UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
----- SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2003
-----------------
or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
----- SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
------------ ------------
Commission File Number 001-10898
---------
THE ST. PAUL COMPANIES, INC.
----------------------------------------------------
(Exact name of Registrant as specified in its charter)
Minnesota 41-0518860
------------------------------ ------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) No.)
385 Washington St., Saint Paul, MN 55102
---------------------------------- --------
(Address of principal executive (Zip Code)
offices)
Registrant's telephone number, including area code: (651) 310-7911
-------------
Indicate by check mark whether the Registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the Registrant was required to file
such reports) and (2) has been subject to such filing requirements
for the past 90 days.
Yes x No
----- -----
The number of shares of the Registrant's Common Stock, without par
value, outstanding at July 25, 2003, was 227,799,983.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION --------
Consolidated Statements of Operations (Unaudited),
Three and Six Months Ended June 30, 2003 and 2002 3
Consolidated Balance Sheets, June 30, 2003
(Unaudited) and December 31, 2002 4
Consolidated Statements of Shareholders' Equity,
Six Months Ended June 30, 2003
(Unaudited) and Twelve Months Ended 6
December 31, 2002
Consolidated Statements of Comprehensive Income (Loss)
(Unaudited), Six Months Ended June 30, 2003
and 2002 7
Consolidated Statements of Cash Flows (Unaudited),
Six Months Ended June 30, 2003 and 2002 8
Notes to Consolidated Financial Statements
(Unaudited) 9
Forward-Looking Statement Disclosure and Certain Risks 28
Management's Discussion and Analysis of
Financial Condition and Results of
Operations 30
Qualitative and Quantitative Disclosures
about Market Risk 60
Controls and Procedures 60
PART II. OTHER INFORMATION
Item 1 through Item 5 61
Item 6 62
Signatures 62
EXHIBIT INDEX 63
Item 1. Financial Statements.
PART I FINANCIAL INFORMATION
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Unaudited
For the three months and six months ended June 30, 2003 and 2002
(In millions, except per share data)
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
2003 2002 2003 2002
------ ------ ------ ------
Revenues:
Premiums earned $ 1,700 $ 1,956 $ 3,429 $ 3,914
Net investment income 274 286 556 579
Asset management 106 90 208 184
Realized investment
gains (losses) 68 (32) 29 (70)
Other 23 44 63 71
------ ------ ------ ------
Total revenues 2,171 2,344 4,285 4,678
------ ------ ------ ------
Expenses:
Insurance losses and
loss adjustment expenses 1,192 1,986 2,328 3,379
Policy acquisition expenses 377 441 784 874
Operating and
administrative expenses 294 281 614 593
------ ------ ------ ------
Total expenses 1,863 2,708 3,726 4,846
------ ------ ------ ------
Income (loss) from
continuing operations
before income taxes and
cumulative effect of
accounting change 308 (364) 559 (168)
Income tax expense
(benefit) 93 (146) 163 (98)
------ ------ ------ ------
Income (loss) before
cumulative effect of
accounting change 215 (218) 396 (70)
Cumulative effect of
accounting change,
net of taxes - - - (6)
------ ------ ------ ------
Income (loss) from
continuing operations 215 (218) 396 (76)
Discontinued operations:
Loss on disposal, net of taxes (1) (5) (1) (14)
------ ------ ------ ------
Loss from discontinued
operations, net of taxes (1) (5) (1) (14)
------ ------ ------ ------
Net income (loss) $ 214 $ (223) $ 395 $ (90)
====== ====== ====== ======
Basic earnings (loss)
per share:
Income (loss) from
continuing operations $ 0.94 $ (1.07) $ 1.71 $ (0.41)
Discontinued operations,
net of taxes (0.01) (0.02) (0.01) (0.06)
------ ------ ------ ------
Net income (loss) $ 0.93 $ (1.09) $ 1.70 $ (0.47)
