (“NAM”), Rittenhouse Asset Management (“Rittenhouse”), NWQ Investment Management Company, LLC (“NWQ”), and Symphony Asset Management (“Symphony”) principally provide investment management services for individual and institutional managed accounts.

Additionally, Nuveen Investments, LLC, a registered broker and dealer in securities under The Securities Exchange Act of 1934, provides investment product distribution and related services for the Company’s managed funds and, through March of 2002, sponsored and distributed the Company’s defined portfolios.

At December 31, 2003, Nuveen Investments’ assets under management totaled $95.4 billion, consisting of $47.1 billion of exchange-traded funds, $25.7 billion of retail managed accounts, $10.3 billion of institutional managed accounts, and $12.3 billion of mutual funds.

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Competition

Property-Liability Insurance

The property-liability insurance industry is highly competitive in the areas of price, service, product offerings, technology and agent relationships. Ratings issued by independent ratings agencies are also a competitive factor in the insurance business. Increasing the competitive pressure is the current low interest rate environment that is impacting investment returns and making underwriting decisions even more critical. Our domestic and international insurance subsidiaries compete with other stock companies, mutual companies, alternative risk sharing groups and other underwriting organizations. Competitors in this market are primarily national property-liability insurance companies willing to write most classes of business using traditional products and pricing and, to a lesser extent, regional insurance companies and companies that have developed niche programs for specific industry segments. In addition, many large commercial customers self-insure their risks or utilize large deductibles on purchased insurance. There are approximately 3,400 property and liability insurance companies in the United States operating independently or in groups, and no single company or group is dominant. According to A.M. Best, we are the sixth-largest United States commercial lines property and liability insurance group based on 2002 direct premiums written. Some of our competitors are larger and have greater access to capital. In various markets, we also compete based on ratings and several of our competitors are more highly rated.

In addition, the financial services industry in general continues to be affected by an intensifying competitive environment, as demonstrated by consolidation through mergers and acquisitions and competition from new entrants, as well as established competitors using new technologies, including the Internet, to establish or expand their businesses. The Gramm-Leach-Bliley Act, passed in 1999, which repealed U.S. laws that separated commercial banking, investment banking and insurance activities, together with changes to the industry resulting from previous reforms, has increased the number of companies competing for a similar customer base.

Our competitors in the Specialty Commercial and Commercial Lines segments include American International Group, The Chubb Corporation, CNA Financial Corporation, Hartford Insurance Group, SAFECO Corporation and Travelers Property Casualty Corp.

Our competitors in the Surety & Construction segment include CNA Surety Corporation, American International Group, Travelers Property Casualty Corp., and Zurich North America. In our International and Lloyd’s segment, our international specialties compete with numerous insurers in the United Kingdom, Canada and Ireland while competitors in Lloyd’s markets in which we are active include various insurance companies and other members of Lloyd’s.

Our subsidiaries compete principally by attempting to offer a combination of superior products, underwriting expertise and services at a competitive, yet profitable, price. Additionally, our relatively large size and underwriting capacity provide us with opportunities not available to smaller companies.

Asset Management

Nuveen Investments is subject to substantial competition in all aspects of its business. The registered representatives that distribute Nuveen Investments’ investment products also distribute numerous competing products, often including products sponsored by the retail distribution firms where they are employed. There are relatively few barriers to entry for new investment management firms. Nuveen Investments’ managed account business is also subject to substantial competition from other investment management firms seeking to be approved as managers in the various “wrap-fee” programs. The sponsor firms have a limited number of approved managers at the highest and most attractive levels of their programs and closely monitor the investment performance and customer service aspects of such firms on an on-going basis as they evaluate which firms are eligible for continued participation in these programs.

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Nuveen Investments is also subject to competition in obtaining the commitment of underwriters to underwrite its exchange traded fund offerings. To the extent the increased competition for underwriting and distribution causes higher distribution costs, Nuveen Investments’ net revenue and earnings will be reduced.

Investment products are sold to the public by broker/dealers, banks, insurance companies and others, and many competing investment product sponsors offer a broader array of investment products. Many of these institutions have substantially greater resources than Nuveen. In addition, continuing consolidation in the financial services industry and the recent bear market environment are altering the landscape in which Nuveen Investments’ distributors compete and the economics of many of the products they offer. The effect that these continuing changes in the brokerage and investment management industries will have on Nuveen Investments and its competitors cannot be predicted. Nuveen Investments competes with other providers of products primarily on the basis of the range of products offered, the investment performance of such products, quality of service, fees charged, the level and type of broker compensation, the manner in which such products are marketed and distributed, and the services provided to registered representatives and investors.

Regulation

Property-Liability Insurance

Insurance Holding Company Regulation.   The St. Paul and our domestic insurance subsidiaries are subject to regulation as an insurance holding company system in states where our insurance subsidiaries are domiciled, which currently include Minnesota, Maryland, Wisconsin, Mississippi, Iowa, Illinois, California, Delaware, Indiana, Vermont and New York. Such regulation generally provides that transactions between companies within the holding company system must be fair and equitable. Transfers of assets among such affiliated companies, certain dividend payments from insurance subsidiaries and certain material transactions between companies within the system may be subject to prior notice to, or prior approval by, state regulatory authorities. Such regulations also require the insurance holding company and each insurance subsidiary to register with the insurance department in the insurance subsidiary’s state of domicile and to furnish annually financial and other information about the operations of companies within the holding company system.

