UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2006

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 Travelers Companies, Inc.

(Exact name of registrant as specified in its charter)

 

385 Washington Street,
St. Paul, MN 55102
(Address of principal executive offices) (Zip Code)

(651) 310-7911
(Registrant’s telephone number, including area code)

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 whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o    No x

The number of shares of the Registrant’s Common Stock, without par value, outstanding at October 27, 2006 was 690,018,312.

The St. Paul Travelers Companies, Inc.

Quarterly Report on Form 10-Q

For Quarterly Period Ended September 30, 2006

TABLE OF CONTENTS

		Page
	Part I – Financial Information
Item 1.	Financial Statements:
	Consolidated Statement of Income (Unaudited) – Three and Nine Months Ended September 30, 2006 and 2005	3
	Consolidated Balance Sheet – September 30, 2006 (Unaudited) and December 31, 2005	4
	Consolidated Statement of Changes in Shareholders’ Equity (Unaudited) – Nine Months Ended September 30, 2006 and 2005	5
	Consolidated Statement of Cash Flows (Unaudited) – Nine Months Ended September 30, 2006 and 2005	6
	Notes to Consolidated Financial Statements (Unaudited)	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	51
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	85
Item 4.	Controls and Procedures	85
	Part II – Other Information
Item 1.	Legal Proceedings	86
Item 1A.	Risk Factors	92
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	92
Item 3.	Defaults Upon Senior Securities	92
Item 4.	Submission of Matters to a Vote of Security Holders	92
Item 5.	Other Information	92
Item 6.	Exhibits	92
	SIGNATURES	93
	EXHIBIT INDEX	94

 

2

Item 1.  FINANCIAL STATEMENTS

THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME (Unaudited)
(in millions, except per share data)

		Three Months Ended September 30,						Nine Months Ended September 30,
		2006			2005			2006			2005
Revenues
Premiums		$	5,260		$	4,977		$	15,432		$	15,205
Net investment income		858			812			2,607			2,352
Fee income		150			169			453			505
Net realized investment gains (losses)		12			39			16			(16		)
Other revenues		36			45			113			138
Total revenues		6,316			6,042			18,621			18,184
Claims and expenses
Claims and claim adjustment expenses		3,047			4,361			9,242			10,685
Amortization of deferred acquisition costs		858			830			2,472			2,423
General and administrative expenses		869			789			2,529			2,391
Interest expense		88			70			242			211
Total claims and expenses		4,862			6,050			14,485			15,710
Income (loss) from continuing operations before income taxes		1,454			(8		)	4,136			2,474
Income tax expense (benefit)		411			(83		)	1,117			591
Income from continuing operations		1,043			75			3,019			1,883
Discontinued operations
Operating income (loss), net of taxes		—			2			—			(663		)
Gain on disposal, net of taxes		—			85			—			223
Income (loss) from discontinued operations, net of taxes		—			87			—			(440		)
Net income		$	1,043		$	162		$	3,019		$	1,443
Basic earnings per share
Income from continuing operations		$	1.52		$	0.11		$	4.37		$	2.79
Income (loss) from discontinued operations		—			0.13			—			(0.65		)
Net income		$	1.52		$	0.24		$	4.37		$	2.14
Diluted earnings per share
Income from continuing operations		$	1.47		$	0.11		$	4.23		$	2.69
Income (loss) from discontinued operations		—			0.12			—			(0.62		)
Net income		$	1.47		$	0.23		$	4.23		$	2.07
Weighted average number of common shares outstanding
Basic		685.3			679.2			689.7			672.3
Diluted		714.6			683.8			718.6			711.3

 

See notes to consolidated financial statements (unaudited).

3

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEET

(in millions)

		September 30, 2006			December 31, 2005
		(Unaudited)
Assets
Fixed maturities, available for sale at fair value (including $1,699 and $2,667 subject to securities lending and repurchase agreements) (amortized cost $60,914 and $58,616)		$	61,354		$	58,983
Equity securities, at fair value (cost $479 and $538)		510			579
Real estate		750			752
Mortgage loans		54			145
Short-term securities		6,221			4,802
Other investments		3,263			3,026
Total investments		72,152			68,287
Cash		357			337
Investment income accrued		791			761
Premiums receivable		6,218			6,124
Reinsurance recoverables		18,378			19,574
Ceded unearned premiums		1,514			1,322
Deferred acquisition costs		1,645			1,527
Deferred tax asset		1,669			2,062
Contractholder receivables		5,642			5,516
Goodwill		3,441			3,442
Intangible assets		802			917
Other assets		2,889			3,318
Total assets		$	115,498		$	113,187
Liabilities
Claims and claim adjustment expense reserves		$	59,850		$	61,090
Unearned premium reserves		11,390			10,927
Contractholder payables		5,642			5,516
Payables for reinsurance premiums		908			720
Debt		6,569			5,850
Other liabilities		6,392			6,781
Total liabilities		90,751			90,884
Shareholders’ equity
Preferred Stock Savings Plan—convertible preferred stock (0.4 shares and 0.5 shares issued and outstanding)		136			153
Common stock (1,750.0 shares authorized; 689.5 and 693.4 shares issued and outstanding)		18,328			18,096
Retained earnings		6,245			3,750
Accumulated other changes in equity from nonowner sources		486			351
Treasury stock, at cost (10.2 and 1.2 shares)		(448		)	(47		)
Total shareholders’ equity		24,747			22,303
Total liabilities and shareholders’ equity		$	115,498		$	113,187

 

See notes to consolidated financial statements (unaudited).