====== ====== ====== ======
Diluted earnings (loss)
per share:
Income (loss) from
continuing operations $ 0.89 $ (1.07) $ 1.64 $ (0.41)
Discontinued operations,
net of taxes - (0.02) - (0.06)
------ ------ ------ ------
Net income (loss) $ 0.89 $ (1.09) $ 1.64 $ (0.47)
====== ====== ====== ======
Dividends declared per
common share $ 0.29 $ 0.29 $ 0.58 $ 0.58
====== ====== ====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2003 (unaudited) and December 31, 2002
(In millions)
2003 2002
Assets ------ ------
Investments:
Fixed income $16,956 $17,188
Real estate and mortgage loans 857 874
Venture capital 547 581
Equities 352 394
Securities on loan 857 806
Other investments 843 738
Short-term investments 1,895 2,152
------ ------
Total investments 22,307 22,733
Cash 177 315
Reinsurance recoverables:
Unpaid losses 7,490 7,777
Paid losses 962 523
Ceded unearned premiums 787 813
Receivables:
Underwriting premiums 2,784 2,711
Interest and dividends 242 247
Other 214 218
Deferred policy acquisition costs 653 532
Deferred income taxes 1,179 1,267
Office properties and equipment 363 459
Goodwill 894 874
Intangible assets 148 139
Other assets 2,338 1,351
------ ------
Total Assets $40,538 $39,959
====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
June 30, 2003 (unaudited) and December 31, 2002
(In millions)
2003 2002
Liabilities ------ ------
Insurance reserves:
Losses and loss adjustment
expenses $21,320 $22,626
Unearned premiums 4,177 3,802
------ ------
Total insurance reserves 25,497 26,428
Debt 2,535 2,713
Payables:
Reinsurance premiums 1,020 1,010
Accrued expenses and other 1,033 963
Securities lending collateral 874 822
Other liabilities 2,414 1,388
------ ------
Total Liabilities 33,373 33,324
------ ------
Company-obligated mandatorily
redeemable preferred securities
of trusts holding solely
subordinated debentures of
the company 890 889
------ ------
Shareholders' Equity
Preferred:
Stock Ownership Plan -
convertible preferred stock 101 105
Guaranteed obligation -
Stock Ownership Plan (33) (40)
------ ------
Total Preferred
Shareholders' Equity 68 65
------ ------
Common:
Common stock 2,635 2,606
Retained earnings 2,734 2,473
Accumulated other comprehensive
income, net of taxes:
Unrealized appreciation
of investments 846 671
Unrealized loss on foreign
currency translation (10) (68)
Unrealized gain (loss)
on derivatives 2 (1)
------ ------
Total accumulated other
comprehensive income 838 602
------ ------
Total Common Shareholders'
Equity 6,207 5,681
------ ------
Total Shareholders' Equity 6,275 5,746
------ ------
Total Liabilities, Redeemable
Preferred Securities of Trusts
and Shareholders' Equity $40,538 $39,959
====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Six Months Ended June 30, 2003 (unaudited) and
Twelve Months Ended December 31, 2002
(In millions)
2003 2002
------ ------
Preferred Shareholders' Equity
Stock Ownership Plan -
convertible preferred stock:
Beginning of period $ 105 $ 111
Redemptions during the period (4) (6)
------ ------
End of period 101 105
------ ------
Guaranteed obligation - Stock
Ownership Plan:
Beginning of period (40) (53)
Principal payments
7 13
End of period ------ ------
(33) (40)
Total Preferred ------ ------
Shareholders' Equity 68 65
------ ------
Common Shareholders' Equity:
Common stock:
Beginning of period 2,606 2,192
Stock issued:
Stock incentive plans 20 32
Preferred shares redeemed 8 13
Net proceeds from stock offering - 413
Present value of equity unit
forward purchase contracts - (46)
Other 1 2
------ ------
End of period 2,635 2,606
------ ------
Retained earnings:
Beginning of period 2,473 2,500
Net income 395 218
Dividends declared on
common stock (132) (252)
Dividends declared on
preferred stock, net of taxes (4) (9)
Deferred compensation -
restricted stock (6) (5)
Tax benefit on employee
stock options, and other changes 12 28
Premium on preferred shares redeemed (4) (7)
------ ------
End of period 2,734 2,473
------ ------
Unrealized appreciation on