Payment of Dividends.   Fire and Marine is our lead U.S. property-liability underwriting subsidiary, and its dividend paying capacity is regulated by the laws of Minnesota, its state of domicile. Minnesota insurance law provides that, except in the case of extraordinary dividends or distributions, all dividends or distributions paid by Fire and Marine may be declared or paid only from earned surplus, or unassigned funds, as determined pursuant to statutory accounting principles. As of December 31, 2003, Fire and Marine’s earned surplus was $2.2 billion. Fire and Marine also must notify the Minnesota insurance regulator of its intent to pay a dividend if the dividend, together with other dividends or distributions made within the preceding twelve months, would exceed a specified statutory limit, and may not pay such dividend until either 30 days after the Minnesota insurance regulator has received notice of it and has not within that period disapproved it, or the regulator has approved the payment. The current statutory limitation applicable to Minnesota property-liability insurers generally is the greater of:

(1)         10% of such insurer’s surplus as regards policyholders as of the December 31 next preceding the date of the proposed dividend or distribution; or

(2)         the net income of such insurer, not including realized investment gains, for the 12-month period ending the December 31 next preceding the date of the proposed dividend or distribution,

in each case determined under statutory accounting principles. Statutory accounting principles differ from GAAP primarily in relation to deferred policy acquisition costs, deferred taxes and certain other assets,

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and reserve calculation assumptions. The Minnesota insurance regulator is also required to review at least annually the dividends paid by a Minnesota domestic insurer to determine if the dividends are reasonable based upon (1) the adequacy of surplus as regards policyholders remaining after the dividend payments and (2) the quality of the insurer’s earnings and extent to which the required earnings include extraordinary items.

Other states and foreign jurisdictions have similar regulations to those of Minnesota that affect the ability of our other insurance subsidiaries, most of which are subsidiaries of Fire and Marine, to pay dividends. The laws regulating dividends of the other states and foreign jurisdictions where our other insurance subsidiaries are domiciled are similar, but not identical, to Minnesota’s, and may be more restrictive. In addition, many of our insurance subsidiaries are held by other insurance subsidiaries, and only indirectly by us. Therefore, the ability of these indirectly-held subsidiaries to pay dividends to their direct parents, and our ability to receive these dividends from those intermediate subsidiaries, will be subject to the respective ability of all such subsidiaries to meet financial and regulatory requirements applicable to them.

Approximately $774 million will be available to us from payment of ordinary dividends by Fire and Marine in 2004. Any dividend payments beyond the $774 million limitation are subject to prior approval of the Minnesota Commissioner of Commerce. Business and regulatory considerations may impact the amount of dividends actually paid. In 2003, we received dividends in the form of cash and securities totaling $625 million from our U.S. underwriting subsidiaries. We received no cash dividends from our U.S. property-liability underwriting subsidiaries in 2002. In 2001, we received dividends in the form of cash and securities of $827 million from Fire and Marine.

Change of Control.   Most states, including the states in which our domestic insurance subsidiaries are domiciled, have insurance laws that require regulatory approval of a change of control of an insurer or an insurer’s holding company. Laws such as these that apply to us prevent any person from acquiring control of The St. Paul or of our insurance subsidiaries unless that person has filed a statement with specified information with the insurance regulators and has obtained their prior approval. Under most states’ statutes, acquiring 10% or more of the voting stock of an insurance company or its parent company is presumptively considered a change of control, although such presumption may be rebutted. Accordingly, any person who acquires 10% or more of the voting securities of The St. Paul without the prior approval of the insurance regulators of the states in which our insurance subsidiaries are domiciled will be in violation of these states’ laws and may be subject to injunctive action requiring the disposition or seizure of those securities by the relevant insurance regulator or prohibiting the voting of those securities and to other actions determined by the relevant insurance regulator.

In addition, many state insurance laws require prior notification of state insurance departments of a change in control of a non-domiciliary insurance company doing business in that state. While these pre-notification statutes do not authorize the state insurance departments to disapprove the change in control, they authorize regulatory action in the affected state if particular conditions exist such as undue market concentration. Any future transactions that would constitute a change in control of The St. Paul may require prior notification in those states that have adopted pre-acquisition notification laws.

Change of control laws may discourage potential acquisition proposals and may delay, deter or prevent a change of control of The St. Paul, including through transactions, and in particular unsolicited transactions, that some or all of our shareholders might consider to be desirable.

State Regulation of Insurance Operations.   Our insurance subsidiaries are subject to licensing and supervision by government regulatory agencies in the jurisdictions in which they do business. The nature and extent of such regulation vary but generally have their source in statutes that delegate regulatory, supervisory and administrative powers to insurance regulators, which in the U.S. are state authorities. Such regulation, supervision and administration of the insurance subsidiaries may relate, among other things, to

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the standards of solvency which must be met and maintained; the licensing of insurers and their agents; the nature of and limitations on investments; restrictions on the size of risk which may be insured under a single policy; deposits of securities for the benefit of policyholders; regulation of policy forms and premium rates; periodic examination of the affairs of insurance companies; annual and other reports required to be filed on the financial condition of insurers or for other purposes; requirements regarding reserves for unearned premiums, losses and other matters; the nature of and limitations on dividends to policyholders and shareholders; the nature and extent of required participation in insurance guaranty funds; and the involuntary assumption of hard-to-place or high-risk insurance business, primarily in workers’ compensation insurance lines.

Loss ratio trends in property-liability insurance underwriting experience may be improved by, among other things, changing the kinds of coverages provided by policies, providing loss prevention and risk management services, increasing premium rates, purchasing reinsurance or by a combination of these factors. The ability of our insurance subsidiaries to meet emerging adverse underwriting trends may be delayed, from time to time, by the effects of laws which require prior approval by insurance regulatory authorities of changes in policy forms and premium rates. Our U.S. underwriting operations do business in all 50 states and the District of Columbia, Puerto Rico, Guam and the U.S. Virgin Islands. A number of these jurisdictions require prior approval of most or all premium rates.

Risk-Based Capital Requirements.   In order to enhance the regulation of insurer solvency, the National Association of Insurance Commissioners (the “NAIC”) has adopted a formula and model law to implement risk-based capital (“RBC”) requirements for most property and casualty insurance companies, which is designed to determine minimum capital requirements and to raise the level of protection that statutory surplus provides for policyholder obligations. The RBC formula for property and casualty insurance companies measures three major areas of risk facing property and casualty insurers: underwriting, which encompasses the risk of adverse loss developments and inadequate pricing; declines in asset values arising from market and/or credit risk; and off-balance sheet risk arising from adverse experience from non-controlled assets, guarantees for affiliates or other contingent liabilities and excessive premium growth.

Under laws adopted by individual states, insurers having less total adjusted capital than that required by the RBC calculation will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The RBC ratios for each of our insurance subsidiaries currently are above the ranges that would require any regulatory or corrective action.