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)

(in millions)

For the nine months ended September 30,		2006			2005
Convertible preferred stock—savings plan
Balance, beginning of year		$	153		$	193
Redemptions during period		(17		)	(33		)
Balance, end of period		136			160
Guaranteed obligation—stock ownership plan
Balance, beginning of year		—			(5		)
Principal payments		—			5
Balance, end of period		—			—
Total preferred shareholders’ equity		136			160
Common stock
Balance, beginning of year		18,096			17,331
Net shares issued under employee share-based compensation plans		109			162
Compensation amortization under share-based plans and other		123			83
Shares issued pursuant to maturity of equity unit forward contracts		—			442
Balance, end of period		18,328			18,018
Retained earnings
Balance, beginning of year		3,750			2,744
Net income		3,019			1,443
Dividends		(523		)	(467		)
Minority interest and other		(1		)	13
Balance, end of period		6,245			3,733
Accumulated other changes in equity from nonowner sources, net of tax
Balance, beginning of year		351			952
Change in net unrealized gain (loss) on investment securities		83			(396		)
Net change in unrealized foreign currency translation and other changes		52			(18		)
Balance, end of period		486			538
Treasury stock (at cost)
Balance, beginning of year		(47		)	(14		)
Net shares reacquired related to employee share-based compensation plans		(30		)	(27		)
Treasury shares acquired – share repurchase program		(371		)	—
Balance, end of period		(448		)	(41		)
Total common shareholders’ equity		24,611			22,248
Total shareholders’ equity		$	24,747		$	22,408
Common shares outstanding
Balance, beginning of year		693.4			670.3
Net shares issued under employee share-based compensation plans		4.5			6.7
Treasury shares acquired – share repurchase program		(8.4		)	—
Shares issued pursuant to maturity of equity unit forward contracts		—			15.2
Balance, end of period		689.5			692.2
Summary of changes in equity from nonowner sources
Net income		$	3,019		$	1,443
Other changes in equity from nonowner sources, net of tax		135			(414		)
Total changes in equity from nonowner sources		$	3,154		$	1,029

 

See notes to consolidated financial statements (unaudited).

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)

 (in millions)

For the nine months ended September 30,		2006			2005 (1)
Cash flows from operating activities
Net income		$	3,019		$	1,443
Adjustments to reconcile net income to net cash provided by operating activities:
Loss from discontinued operations, net of tax		—			440
Net realized investment (gains) losses		(16		)	16
Depreciation and amortization		607			499
Deferred federal income tax expense on continuing operations		353			517
Amortization of deferred policy acquisition costs		2,472			2,423
Premiums receivable		(94		)	52
Reinsurance recoverables		1,440			(398		)
Deferred acquisition costs		(2,590		)	(2,422		)
Claims and claim adjustment expense reserves		(1,997		)	1,528
Unearned premium reserves		462			(146		)
Trading account activities		6			6
Excess tax benefits from share-based payment arrangements		(8		)	—
Other		(536		)	(846		)
Net cash provided by operating activities of continuing operations		3,118			3,112
Net cash provided by operating activities of discontinued operations		—			24
Net cash provided by operating activities		3,118			3,136
Cash flows from investing activities
Proceeds from maturities of investments:
Fixed maturities		4,408			3,814
Mortgage loans		87			49
Proceeds from sales of investments:
Fixed maturities		3,626			3,433
Equity securities		224			281
Real estate		—			39
Purchases of investments:
Fixed maturities		(10,240		)	(12,163		)
Equity securities		(91		)	(37		)
Real estate		(23		)	(29		)
Short-term securities purchases, net		(1,368		)	(1,030		)
Other investments, net		211			630
Securities transactions in course of settlement		350			203
Other		(215		)	(73		)
Net cash used in investing activities of continuing operations		(3,031		)	(4,883		)
Net cash used in investing activities of discontinued operations		—			(20		)
Net cash used in investing activities		(3,031		)	(4,903		)
Cash flows from financing activities
Payment of debt		(46		)	(522		)
Issuance of debt		786			—
Dividends to shareholders		(524		)	(467		)
Issuance of common stock – employee share options		89			129
Issuance of common stock – maturity of equity unit forward contracts		—			442
Excess tax benefits from share-based payment arrangements		8			—
Treasury stock acquired – share repurchase program		(367		)	—
Treasury stock acquired – net employee share-based compensation		(17		)	(27		)
Net cash used in financing activities of continuing operations		(71		)	(445		)
Net cash provided by financing activities of discontinued operations		—			4
Net cash used in financing activities		(71		)	(441		)
Effect of exchange rate changes on cash		4			(3		)
Elimination of cash provided by discontinued operations		—			(8		)
Net proceeds from the sale of discontinued operations		—			2,399
Net increase in cash		20			180
Cash at beginning of period		337			262
Cash at end of period		$	357		$	442
Supplemental disclosure of cash flow information
Income taxes paid		$	591		$	522
Interest paid		$	250		$	267

 

(1)  See note 2.

See notes to consolidated financial statements (unaudited).

6

THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

The interim consolidated financial statements include the accounts of The St. Paul Travelers Companies, Inc. (together with its subsidiaries, the Company). These financial statements are prepared in conformity with U.S. generally accepted accounting principles (GAAP) and are unaudited.  In the opinion of the Company’s management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation, have been reflected.  Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been omitted.  Certain reclassifications have been made to the 2005 financial statements to conform to the 2006 presentation, including reclassifications related to the realignment of the Company’s reportable business segments described below and in the Company’s Current Report on Form 8-K dated September 29, 2006.  The accompanying interim consolidated financial statements and related notes should be read in conjunction with the Company’s consolidated financial statements and related notes included in the Company’s 2005 Annual Report on Form 10-K, and with the Company’s Current Report on Form 8-K dated September 29, 2006.