investments, net of taxes:
Beginning of period 671 442
Change during the period 175 229
------ ------
End of period 846 671
------ ------
Unrealized loss on foreign
currency translation, net of taxes:
Beginning of period (68) (76)
Currency translation adjustments 58 8
------ ------
End of period (10) (68)
------ ------
Unrealized gain (loss) on
derivatives, net of taxes:
Beginning of period (1) (2)
Change during the period 3 1
------ ------
End of period 2 (1)
------ ------
Total Common
Sharehoders' Equity 6,207 5,681
------ ------
Total Shareholders' Equity $ 6,275 $ 5,746
====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
For the three months and six months ended June 30, 2003 and
2002
(In millions)
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(in millions) 2003 2002 2003 2002
----------- ----- ----- ----- -----
Net income (loss) $ 214 $ (223) $ 395 $ (90)
----- ----- ----- -----
Other comprehensive income
(loss), net of taxes:
Change in unrealized
appreciation of investments 168 139 175 21
Change in unrealized loss
on foreign currency
translation 40 7 58 11
Change in unrealized loss
on derivatives 1 2 3 2
----- ----- ----- -----
Other comprehensive
income (loss) 209 148 236 34
----- ----- ----- -----
Comprehensive income
(loss) $ 423 $ (75) $ 631 $ (56)
===== ===== ===== =====
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2003 and 2002
(Unaudited)
(In millions)
2003 2002
------ ------
Operating Activities:
Net income (loss) $ 395 $ (90)
Adjustments:
Loss from discontinued operations 1 14
Change in property-liability
insurance reserves (1,209) 332
Change in reinsurance balances 125 (136)
Change in deferred acquisition costs (112) (21)
Change in insurance premiums receivable (43) 55
Change in accounts payable and
accrued expenses (130) (90)
Change in income taxes
payable /refundable 61 104
Realized investment (gains) losses (29) 70
Provision for federal deferred
tax expense (benefit) 2 (82)
Depreciation and amortization 46 43
Cumulative effect of
accounting change - 6
Other 60 (123)
------ ------
Net Cash Provided (Used)
by Operating Activities (833) 82
------ ------
Investing Activities:
Net sales of short-term investments 323 287
Purchases of other investments (2,120) (3,834)
Proceeds from sales and
maturities of other investments 2,783 3,975
Change in open security transactions 119 (184)
Purchase of office property and equipment (24) (37)
Sales of office property and equipment 73 10
Acquisitions, net of cash acquired (5) (59)
Other (157) (51)
------ ------
Net Cash Provided by
Continuing Operations 992 107
Net Cash Used by
Discontinued Operations (16) (5)
------ ------
Net Cash Provided by
Investing Activities 976 102
------ ------
Financing Activities:
Dividends paid on common and
preferred stock (136) (123)
Proceeds from issuance of debt 145 498
Repayment of debt and preferred securities (336) (526)
Subsidiary's repurchase of common shares (21) (105)
Stock options exercised and other 58 84
------ ------
Net Cash Used by Financing
Activities (290) (172)
------ ------
Effect of exchange rate changes on cash 9 3
------ ------
Increase (decrease) in cash (138) 15
Cash at beginning of period 315 151
------ ------
Cash at end of period $ 177 $ 166
====== ======
See notes to consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
Unaudited
June 30, 2003
Note 1 - Basis of Presentation
------------------------------
The financial statements include The St. Paul Companies, Inc. and
subsidiaries ("The St. Paul" or "the Company"), and have been
prepared in conformity with United States generally accepted
accounting principles ("GAAP").
These consolidated financial statements rely, in part, on
estimates. Our most significant estimates are those relating to
our reserves for losses and loss adjustment expenses. We
continually review our estimates and make adjustments as
necessary, but actual results could turn out to be significantly
different from what we expected when we made these estimates.