IRIS Tests.   The NAIC has developed a set of financial relationships or tests known as the Insurance Regulatory Information System to assist state regulators in monitoring the financial condition of insurance companies and identifying companies that require special attention or action by insurance regulatory authorities. Insurance companies generally submit data annually to the NAIC, which in turn analyzes the data using prescribed financial data ratios, each with defined “usual ranges.”  Generally, regulators will begin to investigate or monitor an insurance company if its ratios fall outside the usual ranges for four or more of the ratios. If an insurance company has insufficient capital, regulators may act to reduce the amount of insurance it can issue. We are not aware that any of our insurance companies are currently subject to regulatory scrutiny based on these ratios.

Insurance Reserves.   State and provincial insurance laws require us to analyze the adequacy of our reserves annually. Our actuaries must submit an opinion that our reserves, when considered in light of the assets we hold with respect to those reserves, make adequate provision for our contractual obligations and related expenses.

Shared Market and Similar Arrangements.   State insurance laws and regulations require us to participate in mandatory property-liability “shared market,” “pooling” or similar arrangements that provide insurance coverage to individuals or others who otherwise are unable to purchase coverage

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voluntarily provided by private insurers. Shared market mechanisms include assigned risk plans; fair access to insurance requirement or “FAIR” plans; and reinsurance facilities for covering catastrophic risk. In addition, some states require insurers to participate in reinsurance pools for claims that exceed specified amounts. Our participation in these mandatory shared market or pooling mechanisms generally is related to the amounts of our direct writings for the type of coverage written by the specific arrangement in the applicable state. We cannot predict the financial impact of our participation in these arrangements.

Insurance Guaranty Association Assessments.   Each state has insurance guaranty association laws under which life and property and casualty insurers doing business in the state may be assessed by state insurance guaranty associations for certain obligations of insolvent insurance companies to policyholders and claimants. Typically, states assess each member insurer in an amount related to the member insurer’s proportionate share of the business written by all member insurers in the state. For the years ended December 31, 2003 and 2002, we incurred net expense of $10 million and $13 million, respectively, pursuant to state insurance guaranty association laws. While we cannot predict the amount and timing of any future assessments on our insurance companies under these laws, we have established reserves that we believe are adequate for assessments relating to insurance companies that are currently subject to insolvency proceedings.

Federal Regulation of Insurance Operations.   On November 26, 2002, President Bush signed into law the Terrorism Risk Insurance Act of 2002, or “TRIA.”  A discussion of TRIA’s principal provisions can be found in the “Terrorism Risk and Legislation” section of this report.

Our domestic insurance subsidiaries are subject to TRIA, although TRIA does not apply to all of the coverages they write. TRIA does apply to most of our coverages written, including property, commercial multi-peril, fire, ocean marine, inland marine, liability, commercial auto, aircraft, surety and workers’ compensation.

International Regulation of Insurance Operations.   Our insurance underwriting operations in the United Kingdom are regulated by the Financial Services Authority (FSA). The FSA’s principal objectives are to maintain market confidence, promote public understanding of the financial system, protect consumers, and to fight financial crime. In Canada, the conduct of insurance business is regulated under provisions of the Insurance Companies Act of 1992, which requires insurance companies to maintain certain levels of capital depending on the type and amount of insurance policies in force. The Lloyd’s operation is also regulated by the FSA, which has delegated certain regulatory responsibilities to the Council of Lloyd’s. We are also subject to regulations in the other countries and jurisdictions in which we underwrite insurance business. The terms and conditions of our plans to cease underwriting operations in selected foreign countries were subject to regulatory approval in several of those countries.

Asset Management

One of Nuveen Investments’ subsidiaries is registered as a broker/dealer under the Securities Exchange Act of 1934 and is subject to regulation by the Securities and Exchange Commission (the “Commission”), NASD Regulation, Inc. and other federal and state agencies and self-regulatory organizations. The securities industry is one of the most highly regulated in the United States, and failure to comply with related laws and regulations can result in the revocation of broker/dealer licenses, the imposition of censures or fines, and the suspension or expulsion of a firm and/or its employees from the securities business.

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Each of Nuveen Investments’ investment adviser subsidiaries is registered with the Commission under the Investment Advisers Act. Virtually all aspects of Nuveen Investments’ investment management business are subject to various federal and state laws and regulations. These laws and regulations are primarily intended to benefit the investment product holder and generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict Nuveen from carrying on its investment management business in the event that it fails to comply with such laws and regulations. In such event, the possible sanctions that may be imposed include the suspension of individual employees, limitations on Nuveen Investments’ engaging in the investment management business for specified periods of time, the revocation of its advisory subsidiaries’ registrations as investment advisers or other censures and fines.

Nuveen Investments has responded and continues to respond to various requests and inquiries from regulatory and governmental officials that are related to recent well-publicized alleged incidents of inappropriate and illegal trading within the asset management industry. These incidents could result in increased regulation of all asset managers, including Nuveen Investments. Such regulation could have an adverse effect on Nuveen Investments’ profitability.

Item 2.                  Properties.

Fire and Marine owns our corporate headquarters buildings, located at 385 Washington Street and 130 West Sixth Street, St. Paul, MN. These buildings are adjacent to one another and consist of approximately 1.1 million square feet of gross floor space. Fire and Marine also owns property in Woodbury, MN where its Administrative Services Building and off-site computer processing operations are located.

We own a building in London, England, which houses a portion of our U.K. operations. We retained ownership of another building in London subsequent to the sale of Minet Holdings plc to Aon Corporation in 1997, which is being leased to an outside party. In a transaction completed in March 2001, we sold a 50% interest in this building. In April 2003, we completed the sale of our 68-acre office campus in Baltimore, MD that we acquired as part of our merger with USF&G Corporation in 1998. As part of the sale agreement, we agreed to lease a portion of the office space on the campus until September 2004. In August 2003, we sold a parking ramp we owned in downtown St. Paul, MN for total proceeds of approximately $5 million.