In August 2006, the Company announced a realignment of two of its three reportable business segments. The former Commercial and Specialty segments were realigned into two new reportable segments: the Business Insurance segment and the Financial, Professional & International Insurance segment. The Personal segment was renamed Personal Insurance. The changes were designed to reflect the manner in which the Company’s businesses are currently managed and represent an aggregation of products and services based on type of customer, how the business is marketed, and the manner in which risks are underwritten.

In March 2005, the Company and Nuveen Investments, Inc. (Nuveen Investments), the Company’s asset management subsidiary, jointly announced that the Company would implement a program to divest its 78% equity interest in Nuveen Investments.  The Company completed the divestiture through a series of transactions in the second and third quarters of 2005.  The Company’s share of Nuveen Investments’ earnings prior to divestiture was classified as income from discontinued operations on the consolidated statement of income. See note 2.

Adoption of New Accounting Standards

Statement of Financial Accounting Standards No. 123R - Share-Based Payment

In December 2004, the Financial Accounting Standards Board (FASB) issued Revised Statement of Financial Accounting Standards No. 123, Share-Based Payment (FAS 123R), an amendment to FAS 123, Accounting for Stock-Based Compensation, and a replacement of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, and its related implementation guidance. FAS 123R requires public entities to measure the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award and to recognize that cost over the requisite service period.

FAS 123R, which became effective January 1, 2006, requires entities that use the fair-value method of either recognition or disclosure under FAS 123 to apply a modified version of the prospective application. Under modified prospective application, compensation cost is recognized on or after the effective date for all unvested awards, based on their grant-date fair value as calculated under FAS 123 for either recognition or pro forma disclosure purposes.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES, Continued

In addition, the accounting for certain grants of equity awards to individuals who are retirement-eligible on the date of grant has been clarified. FAS 123R states that an employee’s share-based award becomes vested at the date that the employee’s right to receive or retain equity shares is no longer contingent on the satisfaction of a market, performance or service condition. Accordingly, awards granted to retirement-eligible employees are not contingent on satisfying a service condition and therefore are recognized at fair value on the date of the grant. Additionally, the period over which cost is recognized for awards granted to those who become retirement-eligible before the vesting date will be from the grant date to the retirement-eligible date rather than to the vesting date. This guidance is to be applied prospectively to new or modified awards granted upon adoption of FAS 123R.

The Company adopted FAS 123R effective January 1, 2006 using modified prospective application.  The adoption of FAS 123R did not have a material effect on the Company’s results of operations, financial condition or liquidity.  See note 10.

Staff Accounting Bulletin No. 107 - Share-Based Payment

In March 2005, the staff of the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107 (SAB 107) as an interpretation by the SEC staff of the interaction between FAS 123R and certain SEC rules and regulations regarding the valuation of share-based payment arrangements. SAB 107 requires that all disclosure requirements for annual reporting be provided for interim periods during the first year of adoption, beginning in the period of adoption.  Accordingly, in note 10 of the financial statements, the Company has included, on a year-to-date basis, the annual disclosure requirements of FAS 123R.

Accounting Changes and Error Corrections

In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections (FAS 154), which replaced APB Opinion No. 20, Accounting Changes, and FASB Statement of Financial Accounting Standards No. 3, Reporting Changes in Interim Financial Statements.  FAS 154 changed the requirements for the accounting for and reporting of a change in accounting principle. It requires retrospective application to prior period financial statements of voluntary changes in accounting principle and changes required by new accounting standards when the standard does not include specific transition provisions, unless it is impracticable to do so. FAS 154 was effective for accounting changes and corrections of errors in fiscal years beginning after December 15, 2005.  Early adoption was permitted for accounting changes and corrections of errors made in fiscal years beginning after June 1, 2005.  It did not change the transition provisions of any existing accounting pronouncements, including those that were in a transition phase as of December 15, 2005.  The adoption of FAS 154 had no effect on the Company’s results of operations, financial condition or liquidity.

The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments

In November 2005, the FASB issued FASB Staff Position (FSP) FAS 115-1 and FAS 124-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.  The FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other-than-temporary, and the measurement of an impairment loss.  It requires the establishment of a new cost basis subsequent to the recognition of an other-than-temporary impairment and certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments.  The FSP is effective for reporting periods beginning after December 15, 2005. The Company had previously implemented these requirements.  Therefore, the adoption of the FSP had no effect on the Company’s results of operations, financial condition or liquidity.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES, Continued

Accounting Standards Not Yet Adopted

Staff Accounting Bulletin No. 108 – Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements

In September 2006, the staff of the SEC issued Staff Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements (SAB 108), as an interpretation by the SEC staff of the process of quantifying financial statement misstatements for purposes of determining whether a misstatement is material.  SAB 108 was issued to address diversity in practice used by registrants in quantifying financial statement misstatements, and the potential under the current practice for the build up of improper amounts on the balance sheet.  SAB 108 requires registrants to quantify the impact of correcting all misstatements, including both the carryover and reversing effects of prior year statements, on the current year financial statements (i.e., the income statement and the balance sheet).  Staff Accounting Bulletin No. 99, Materiality, which requires that both qualitative and quantitative factors be evaluated in determining whether a misstatement is material to the financial statements, is not affected by the issuance of SAB 108.

SAB 108 is effective for the first interim period of the first fiscal year ending after November 15, 2006, with early adoption encouraged.  The Company does not expect the provisions of SAB 108 to have a material effect on its results of operations, financial condition or liquidity.

Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R)

In September 2006, FASB issued Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106 and 132(R) (FAS 158).  FAS 158 requires an employer to recognize the funded status of a benefit plan as an asset or liability in its statement of financial position, measured as the difference between plan assets at fair value and the benefit obligation, and to recognize as a component of accumulated other changes in equity from nonowner sources, net of tax, gains or losses and prior service costs or credits that arise during the period but which are not recognized as components of net periodic benefit cost pursuant to FASB Statement No. 87, Employers’ Accounting for Pensions (FAS 87), or FASB Statement No. 106, Employers’ Accounting for Postretirement Benefits Other Than Pensions (FAS 106). The provisions of FAS 87 and FAS 106 continue to apply in measuring plan assets and benefit obligations, as of the date of the fiscal year-end statement of financial position, and in determining the amount of net periodic benefit cost. The provisions of FAS 158 are effective for fiscal years ending after December 15, 2006 and shall not be applied retrospectively. Upon the adoption of FAS 158 at fiscal year ended December 31, 2006, the Company is required to recognize, net of tax, an adjustment to the ending balance of accumulated other changes in equity from nonowner sources, any gains or losses and prior service costs or credits that have not yet been included in net periodic pension costs and to reverse any additional minimum pension liability. The Company does not expect that the provisions of FAS 158 will have a material effect on its results of operations or liquidity, as this statement does not affect the determination of net periodic pension cost, nor on its financial condition.

Accounting for Certain Hybrid Financial Instruments

In February 2006, the FASB released Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140 (FAS 155).  FAS 155 nullifies the guidance in the FASB’s Derivatives Implementation Group Issue D1 “Application of Statement 133 to Beneficial Interests in Securitized Assets”, which had deferred the bifurcation requirements of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133), for certain beneficial interests in securitized financial assets.  FAS 155 requires beneficial interests in securitized financial assets be analyzed to determine whether they are freestanding derivatives or hybrid instruments that contain an embedded derivative requiring bifurcation.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES, Continued

FAS 155 permits entities to fair value any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation.  This election is on a contract-by-contract basis and is irrevocable.  Additionally, FAS 155 narrows the exception afforded to interest-only strips and principal-only strips from derivative accounting.  The FASB has proposed to amend this exception by issuing a FAS 133 Implementation Issue which will, if approved, create a scope exception for securitized interests that (1) only contain an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial assets, and (2) the investor does not control the right to accelerate the settlement.

In addition, FAS 155 clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement 125, to eliminate the restriction on the passive derivative instruments a Qualifying Special Purpose Entity can hold.

FAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s fiscal year that begins after September 15, 2006.  At adoption, for contracts where the fair value option has been elected, any difference between the total carrying amount of the individual components of the existing bifurcated hybrid financial instrument and the fair value of the combined hybrid financial instrument should be recognized as a cumulative-effect adjustment to beginning retained earnings.  The Company does not plan to elect the fair value option and thus does not expect to have a cumulative effect upon adoption of FAS 155.  The Company is in the process of determining the ongoing effect of FAS 155 on its results of operations, financial condition and liquidity.

Fair Value Measurements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157).  FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure about fair value measurements.  It applies to other pronouncements that require or permit fair value but does not require any new fair value measurements.  The statement defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

FAS 157 establishes a fair value hierarchy to increase consistency and comparability in fair value measurements and disclosures.  The hierarchy is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets.  The highest possible level should be used to measure fair value.

FAS 157 is effective for fiscal years beginning after November 15, 2007.  The Company does not expect the provisions of FAS 157 to have a material effect on its results of operations, financial condition or liquidity.

Accounting for Uncertainty in Income Taxes

In July 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 (FIN 48).  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes the recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

Under FIN 48, evaluation of a tax position is a two-step process.  The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of the position.  The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements.  A tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES, Continued

Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met.  Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.

FIN 48 is effective for fiscal years beginning after December 15, 2006.  The Company does not expect the provisions of FIN 48 to have a material effect on results of operations, financial condition or liquidity.

Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts

In September 2005, the Accounting Standards Executive Committee (AcSEC) issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1).  SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in FAS 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.  SOP 05-1 defines an internal replacement as a modification in product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract.

SOP 05-1 is effective for internal replacements occurring in fiscal years beginning after December 15, 2006, with earlier adoption encouraged.  The Company does not expect the provisions of SOP 05-1 to have a material effect on its results of operations, financial condition or liquidity.

Endorsement Split-Dollar Life Insurance Arrangements

In September 2006, FASB issued Emerging Issues Task Force Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (EITF 06-4).  EITF 06-4 requires a company to recognize a liability and related compensation expense for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods.  The provisions of EITF 06-4 are effective for fiscal years beginning after December 15, 2006.  The Company does not expect the provisions of EITF 06-4 to have a material effect on the Company’s results of operations, financial condition or liquidity.

Accounting Policies

Reinsurance to Close

Under the accounting conventions used by Lloyd’s members, each underwriting account is normally kept open for three years and the underwriting results determined at the end of the third year when the account is closed, normally by reinsurance into the following year of account.  When a year of account is closed, a reinsurance contract (the “reinsurance to close” or RITC) is entered into with a subsequent year of account in consideration for which all subsequent underwriting transactions resulting from the closing year and all previous years reinsured therein are brought forward to (accepted by) the subsequent year of account.  The RITC, which is calculated by the underwriter and approved by the managing agent, comprises an estimate of all net outstanding liabilities of the closing year and all previous years.

The amount of the assets received in an RITC is equal to the accepted claims including incurred but not reported (IBNR) claims and is undiscounted for the time value of money.  Accordingly, there is no gain or loss at the time the assets and liabilities are acquired and recognized by the subsequent year of account.  In addition, there is no impact on reported premiums and losses as a result of an RITC transaction.