With respect to those underwriting lines of business that we have
placed in runoff, we believe the process of estimating required
reserves for losses and loss adjustment expenses has an increased
level of risk and uncertainty due to regulatory and other
business considerations. In the opinion of management, all
necessary adjustments, consisting of normal recurring
adjustments, have been reflected for a fair presentation of the
results of operations, financial position and cash flows in the
accompanying unaudited consolidated financial statements. The
results for the period are not necessarily indicative of the
results to be expected for the entire year.
Reference should be made to the "Notes to Consolidated Financial
Statements" in our annual report to shareholders for the year
ended Dec. 31, 2002. The amounts in those notes have not changed
materially except as a result of transactions in the ordinary
course of business or as otherwise disclosed in these notes.
In 2003, we changed the method by which we recognize premium
revenue at our operations at Lloyd's. Prior to 2003, such
revenue was recognized using the "one-eighths" method, which
reflected the fact that we converted Lloyd's syndicate accounts
to U.S. GAAP on a quarterly basis. Since Lloyd's accounting does
not recognize the concept of earned premium, we calculated earned
premium as part of the conversion to GAAP, assuming business was
written at the middle of each quarter, effectively breaking the
calendar year into earnings periods of eighths. In 2003, we
began recognizing Lloyd's premium revenue in a manner that more
accurately reflects the underlying policy terms and exposures and
is more consistent with the method by which we recognize premium
revenue in our non-Lloyd's business. This change did not have a
material impact on our consolidated financial statements for the
three months or six months ended June 30, 2003.
In the first quarter of 2003, we eliminated the one-quarter
reporting lag for our operations at Lloyd's, the impact of which
is discussed in more detail in Note 7 of this report.
Some amounts in the 2002 consolidated financial statements have
been reclassified to conform to the 2003 presentation. In
particular, we reclassified certain commissions in our operations
at Lloyd's, which is discussed in more detail in Note 7 of this
report. These reclassifications had no effect on net income,
comprehensive income or shareholders' equity, as previously
reported.
New Accounting Policy - Goodwill and Intangible Assets
------------------------------------------------------
In the first quarter of 2002, we began implementing the
provisions of SFAS No. 142, "Goodwill and Other Intangible
Assets," which established financial accounting and reporting for
acquired goodwill and other intangible assets. The statement
changed prior accounting practice in the way intangible assets
with indefinite useful lives, including goodwill, are tested for
impairment on an annual basis. Generally, it also required that
those assets meeting the criteria for classification as
intangible with finite useful lives be amortized to expense over
those lives, while intangible assets with indefinite useful lives
and goodwill are not to be amortized. In the second quarter of
2002, we completed an evaluation for impairment of our recorded
goodwill in accordance with the provisions of
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 1 - Basis of Presentation (continued)
-----------------------------------------
SFAS No. 142. That evaluation concluded that none of our
goodwill was impaired. In connection with our reclassification
of certain assets previously accounted for as goodwill to other
intangible assets in 2002, we established a deferred tax
liability of $6 million in the second quarter of 2002. That
provision was classified as a cumulative effect of accounting
change effective as of January 1, 2002. In accordance with SFAS
No. 142, we restated our previously reported results for the
first quarter of 2002, reducing net income for that period from
the originally reported $139 million, or $0.63 per common share
(diluted) to $133 million, or $0.60 per common share (diluted).
We evaluate our goodwill for impairment on an annual basis. If
an event occurs or circumstances change that would more likely
than not reduce the fair value of a reporting unit below its
carrying amount, we will test for impairment between annual
tests. In the second quarter of 2003, we peformed our annual
evaluation for impairment of recorded goodwill in accordance with
provisions of SFAS No. 142. That evaluation concluded that none
of our goodwill was impaired.