Fire and Marine and its subsidiary, St. Paul Properties, Inc., own a portfolio of income-producing properties in various locations across the United States that they have purchased for investment. Included in this portfolio are four office buildings in which we hold a 50% ownership interest located on Manhattan Island in New York, NY which collectively accounted for approximately 7% of the carrying value of the property portfolio at December 31, 2003.

Our operating subsidiaries rent or lease office space in most cities in which they operate.

Management considers the currently owned and leased office facilities of The St. Paul and its subsidiaries adequate for the current and anticipated future level of operations.

Item 3.                  Legal Proceedings.

Legal Matters—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 liability under environmental protection laws and for injury caused by exposure to asbestos products. Plaintiffs in these 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.

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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; however, we do not believe that the total amounts that we and our subsidiaries will ultimately have to pay in all of these lawsuits will have a material effect on our liquidity or overall financial position.

The following is a summary of certain litigation matters with contingencies:

·       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, St. Paul Fire and Marine Insurance Company and their affiliates and subsidiaries, including us, with any of MacArthur Company, Western MacArthur Company, and Western Asbestos Company. In January 2004, the U.S. Bankruptcy Court for the Northern District of California issued an order approving the settlement agreement and confirming the MacArthur Companies’ proposed plan of reorganization. See further discussion in Note 20 to the consolidated financial statements included in Item 8 of this report. 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. That 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 confirmation of the bankruptcy court approval of the settlement agreement and the MacArthur Companies’ plan of reorganization. Accordingly, as of December 31, 2003, these payments were recorded in the amounts of $807 million in both “Other Assets” and “Other Liabilities.”

·       Petrobras Oil Rig Construction—In September 2002, the United States District Court for the Southern District of New York entered a judgment in the amount of approximately $370 million to Petrobras, an energy company that is majority-owned by the government of Brazil, in a claim related to the construction of two oil rigs. One of our subsidiaries provided a portion of the surety coverage for that construction. As a result, we recorded a pretax loss of $34 million ($22 million after-tax) in 2002 in our Surety & Construction business segment. The loss recorded was net of reinsurance and previously established case reserves for this exposure, and prior to any possible recoveries related to indemnity. We continue to actively pursue an appeal of this judgment.

·       Purported Class Action Shareholder Lawsuits—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. In the fourth quarter of 2003, we agreed in principle to a settlement, which is subject to certain customary conditions and subject to court approval. If the settlement is consummated, it will result in our payment of an amount that is not material to our results of operations.

·       Boson v. Union Carbide Corp., et al; Abernathy v. Ace American Ins. Co—In 2003, lawsuits were 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. Subsequently, the court dismissed another case on the same grounds. We view these as significant rulings in our favor. The special exceptions in the remaining 50 cases have not yet been ruled upon. We intend to file similar motions to dismiss in the Ohio cases.

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·       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 occurrence. 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 ruled that under terms of the policy form we used to underwrite property coverage for the WTC, the terrorist attack constituted one occurrence.

·       Farina v. Travelers Property Casualty Corp., et al—A purported class action was recently filed in Connecticut state court against Travelers Property Casualty Corp. and its board of directors alleging that they breached their fiduciary duties to Travelers’ shareholders in connection with the adoption of the merger and the merger agreement with the Company. The complaint seeks injunctive relief as well as unspecified monetary damages. The complaint also names the Company and its subsidiary, Adams Acquisition Corp., as defendants, alleging that they aided and abetted the alleged breach of fiduciary duty. We believe this suit is wholly without merit and intend to vigorously defend against it.

In 1990, at the direction of the UK Department of Trade and Industry (DTI), five insurance underwriting subsidiaries of London United Investments PLC (LUI) suspended underwriting new insurance business. At the same time, four of those subsidiaries, being insolvent, suspended payment of claims and have since been placed in provisional liquidation. The fifth subsidiary, Walbrook Insurance Company, continued paying claims until May of 1992 when it was also placed in provisional insolvent liquidation. Weavers Underwriting Agency (Weavers), an LUI subsidiary, managed these insurers. Minet, a former insurance brokerage subsidiary of ours, had brokered business to and from Weavers for many years. From 1973 through 1980, our UK-based underwriting operations, now called St. Paul International Insurance Company Ltd. (SPI), had accepted business from Weavers. A portion of that business was ceded by SPI to reinsurers. Certain of those reinsurers have challenged the validity of certain reinsurance contracts (or the amount of recovery thereunder) relating to the Weavers pool, of which SPI was a member, in an attempt to avoid liability under those contracts. SPI and other members of the Weavers pool are seeking enforcement of the reinsurance contracts. Minet may also become the subject of legal proceedings arising from its role as one of the major brokers for Weavers. When we sold Minet in May 1997, we agreed to indemnify the purchaser for most of Minet’s then existing liabilities, including liabilities relating to the Weavers matter. We will vigorously contest any proceedings relating to the Weavers matter. We recognize that the final outcome of these proceedings, if adverse to us, may materially impact the results of operations in the period in which that outcome occurs. We believe that such an adverse outcome, however, will not have a materially adverse effect on our liquidity or overall financial position.

Item 4.                  Submission of Matters to a Vote of Security Holders.

No matter was submitted to a vote of security holders during the quarter ended December 31, 2003.

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PART II

Item 5.                  Market for the Registrant’s Common Equity and Related Stockholder Matters.

Our common stock is traded on the New York Stock Exchange, where it is assigned the symbol SPC. The number of holders of record, including individual owners, of our common stock was 16,848 as of February 24, 2004. The following table sets forth the amount of cash dividends declared per share and the high and low closing sales prices of our common stock for each quarter during the last two years.

		High			Low			Cash Dividend Declared
2003
First Quarter		$	36.66		$	29.33			$	0.29
Second Quarter		38.02			32.32				0.29
Third Quarter		38.49			34.30				0.29
Fourth Quarter		39.65			35.15				0.29
2002
First Quarter		$	49.41		$	39.50			$	0.29
Second Quarter		50.12			38.34				0.29
Third Quarter		37.88			24.20				0.29
Fourth Quarter		37.24			27.05				0.29

 

Cash dividends paid per share in 2003 and 2002 were $1.16 and $1.15, respectively.