Treasury Stock

Treasury stock represents the cost of common stock repurchased by the Company, which stock represents authorized and unissued shares of the Company under the Minnesota Business Corporation Act.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

2.             DISCONTINUED OPERATIONS

In March 2005, the Company and Nuveen Investments jointly announced that the Company would implement a program to divest its 78% equity interest in Nuveen Investments, which constituted the Company’s Asset Management segment and was acquired as part of the merger on April 1, 2004.  The divestiture was completed through a series of transactions in the second and third quarters of 2005, resulting in net pretax cash proceeds of $2.40 billion, including net pretax proceeds of $532 million in the third quarter of 2005.

In conjunction with these transactions, the Company recorded a pretax gain on disposal of $343 million ($223 million after-tax) for the nine months ended September 30, 2005, including a pretax gain on disposal of $131 million ($85 million after-tax) for the quarter ended September 30, 2005.  Additionally, the Company recorded a net operating loss from discontinued operations of $663 million for the nine months ended September 30, 2005, consisting primarily of $710 million of tax expense due to the difference between the tax basis and the GAAP carrying value of the Company’s investment in Nuveen Investments, partially offset by the Company’s share of Nuveen Investments’ net income for the nine months ended September 30, 2005.  The Company recorded net operating income from discontinued operations of $2 million for the quarter ended September 30, 2005.

The divestiture of Nuveen Investments was completed prior to the end of 2005; accordingly, no balances related to Nuveen Investments are included in the Company’s consolidated balance sheet at December 31, 2005.

For the nine months ended September 30, 2005, the Company has separately disclosed the operating, investing and financing cash flows attributable to its discontinued operations (Nuveen Investments), which previously were reported as components of cash flows from continuing operations.

3.                       SEGMENT INFORMATION

In August 2006, the Company announced a realignment of two of its three reportable business segments. The former Commercial and Specialty segments were realigned into two new reportable segments: the Business Insurance segment and the Financial, Professional & International Insurance segment. The Personal segment was renamed Personal Insurance. The changes were designed to reflect the manner in which the Company’s businesses are currently managed and represent an aggregation of products and services based on type of customer, how the business is marketed, and the manner in which risks are underwritten.  The following discussion reflects the realigned segment reporting structure.  Financial data for prior periods presented in the tables following the discussion has been reclassified to be consistent with the new segment structure.

Business Insurance

The Business Insurance segment offers a broad array of property and casualty insurance and insurance-related services to its clients primarily in the United States. Business Insurance is organized into the following groups, which collectively comprise Business Insurance Core operations:

·                   Select Accounts serves small businesses and offers commercial multi-peril, property, general liability, commercial auto and workers’ compensation insurance.

·                   Commercial Accounts serves primarily mid-sized businesses for property and casualty products, including property, general liability, commercial multi-peril, commercial auto and workers’ compensation insurance.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       SEGMENT INFORMATION, Continued

·                   National Accounts comprises three business units.  The largest provides casualty products and services to large companies, with particular emphasis on workers’ compensation, general liability and automobile liability.  National Accounts also includes Discover Re, which provides unbundled property and casualty insurance products to insureds who utilize programs such as self-insurance, collateralized deductibles and captive reinsurers.  In addition, National Accounts includes the commercial residual market business, which primarily offers workers’ compensation products and services to the involuntary market.

·                   Industry-Focused Underwriting. The following business units serve targeted industries with differentiated combinations of insurance coverage, risk management, claims handling and other services:

·       Construction serves a broad range of construction businesses, offering guaranteed cost products for small to mid-sized policyholders and loss sensitive programs for larger accounts.  For the larger accounts, the customer and the Company work together in actively managing and controlling exposure and claims and they share risk through policy features such as deductibles or retrospective rating.  Products offered include workers’ compensation, general liability and commercial auto coverages, and other risk management solutions.

·       Technology serves small to mid-sized companies involved in telecommunications, information technology, medical technology and electronics manufacturing, offering a well-balanced comprehensive portfolio of products and services.  These products include property, commercial auto, general liability, workers’ compensation, umbrella, internet liability, technology errors and omissions coverages and global companion products.

·       Public Sector Services markets insurance products and services to public entities including municipalities, counties, Indian Nation gaming and selected special government districts such as water and sewer utilities. The policies written by this unit typically cover property, commercial auto, general liability and errors and omissions exposures.

·       Oil & Gas provides specialized property and liability products and services for customers involved in the exploration and production of oil and natural gas, including operators and drilling contractors, as well as various service and supply companies and manufacturers that support upstream operations. The policies written by this business group insure drilling rigs, natural gas facilities, and production and gathering platforms, and cover risks including physical damage, liability and business interruption.

·       Agribusiness serves small to medium-sized agricultural businesses, including farms, ranches, wineries and related operations, offering property and liability coverages other than workers’ compensation.

13

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       SEGMENT INFORMATION, Continued

·                   Target Risk Underwriting. The following business units serve commercial businesses requiring specialized product underwriting, claims handling and risk management services:

·       National Property serves large and mid-sized customers, including retailers, hospitals, colleges and universities, and owners of industrial parks, office buildings, apartments and amusement parks, covering losses on buildings, business assets and business interruption exposures.

·       Inland Marine provides insurance for goods in transit and movable objects for customers such as jewelers, museums, contractors and the transportation industry.  Builders’ Risk insurance is also offered to customers during the construction, renovation or repair of buildings and other structures.

·       Ocean Marine serves the marine transportation industry and related services, as well as other businesses involved in international trade. The Company’s product offerings fall under six main coverage categories: marine liability, cargo, hull and machinery, protection and indemnity, pleasure craft, and marine property and liability.

·       Excess Casualty serves small to mid-sized commercial businesses, offering mono-line umbrella and excess coverage where the Company does not write the primary casualty coverage, or where other business units within the Company prefer to outsource the underwriting of umbrella and excess business based on the expertise and/or limit capacity of Excess Casualty.