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Item 6.                  Selected Financial Data.

SIX-YEAR SUMMARY OF SELECTED FINANCIAL DATA

The St. Paul Companies

		2003			2002			2001			2000			1999			1998
		(In millions, except ratios and per share data)
Consolidated
Revenues from continuing operations		$	8,854		$	9,030		$	9,032		$	7,946		$	7,149		$	7,315
After-tax income (loss) from continuing operations		678			243			(1,009		)	970			705			187
Investment Activity
Net investment income		1,120			1,169			1,217			1,262			1,259			1,295
Pretax realized investment gains (losses)		73			(165		)	(94		)	632			286			203
Other Selected Financial Data (as of December 31)
Totals assets		39,563			39,959			38,321			35,502			33,418			33,211
Debt		3,750			2,713			2,130			1,647			1,466			1,260
Redeemable preferred securities		—			889			893			337			425			503
Common shareholders’ equity		6,150			5,681			5,056			7,178			6,448			6,621
Common shares outstanding		228.4			226.8			207.6			218.3			224.8			233.7
Per Common Share Data
Income (loss) from continuing operations (diluted)		2.79			1.03			(4.84		)	4.14			2.89			0.73
Year-end book value		26.93			25.05			24.35			32.88			28.68			28.32
Year-end market price		39.65			34.05			43.97			54.31			33.69			34.81
Cash dividends declared		1.16			1.16			1.12			1.08			1.04			1.00
Property-Liability Insurance
Net written premiums		7,540			7,137			7,895			5,884			5,112			5,276
Pretax income (loss) from continuing operations		889			243			(1,400		)	1,467			971			298
Statutory combined ratio:
Loss and loss adjustment expense ratio		73.4			79.9			100.9			70.0			72.9			82.2
Underwriting expense ratio		29.1			29.7			29.3			34.8			35.0			35.2
Combined ratio		102.5			109.6			130.2			104.8			107.9			117.4

 

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FORWARD-LOOKING STATEMENT DISCLOSURE AND CERTAIN RISKS

This report contains certain forward-looking statements within the meaning of the Private Securities 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 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;

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·       risks relating to actual and potential credit exposures, including to derivatives counterparties, reinsurers, 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 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;

·       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

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investment performance and risks associated with failure to comply with various governmental regulations;

·       our dependence on the business provided to us by agents and brokers;

·       our implementation of new strategies and initiatives;

·       risks related to our ability to consummate the Proposed Merger in a timely fashion, including the possibility of delays resulting from shareholder or regulatory approvals and other matters beyond our control and potentially adverse consequences, including announced rating agency downgrades, in the event the transaction is not consummated;

·       risks related to our ability to efficiently and effectively integrate the Company’s businesses with the businesses of Travelers in a timely manner following the Proposed Merger, including those arising from the diversion of management resources to the integration process and potential business disruptions resulting from employee uncertainty and lack of focus;

·       risks related to our ability to realize the cost savings and synergies that we expect to achieve in the Proposed Merger;

·       our ability to retain key employees after the Proposed Merger; and

·       various other matters.

Item 7.                  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations
December 31, 2003

The St. Paul Companies, Inc. (“The St. Paul” or the “Company”) 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. 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. Our website address is an inactive textual reference only and the contents of the website are not part of this report.

OVERVIEW

The company generates its return on capital primarily by taking in premiums, net of the expenses to generate those premiums as well as other expenses, and investing them, predominantly in fixed income securities, until the company pays out losses related to the insurance coverage provided. The primary factors impacting returns which are monitored regularly by the company include:

·       the adequacy of premiums charged relative to the risks assumed;

·       investment returns on the premium cash flows;

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·       efficiency of the Company’s operations and ability of management to control expenses; and

·       the amount and timing of paid losses.

Adequacy of premiums

The company experienced its fifth consecutive year of generally increasing prices in 2003. These increases exceeded increases in our estimated loss trends, resulting in improved margins and cash flow. Average price increases during 2003 were 20% in our specialty commercial segment and 11% in our commercial lines segment. While the overall absolute level of price increases in 2003 slowed from 2002 levels, we expect overall price increases in 2004 to continue to exceed overall increases in estimated loss trends. However, the property and casualty insurance industry has historically been highly cyclical, and price competition in the years leading up to 1999 generally resulted in declining profitability in the industry. The company has implemented internal management reporting to monitor pricing and profitability, allowing the company to take actions to maximize profitability as pricing or premium adequacy trends change.

Investment returns

Investment returns are a major component of the company’s revenue and profitability. At December 31, 2003, nearly 90% of the company’s investment portfolio consisted of fixed income securities, securities on loan and short-term investments. Lower rates of return on new money invested in recent years have required higher premium levels to generate the same returns on capital. The Company believes that decreasing interest rates since the beginning of 2000 have been one of the factors causing property-liability insurance prices to increase. Likewise, increases in new money investment rates will increase investment income, but may result in increased price competition in the industry as companies could generate the same return on equity at lower premium levels. However, if new money investment rates increase, the value of our fixed income portfolio will decrease.

During 2003, the Company’s average new money investment rate was 4.5% for taxable bonds and 3.1% for tax-exempts, which reduced the average imbedded pre-tax yield in our long-term fixed income portfolio to 5.7% at December 31, 2003, down from 6.2% a year earlier.

The Company’s fixed income portfolio maintains a very high credit quality with an average rating at AA+ and a relatively short duration of 3.8 years which mitigates the risks of increasing interest rates and widening credit spreads. During 2003, duration lengthened slightly, from 3.3 years.

Efficiency of the operations

The property-liability industry generally measures expenses as a percentage of written premiums, a component of revenue. Management uses a variety of measures, including the statutory expense ratio, to evaluate its success in controlling expenses. Expenses consist of variable components, such as taxes, fees and commissions that are calculated as a percentage of premium, and fixed components such as salaries, benefits, rent and system costs. The statutory expense ratio for the year ended December 31, 2003 was 29.1, an improvement over the comparable 2002 statutory expense ratio of 29.7. While the Company experienced increases in variable costs in the second half of 2003 as premiums grew, the statutory expense ratio declined. A significant portion of the increase in premiums was driven by price increases and not unit or policy increases, and generally did not require commensurate increases in fixed expenses to manage the business. Significant decreases in premiums written in our runoff businesses, combined with continuing expenses to manage those businesses, prevented further improvement in our consolidated expense ratio in 2003. We expect to manage our business in 2004 with a general objective of keeping expenses level, except for variable expenses that vary with premium production, such as premium taxes and commissions.

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Accordingly, absent unfavorable developments in the pricing environment, we expect our statutory expense ratio to generally remain stable or improve in 2004.

The amount and timing of paid losses

Management estimates the amount it expects to pay claimants for insured losses and the cost of investigating, resolving and processing those claims. Given the inherent uncertainty in the reserving process and that many of the coverages we offer involve claims that may not ultimately be settled for many years after they are incurred, our estimates may be materially different from the amounts we ultimately pay or incur with respect to insured losses. If our estimates change, we make adjustments to our reserves and these adjustments are reflected in our income statements for the current period. One measure management uses to assess our profitability is our statutory combined ratio, which reflects the sum of the statutory loss ratio (incurred losses as a percentage of earned premium) and the statutory expense ratio described above. Our loss ratio improved from 79.9 in 2002 to 73.4 in 2003. Over the past two years, increasing pricing has significantly improved the combined ratio in our ongoing segments, which dropped from 108.6 in 2001 to 95.8 in 2002 and 91.7 in 2003.

Proposed Merger with Travelers

Management believes that the Proposed Merger with Travelers Property Casualty Corp., announced on November 17, 2003, will be a transforming event for The St. Paul. Management believes that the Proposed Merger will create a premier property and casualty insurance company that will be well positioned for long-term success and the creation of superior shareholder value in the highly competitive property and casualty insurance industry. Management believes that the combined company will have significant product breadth and geographic reach and will be uniquely positioned as the property casualty insurer of choice for agents, brokers and customers across the United States. Management believes that The St. Paul will benefit from the combined financial resources, management and personnel of the two companies and will be better able to capitalize on opportunities in the insurance industry. In addition, management believes that the Proposed Merger will permit The St. Paul to derive significant advantages from the more efficient utilization of the assets, management and personnel of two companies. These significant opportunities do not come without risks. In particular, it will be a significant challenge to integrate the businesses of The St. Paul and Travelers in an efficient and effective manner. Furthermore, since the risks and uncertainties facing each of The St. Paul and Travelers differ, the results of operations, financial condition and liquidity of the combined company may be affected by risks and uncertainties different from those currently effecting each of The St. Paul and Travelers on a stand-alone basis. We currently expect the Proposed Merger to close in the second quarter of 2004.

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CONSOLIDATED OVERVIEW OF THE ST. PAUL’S RESULTS

The following table summarizes our results for each of the last three years.

		Years Ended December 31
		2003			2002			2001
		(In millions, except per share data)
Pretax income (loss):
Property-liability insurance		$	889		$	244		$	(1,400	)
Asset management		187			162			142
Parent company and other operations		(240		)	(230		)	(173		)
Pretax income (loss) from continuing operations		836			176			(1,431		)
Income tax expense (benefit)		137			(73		)	(422		)
Income (loss) from continuing operations before cumulative effect of accounting change		699			249			(1,009		)
Cumulative effect of accounting change, net of taxes		(21		)	(6		)	—
Income (loss) from continuing operations		678			243			(1,009		)
Discontinued operations, net of taxes		(17		)	(25		)	(79		)
Net income (loss)		$	661		$	218		$	(1,088	)
Net income (loss) per share (diluted)		$	2.72		$	0.92		$	(5.22	)

 

Our pretax income from continuing operations of $836 million in 2003 was significantly higher than the 2002 total of $176 million, due to strong improvement in results produced by our ongoing property-liability underwriting segments. Our 2003 result included a total of $646 million in pretax loss provisions to strengthen prior-year loss reserves, of which $350 million was recorded in our runoff Health Care operation and $260 million was recorded in our other runoff operations. Our majority-owned asset management subsidiary, Nuveen Investments, Inc., achieved its ninth consecutive year of record results in 2003, driven by a significant increase in assets under management. In 2002, our pretax results included a $472 million loss provision, net of reinsurance, related to a settlement agreement we entered into with respect to the Western MacArthur asbestos litigation (described in more detail later in this discussion). Our pretax loss of $1.43 billion in 2001 was dominated by $941 million of pretax losses resulting from the September 11, 2001 terrorist attack and pretax provisions totaling $735 million to strengthen prior-year loss reserves in our Health Care business center. The 2003 and 2002 pretax losses in the “Parent company and other operations” category (which primarily consists of management, administrative and debt service expenses at the holding company level) were significantly higher than comparable loss in 2001 primarily due to an increase in distributions related to preferred securities issued in the fourth quarter of 2001.

Our effective tax rate on pretax earnings was 16% in 2003, primarily reflecting the benefit of investment income from tax-exempt fixed income securities in our property-liability investment operations segment. In 2002, our income tax benefit of $73 million on pretax income of $176 million included $124 million of tax benefits associated with net realized investment losses. That $124 million reflected a $207 million benefit related to the sale of certain of our international operations and all other net realized gains and losses, and $83 million of tax expense related to the transfer of our ongoing reinsurance operations (discussed in more detail later in this discussion). In 2002, we substantially completed the refocusing of our international property-liability underwriting operations. As part of that effort, we sold certain of those operations in the fourth quarter of 2002, resulting in a net after-tax realized gain of $132 million that was predominantly comprised of the aforementioned tax benefits. The pretax impact on our results in 2002 from those sales was nominal, as significant operating losses had previously been reflected in our reported results for these operations prior to their divestiture.

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As a result of implementing the provisions of a new accounting pronouncement in 2002 (discussed in more detail later in this discussion), we did not record any goodwill amortization expense in 2003 or 2002. In 2001, expenses related to goodwill totaled $114 million, which included $73 million of goodwill write-downs related to businesses we decided to exit. Amortization expense related to other intangible assets totaled $31 million in 2003, compared with $18 million in 2002 and $2 million in 2001.