·       Boiler & Machinery serves customers ranging from small businesses to Fortune 100 companies, offering comprehensive breakdown coverages for equipment, including property and business interruption coverages.   Through the BoilerRe unit, Boiler and Machinery also serves other property casualty carriers that do not have in-house expertise with reinsurance, underwriting, engineering, claim handling and risk management services for this type of coverage.

·       Global Accounts provides insurance to U.S. companies with foreign property and liability exposures (“home-foreign”), and foreign organizations with property and liability exposures located in the United States (“reverse-flow”), as part of a global program.

·                   Specialized Distribution. The following business units market and underwrite their products to customers predominantly through licensed wholesale, general and program agents that manage customers’ unique insurance requirements.

·       Northland provides insurance coverage for the commercial transportation industry, as well as commercial liability and package policies for small, difficult to place specialty classes of commercial business on an admitted or excess and surplus lines basis.

·       National Programs offers tailored property and casualty programs on an admitted basis for customers with common risk characteristics or coverage requirements.  Programs available include those for entertainment, architects and engineers, equipment rental and golf services.

·       Underwriting Facilities serves small commercial businesses, offering general liability, property and commercial auto physical damage coverages on an admitted or excess and surplus lines basis.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       SEGMENT INFORMATION, Continued

Business Insurance also includes the Special Liability Group (which manages the Company’s asbestos and environmental liabilities); the assumed reinsurance, health care, and certain international and other runoff operations; policies written by the Company’s Gulf operation (Gulf), which was placed into runoff during the second quarter of 2004; and the Company’s Personal Catastrophe Risk operation, which was sold in November 2005.  The Company’s Personal Catastrophe Risk business had been included in the Specialty segment prior to the August 2006 segment realignment.  In accordance with the terms of the sale agreement, the Company retained responsibility for the pre-sale claims and claim adjustment expense reserves related to the Personal Catastrophe Risk operation and remains responsible for any changes in estimates in those reserves through a quota-share reinsurance agreement.  All of these operations are collectively referred to as Business Insurance Other.  The Personal Catastrophe Risk operation accounted for the majority of net written premiums in this category in 2005.

Financial, Professional & International Insurance

The Financial, Professional & International Insurance segment includes surety and financial liability coverages, which require a primarily credit-based underwriting process, as well as property and casualty products that are primarily marketed on an international basis.  The segment includes the following groups:

·                  Bond provides a wide range of customers with specialty products built around the Company’s market leading surety bond business along with an expanding executive liability practice for middle and small market private companies and not-for-profit organizations. Bond’s range of products includes surety and fidelity bonds, directors’ and officers’ liability insurance, errors and omissions insurance, professional liability insurance, employment practices liability insurance, fiduciary liability insurance, and other related coverages.

·                  Financial & Professional Services primarily provides professional liability and management liability coverages for public corporations against losses caused by the negligence or misconduct of named directors and officers, professional liability coverages for a variety of professionals, such as lawyers, design professionals and real estate agents, for errors and omissions committed in the course of professional conduct or practice, and a full range of insurance coverages including property, auto, liability, fidelity and professional liability coverages for financial institutions.

·                  International and Lloyd’s includes coverages marketed and underwritten to several customer groups within the United Kingdom, Canada and the Republic of Ireland and the Company’s participation in Lloyd’s.  The International operations offer specialized insurance and risk management services to several customer groups, including those in the technology, public services, and financial and professional services industry sectors. The Company’s International operations primarily underwrite employers’ liability (similar to workers’ compensation coverage in the United States), public and product liability (the equivalent of general liability), professional indemnity (similar to professional liability coverage), motor (similar to automobile coverage in the United States) and property coverages.  At Lloyd’s, the Company underwrites four principal lines of business—aviation, marine, global property, and accident and special risks—through Syndicate 5000, for which the Company provides 100% of the capital. During the second half of 2004, the Company made a decision to exit certain portions of the Lloyd’s personal lines business and, in early 2005, sold the right to renew this business as well as the operating companies that supported it.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       SEGMENT INFORMATION, Continued

Personal Insurance

The Personal Insurance segment writes virtually all types of property and casualty insurance covering personal risks. The primary coverages in Personal Insurance are automobile and homeowners insurance sold to individuals. These products are distributed through independent agents, sponsoring organizations such as employee and affinity groups, and joint marketing arrangements with other insurers.

Automobile policies provide coverage for liability to others for both bodily injury and property damage, and for physical damage to an insured’s own vehicle from collision and various other perils. In addition, many states require policies to provide first-party personal injury protection, frequently referred to as no-fault coverage.

Homeowners policies are available for dwellings, condominiums, mobile homes and rental property contents. Protection against losses to dwellings and contents from a wide variety of perils is included in these policies, as well as coverage for liability arising from ownership or occupancy.

16

THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       SEGMENT INFORMATION, continued

(for the three months ended September 30, in millions)		Business Insurance			Financial, Professional & International Insurance			Personal Insurance			Total Reportable Segments
2006 Revenues
Premiums		$	2,737		$	850		$	1,673		$	5,260
Net investment income		610			108			140			858
Fee income		150			—			—			150
Other revenues		8			5			23			36
Total operating revenues (1)		$	3,505		$	963		$	1,836		$	6,304
Operating income (1)		$	613		$	144		$	341		$	1,098
2005 Revenues
Premiums		$	2,707		$	759		$	1,511		$	4,977
Net investment income		591			96			112			799
Fee income		168			1			—			169
Other revenues		19			2			24			45
Total operating revenues (1)		$	3,485		$	858		$	1,647		$	5,990
Operating income (loss) (1)		$	30		$	86		$	(25	)	$	91

 