CONSOLIDATED REVENUES

The following table summarizes the sources of our consolidated revenues from continuing operations for the last three years.

		Years Ended December 31
		2003			2002			2001
		(In millions)
Revenues:
Property-liability insurance premiums earned		$	7,039		$	7,502		$	7,409
Net investment income		1,120			1,169			1,217
Asset management		453			398			375
Realized investment gains (losses)		73			(165		)	(94		)
Other		169			126			125
Total revenues		$	8,854		$	9,030		$	9,032

 

2003 vs. 2002—The 6% decline in insurance premiums earned in 2003 was centered in our runoff Other segment, reflecting the impact of our decision to withdraw from lines of business included in that segment. In our ongoing property-liability underwriting segments, earned premiums of $6.71 billion were 22% higher than comparable 2002 earned premiums of $5.52 billion, due to a combination of new business, higher business retention levels and price increases. The $49 million decline in net investment income in 2003 was primarily due to a decline in investment yields on new investments, and a reduced amount of invested assets during 2003 resulting from the first-quarter payment of $747 million related to the Western MacArthur asbestos litigation settlement agreement. Asset management revenues grew 14% over 2002, driven by a significant increase in investment advisory fees resulting from a $15.6 billion increase in assets under management. Realized investment gains in 2003 were driven by sales of certain venture capital and equity holdings. The increase in Other revenues in 2003 over 2002 was largely due to foreign currency exchange gains.

2002 vs. 2001—Earned premiums in 2002 grew 1% over 2001, as the positive impacts of significant price increases in 2001 and 2002 and new business in many of our ongoing operations were largely offset by our withdrawal from several lines of business and the transfer of our ongoing reinsurance operations to Platinum. Earned premiums of $5.52 billion generated by our two ongoing property-liability underwriting segments in 2002 grew 24% over comparable 2001 earned premiums of $4.44 billion, whereas earned premiums produced by our runoff segment in 2002 declined 33% compared with 2001. Net investment income declined 4% from 2001, primarily due to reduced yields on new investments. Realized investment losses in 2002 were concentrated in our venture capital and equity portfolios and included losses originating from sales of investments, as well as impairment write-downs. The majority of our Other revenues consisted of risk management consulting fees and claim servicing fees in our insurance underwriting operations and foreign exchange gains and losses.

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 managed. Our property-liability underwriting operations consist of two segments constituting our ongoing operations (Specialty Commercial and

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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 later in this discussion. 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. In addition to our participation in voluntary insurance pools, this 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 addition, in the fourth quarter of 2003, our Specialty Programs business center, previously reported in our Specialty Commercial segment, was moved to our Commercial Lines segment to more accurately reflect the manner in which this business is underwritten and managed. See the “Commercial Lines” segment discussion below for a further description of the Specialty Programs business center. All data for 2002 and 2001 included in this report were restated to be consistent with the changes made to our segment reporting structure in the first and fourth quarters of 2003.

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 3 to our consolidated financial statements and in Management’s Discussion and Analysis, information about those businesses in 2003 and the corresponding periods of 2002 and 2001.

Our operations in runoff do not qualify as “discontinued operations” for accounting purposes. For the year ended December 31, 2003, these runoff operations collectively accounted for $327 million, or 5%, of our net earned premiums, and generated underwriting losses totaling $762 million (an amount that does not include investment income from the assets maintained to support these operations). For the year ended December 31, 2002, these runoff operations collectively accounted for $1.98 billion, or 26%, of our net earned premiums, and generated underwriting losses totaling $874 million, an amount that included a $585 million pretax loss provision related to the Western MacArthur asbestos litigation settlement agreement. For the year ended December 31, 2001, these runoff operations collectively accounted for $2.97 billion, or 40%, of our net earned premiums, and generated underwriting losses totaling $1.87 billion, an amount that included a $735 million pretax loss provision to strengthen prior-year loss reserves in our Health Care operation and $662 million of pretax losses related to the September 11, 2001 terrorist attack.

Our consolidated net loss and loss adjustment expense reserves of $13.3 billion at December 31, 2003 and $14.8 billion at December 31, 2002 included approximately $5.6 billion and $8.0 billion, respectively, of net reserves related to our runoff segment. The payment of claims from these reserves will negatively impact our investment income in future periods as the invested assets related to these reserves decline.

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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 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 had the right to underwrite specified reinsurance business on our behalf in cases where Platinum was unable to underwrite that business because it had yet to obtain necessary regulatory licenses or approval to do so, or Platinum had 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 was fully ceded to Platinum under the quota share reinsurance agreements.

The transaction resulted in a pretax gain of $29 million and an after-tax loss of $54 million in the year ended December 31, 2002. The after-tax loss was driven by the write-off of approximately $73 million in deferred tax assets associated with previously incurred losses related to St. Paul Re’s United Kingdom-based operations, as well as approximately $10 million in taxes associated with the pretax gain.

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

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“Net investment income.”  Our option to purchase additional Platinum shares is carried at market value ($65 million and $61 million at December 31, 2003 and 2002, respectively), with changes in its fair value recorded as other realized gains or losses in our statement of operations. In 2003 and 2002, we recorded net pretax realized gains of $4 million and $7 million, respectively, related to this option.

ACQUISITIONS AND DIVESTITURES

In December 2003, we completed the sale of Camperdown UK Limited, one of our Lloyd’s corporate names and the vehicle for our participation on the 2003 and prior years of account, to Foltus Investments Limited. We recognized a $2 million pretax gain on this transaction. At Lloyd’s, we underwrite business through a single syndicate (“Syndicate 5000”) for which we provide 100% of the capital. In 2003, Fire and Marine entered into a 100% quota share reinsurance agreement directly with Syndicate 5000 that in effect transferred Syndicate 5000’s underwriting results for the 2003 year of account to Fire and Marine. In order to continue our ongoing operations at Lloyd’s, we activated two corporate names that will be used for 2004 and future years of account to underwrite Syndicate 5000 business.

In November 2003, The St. Paul and Travelers Property Casualty Corp. announced the signing of a definitive merger agreement. See Item 1 in this report for further discussion of the Proposed Merger.