(for the nine months ended September 30, in millions)		Business Insurance			Financial, Professional & International Insurance			Personal Insurance			Total Reportable Segments
2006 Revenues
Premiums		$	8,095		$	2,477		$	4,860		$	15,432
Net investment income		1,881			313			411			2,605
Fee income		453			—			—			453
Other revenues		24			16			69			109
Total operating revenues (1)		$	10,453		$	2,806		$	5,340		$	18,599
Operating income (1)		$	1,919		$	434		$	784		$	3,137
2005 Revenues
Premiums		$	8,371		$	2,368		$	4,466		$	15,205
Net investment income		1,750			258			337			2,345
Fee income		504			1			—			505
Other revenues		52			17			71			140
Total operating revenues (1)		$	10,677		$	2,644		$	4,874		$	18,195
Operating income (1)		$	1,154		$	334		$	526		$	2,014

 

(1)                   Operating revenues exclude net realized investment gains (losses) and revenues from discontinued operations. Operating income equals net income excluding the after-tax impact of net realized investment gains (losses) and the after-tax impact of discontinued operations.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.              SEGMENT INFORMATION, Continued

The Company allocates pretax net investment income (NII) to its reportable business segments based upon an investable funds concept, which takes into account liabilities (net of non-invested assets) and appropriate capital considerations for each segment.  The investment yield for investable funds reflects the duration of the loss reserves’ future cash flows, the interest rate environment at the time the losses were incurred and A+ rated corporate debt instruments.  This duration yield is compared to the average portfolio yield and a new average yield is determined.  It is this average yield that is used in the calculation of NII on investable funds.  Yields are updated annually.  Invested assets are allocated to segments in proportion to the pretax allocation of NII.  

The cost of the Company’s catastrophe treaty program is included in the Company’s ceded premiums and is allocated among reportable business segments based on an estimate of actual market reinsurance pricing using expected losses calculated by the Company’s catastrophe model, adjusted for any experience adjustments.  For Hurricane Katrina, the initial allocation of reinsurance recoverables to the segments was based upon the best estimate of segment incurred losses.  

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.              SEGMENT INFORMATION, Continued

Business Segment Reconciliations

		Three Months Ended September 30,						Nine Months Ended September 30,
(in millions)		2006			2005			2006			2005
Revenue reconciliation
Earned premiums:
Business Insurance:
Commercial multi-peril		$	771		$	729		$	2,276		$	2,206
Workers’ compensation		494			469			1,510			1,526
Commercial automobile		508			539			1,487			1,635
Property		472			440			1,405			1,367
General liability		480			513			1,394			1,586
Other		12			17			23			51
Total Business Insurance		2,737			2,707			8,095			8,371
Financial, Professional & International Insurance:
General liability		254			247			752			669
Fidelity and surety		283			243			819			798
International		283			243			816			822
Other		30			26			90			79
Total Financial, Professional & International Insurance		850			759			2,477			2,368
Personal Insurance:
Automobile		939			864			2,721			2,555
Homeowners and other		734			647			2,139			1,911
Total Personal Insurance		1,673			1,511			4,860			4,466
Total earned premiums		5,260			4,977			15,432			15,205
Net investment income		858			799			2,605			2,345
Fee income		150			169			453			505
Other revenues		36			45			109			140
Total operating revenues for reportable segments		6,304			5,990			18,599			18,195
Interest Expense and Other		—			13			6			5
Net realized investment gains (losses)		12			39			16			(16		)
Total consolidated revenues		$	6,316		$	6,042		$	18,621		$	18,184
Income reconciliation, net of tax
Total operating income for reportable segments		$	1,098		$	91		$	3,137		$	2,014
Interest Expense and Other		(61		)	(41		)	(130		)	(139		)
Total operating income from continuing operations		1,037			50			$	3,007		$	1,875
Net realized investment gains		6			25			12			8
Total income from continuing operations		1,043			75			3,019			1,883
Discontinued operations		—			87			—			(440		)
Total consolidated net income		$	1,043		$	162		$	3,019		$	1,443

 

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       SEGMENT INFORMATION, Continued

(in millions)		September 30, 2006			December 31, 2005
Assets for reportable segments:
Business Insurance		$	88,222		$	87,188
Financial, Professional & International Insurance		12,941			11,908
Personal Insurance		13,619			12,710
Total assets for reportable segments		114,782			111,806
Other assets (1)		716			1,381
Total consolidated assets		$	115,498		$	113,187

 

(1)                   The primary components of other assets in 2006 were prepaid pension costs and deferred taxes and in 2005 were invested assets, prepaid pension costs and deferred taxes.

4.                       INVESTMENTS

Fixed Maturities

The amortized cost and fair value of investments in fixed maturities classified as available-for-sale were as follows:

		Amortized			Gross Unrealized						Fair
(at September 30, 2006, in millions)		Cost			Gains			Losses			Value
Mortgage-backed securities, collateralized mortgage obligations and pass-through securities		$	7,671		$	60		$	134		$	7,597
U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities		2,601			16			30			2,587
Obligations of states, municipalities and political subdivisions		34,278			679			74			34,883
Debt securities issued by foreign governments		1,620			11			8			1,623
All other corporate bonds		14,664			162			256			14,570
Redeemable preferred stock		80			15			1			94
Total		$	60,914		$	943		$	503		$	61,354

 

		Amortized			Gross Unrealized						Fair
(at December 31, 2005, in millions)		Cost			Gains			Losses			Value
Mortgage-backed securities, collateralized mortgage obligations and pass-through securities		$	7,997		$	66		$	121		$	7,942
U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities		3,458			18			35			3,441
Obligations of states, municipalities and political subdivisions		31,372			587			137			31,822
Debt securities issued by foreign governments		1,583			11			6			1,588
All other corporate bonds		14,098			201			230			14,069
Redeemable preferred stock		108			14			1			121
Total		$	58,616		$	897		$	530		$	58,983