In October 2003, we sold our subsidiary, Octagon Risk Services, Inc., a claim management and consulting services company, for proceeds of approximately $30 million. We recorded a pretax gain of $5 million on the sale.

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.

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 is being amortized on an accelerated basis over four years. The portfolio of business involved in this transaction included 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 month period subsequent to this purchase. We believe it is unlikely that any additional payment would exceed $30 million. At December 31, 2003, we had accrued $10 million toward this additional obligation, recorded in “Other liabilities.”  Our consolidated gross written premiums for the year ended December 31, 2003 included approximately $280 million attributable to business underwritten as a result of this purchase of renewal rights, the majority of which were included in our Commercial Lines segment.

In December 2002, we acquired the right to seek to renew the Professional and Financial Risk Practice business previously underwritten by Royal & SunAlliance in the United States, without assuming past liabilities. That business generated approximately $80 million in written premiums in 2003. The nominal cost of this acquisition was accounted for as an intangible asset and is being amortized over four years.

In December 2002, we sold our insurance operations in Spain and Argentina and all of our operations in Mexico except our surety business. Proceeds from these sales totaled $29 million, and we recorded a pretax gain of $4 million related to the sales.

In March 2002, we completed our acquisition of London Guarantee Insurance Company (“London Guarantee,” now operating under the name “St. Paul Guarantee”), a specialty property-liability insurance company focused on providing surety products and management liability, bond, and professional indemnity products. The total cost of the acquisition was approximately $80 million, of which approximately $18

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million represented goodwill and $37 million represented other intangible assets. The purchase price was funded through internally generated funds.

In December 2001, we purchased the right to seek to renew surety bond business previously underwritten by Fireman’s Fund Insurance Company (“Fireman’s Fund”), without assuming past liabilities. We paid Fireman’s Fund $10 million in consideration, which we recorded as an intangible asset and which we expect to amortize over nine years. Based on the volume of business renewed during 2002, we made a modest additional payment to Fireman’s Fund in the first quarter of 2003. That amount was also recorded as an intangible asset and is being amortized on an accelerated basis over the remaining life of the intangible asset.

In January 2001, we acquired the right to seek to renew a book of municipality insurance business from Penco, a program administrator for Willis North America Inc., for a total consideration of $3.5 million. The cost was recorded as an intangible asset and is being amortized over five years.

In addition, Nuveen Investments made strategic acquisitions in both 2002 and 2001, which are discussed in greater detail in the “Asset Management” section of this discussion.

DISCONTINUED OPERATIONS

LIFE INSURANCE—In September 2001, we completed the sale of our life insurance company, Fidelity and Guaranty Life Insurance Company and its subsidiary, Thomas Jefferson Life (together, “F&G Life”) to Old Mutual plc (“Old Mutual”), for $335 million in cash and $300 million in ordinary shares of Old Mutual. In June 2002, we sold all of the Old Mutual shares we were holding for a total net consideration of $287 million, resulting in a pretax realized loss of $13 million that was recorded as a component of discontinued operations on our statement of operations in 2002. At the time of the sale of the Old Mutual shares, there was a derivative “collar” agreement in place that would have determined any possible adjustment to the original F&G Life sale price one year after the closing date.  The collar was recorded on our balance sheet as an asset and had a fair value of $12 million when we sold our Old Mutual shares. We agreed to terminate the collar at no value as part of the sale of our Old Mutual shares. That $12 million pretax loss was also included in discontinued operations on our statement of operations in 2002.

At the time of the sale of F&G Life in 2001, we recorded a net after-tax loss of $74 million on the sale proceeds. That loss was combined with F&G Life’s results of operations prior to sale for an after-tax loss of $55 million and was included in the reported loss from discontinued operations for the year ended December 31, 2001.

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. We have no other contingent liabilities related to this sale.

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NONSTANDARD AUTO INSURANCE—In 1999, Prudential purchased our nonstandard auto insurance business marketed under the Victoria Financial and Titan Auto brands for $175 million in cash (net of a $25 million dividend paid by these operations to our property-liability insurance operations prior to closing). We recorded an estimated after-tax loss of $83 million on the sale, representing the estimated excess of carrying value of these entities at closing date over proceeds to be received from the sale, plus estimated income through the disposal date. This excess primarily consisted of goodwill. We recorded an after-tax loss on disposal of $9 million in 2000, primarily representing additional losses incurred through the disposal date in May, and an additional after-tax loss on disposal of $5 million in 2001, primarily representing tax adjustments made to the sale transaction.

MINET—In 1997, we sold our insurance brokerage operation, Minet Holdings plc (“Minet”) to Aon Corporation. We recorded expenses in discontinued operations in each of the last three years related to the Minet sale. In 2003, we recorded expense primarily related to an adjustment to the tax provision on the sale, whereas the expenses recorded in 2002 and 2001 primarily represented additional funds due Aon pursuant to provisions of the sale agreement.

Our operations in runoff do not qualify as “discontinued operations” for accounting purposes.

The following table presents the components of discontinued operations reported in our consolidated statement of operations for each of the last three years.

		Years Ended December 31
		2003			2002			2001
		(In millions)
F&G Life:
Operating income, net of taxes		$	—		$	—		$	19
Loss on disposal, net of taxes		—			(12		)	(74		)
Total F&G Life		—			(12		)	(55		)
Standard Personal Insurance:
Operating income, net of taxes		—			—			—
Loss on disposal, net of taxes		(7		)	(7		)	(13		)
Total Standard Personal Insurance		(7		)	(7		)	(13		)
Nonstandard Auto Insurance:
Operating income, net of taxes		—			—			—
Loss on disposal, net of taxes		—			(3		)	(5		)
Total Nonstandard Auto Insurance		—			(3		)	(5		)
Minet Holdings plc:
Operating income, net of taxes		—			—			—
Loss on disposal, net of taxes		(10		)	(3		)	(6		)
Total Minet Holdings plc		(10		)	(3		)	(6		)
Total discontinued operations		(17		)	$	(25	)	$	(79	)

 

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”).

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