 

Equity Securities

The cost and fair value of investments in equity securities were as follows:

					Gross Unrealized						Fair
(at September 30, 2006, in millions)		Cost			Gains			Losses			Value
Common stock		$	103		$	21		$	4		$	120
Non-redeemable preferred stock		376			18			4			390
Total		$	479		$	39		$	8		$	510

 

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

4.                       INVESTMENTS, Continued

					Gross Unrealized						Fair
(at December 31, 2005, in millions)		Cost			Gains			Losses			Value
Common stock		$	136		$	24		$	3		$	157
Non-redeemable preferred stock		402			24			4			422
Total		$	538		$	48		$	7		$	579

 

Real Estate

The Company’s real estate investments include warehouses, office buildings, land and other commercial real estate assets that are directly owned. The Company negotiates commercial leases with individual tenants through unrelated, licensed real estate brokers. Negotiated terms and conditions include, among others, rental rates, length of lease period and improvements to the premises to be provided by the landlord. 

Venture Capital

The cost and fair value of investments in venture capital, which are reported as part of other investments in the Company’s consolidated balance sheet, were as follows:

					Gross Unrealized						Fair
(at September 30, 2006, in millions)		Cost			Gains			Losses			Value
Venture capital		$	391		$	100		$	7		$	484

 

					Gross Unrealized						Fair
(at December 31, 2005, in millions)		Cost			Gains			Losses			Value
Venture capital		$	406		$	91		$	2		$	495

 

Variable Interest Entities (VIEs)

The Company has significant interests in the following VIEs which are not consolidated because the Company is not considered to be the primary beneficiary:

·                  The Company has a significant variable interest in two real estate entities.  Of these two investments, one became a reportable VIE during the third quarter of 2006 due to an increase in the Company’s ownership interest. These investments have total assets of approximately $300 million and $299 million as of September 30, 2006 and December 31, 2005, respectively. The carrying value of the Company’s share of these investments was approximately $44 million at September 30, 2006 and $38 million at December 31, 2005. The Company has an unfunded commitment of $12 million associated with one of these funds. The Company’s exposure to loss is limited to the investment carrying amounts reported in the consolidated balance sheet and the unfunded commitment amount. The purpose of the Company’s involvement in these entities is to generate investment returns.

·                  The Company has a significant variable interest in Camperdown UK Limited, which The St. Paul Companies, Inc. (SPC) sold in December 2003. The Company’s variable interest resulted from an agreement to indemnify the purchaser in the event a specified reserve deficiency develops, a reserve-related foreign exchange impact occurs, or a foreign tax adjustment is imposed on a pre-sale reporting period. The maximum amount of this indemnification obligation is $178 million. The fair value of this obligation as of September 30, 2006 and December 31, 2005 was $63 million and $66 million, respectively.  See “Guarantees” section of note 9.

The Company has other significant interests in variable interest entities that are not material.

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THE ST. PAUL TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

4.                       INVESTMENTS, Continued

The following securities are not consolidated:

·                  Mandatorily redeemable preferred securities of trusts holding solely the subordinated debentures of the Company - These securities were issued by five separate trusts that were established for the sole purpose of issuing the securities to investors, and are fully guaranteed by the Company. The debt that the Company issued to these trusts is included in the “Debt” section of liabilities on the Company’s consolidated balance sheet. That debt had a carrying value of $1.03 billion at September 30, 2006 and December 31, 2005.

Impairments

Fixed Maturities and Equity Securities

An investment in a fixed maturity or equity security which is available for sale is impaired if its fair value falls below its cost and the decline is considered to be other-than-temporary.  Cost includes adjustments, if any, made to the cost basis of an investment for accretion, amortization and previous other-than-temporary impairments.  Factors considered in determining whether a decline is other-than-temporary include the length of time and the extent to which fair value has been below cost, the financial condition and near-term prospects of the issuer, and the Company’s ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery.

Additionally, for certain securitized financial assets with contractual cash flows (including asset-backed securities), FASB Emerging Issues Task Force (EITF) 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets, requires the Company to periodically update its best estimate of cash flows over the life of the security. If management determines that the fair value of its securitized financial asset is less than its carrying amount and there has been a decrease in the present value of the estimated cash flows since the last revised estimate, considering both timing and amount, then an other-than-temporary impairment is recognized.

A fixed maturity security is impaired if it is probable that the Company will not be able to collect all amounts due under the security’s contractual terms. Equity securities are impaired when it becomes apparent that the Company will not recover its cost over the expected holding period. Further, for securities planned to be sold, an other-than-temporary impairment charge is recognized if the Company does not expect the fair value of a security to recover prior to the expected date of sale.

The Company’s process for reviewing invested assets for impairments during any quarter includes the following:

·                  identification and evaluation of investments which have possible indications of impairment;

·                  analysis of investments with gross unrealized investment losses that have fair values less than 80% of amortized cost during successive quarterly periods over a rolling one-year period;

·                  review of portfolio manager(s) recommendations for other-than-temporary impairments based on the investee’s current financial condition, liquidity, near-term recovery prospects and other factors, as well as consideration of other investments that were not recommended for other-than-temporary impairments;

·                  consideration of evidential matter, including an evaluation of factors or triggers that may cause individual investments to qualify as having other-than-temporary impairments; and

·                  determination of the status of each analyzed investment as other-than-temporary or not, with documentation of the rationale for the decision.

Real Estate Investments

The carrying values of real estate properties are reviewed for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. The review for impairment includes an estimate of the undiscounted cash flows expected to result from the use and eventual disposition of the real estate property. An impairment loss is recognized if the expected future undiscounted cash flows are less than the carrying value of the real estate property.

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