Stock Option Accounting
-----------------------
We follow the provisions of Accounting Principles Board Opinion
No. 25, "Accounting for Stock Issued to Employees" ("APB 25"),
FASB Interpretation 44, "Accounting for Certain Transactions
involving Stock Compensation (an interpretation of APB Opinion
No. 25)," and other related interpretations in accounting for our
stock option plans utilizing the "intrinsic value method"
described in that literature. We also follow the disclosure
provisions of SFAS No. 123, "Accounting for Stock-Based
Compensation" for our option plans, as amended by SFAS No. 148,
"Accounting for Stock-Based Compensation - Transition and
Disclosure; an amendment of FASB Statement No. 123". These
require pro forma net income and earnings per share information,
which is calculated assuming we had accounted for our stock
option plans under the "fair value method" described in those
Statements.
Had we calculated compensation expense on a combined basis for
our stock option grants based on the "fair value method"
described in SFAS No. 123, our net income and earnings per share
would have been reduced to the pro forma amounts as indicated in
the following table.
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(in millions, except per share data) 2003 2002 2003 2002
----- ----- ----- -----
Net income (loss):
As reported* $ 214 $(223) $ 395 $ (90)
Less: Additional stock-
based employee compensation
expense determined under
fair value-based method for
all awards, net of related
tax effects (12) (9) (22) (16)
----- ----- ----- -----
Pro forma $ 202 $(232) $ 373 $(106)
===== ===== ===== =====
Basic earnings (loss) per
common share:
As reported $0.93 $(1.09) $1.70 $(0.47)
===== ===== ===== =====
Pro forma $0.87 $(1.13) $1.61 $(0.55)
===== ===== ===== =====
Diluted earnings (loss) per
common share:
As reported $0.89 $(1.09) $1.64 $(0.47)
===== ===== ===== =====
Pro forma $0.84 $(1.13) $1.55 $(0.55)
===== ===== ===== =====
*As reported net income (loss) included $1 million and $2 million
of stock-based compensation expenses, net of related tax
benefits, for the quarters ended June 30, 2003 and 2002,
respectively. On a year-to-date basis, as reported net income
(loss) included $3 million and $5 million of such expenses,
respectively.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 2 - Earnings Per Common Share
----------------------------------
The following table provides the calculation of our earnings per
common share for the three months and six months ended June 30,
2003 and 2002.
Three Months Ended Six Months Ended
June 30 June 30
(in millions, except ------------------ ----------------
(per share data) 2003 2002 2003 2002
-------------- ----- ----- ----- -----
Earnings
Basic:
Net income (loss), as reported $ 214 $ (223) $ 395 $ (90)
Preferred stock
dividends, net of taxes (2) (2) (4) (4)
Premium on preferred
shares redeemed (2) (2) (4) (5)
----- ----- ----- -----
Net income (loss)
available to common
shareholders $ 210 $ (227) $ 387 $ (99)
===== ===== ===== =====
Diluted:
Net income (loss)
available to common
shareholders $ 210 $ (227) $ 387 $ (99)
Dilutive effect of affiliates - - (1) -
Effect of dilutive securities:
Convertible preferred stock 1 - 3 -
Zero coupon convertible
notes 1 - 2 -
----- ----- ----- -----
Net income (loss)
available to common
shareholders $ 212 $ (227) $ 391 $ (99)
===== ===== ===== =====
Common Shares
Basic:
Weighted average common
shares outstanding 228 208 228 208
===== ===== ===== =====
Diluted:
Weighted average common
shares outstanding 228 208 228 208
Effect of dilutive securities:
Stock options and
other incentive plans 1 - 1 -
Convertible preferred stock 6 - 6 -
Zero coupon convertible notes 2 - 2 -
Equity unit stock
purchase contracts 3 - 2 -
----- ----- ----- -----
Total 240 208 239 208
===== ===== ===== =====
Earnings (Loss) per Common Share
Basic $ 0.93 $(1.09) $ 1.70 $(0.47)
===== ===== ===== =====
Diluted $ 0.89 $(1.09) $ 1.64 $(0.47)
===== ===== ===== =====
Diluted EPS is the same as Basic EPS for both periods of
2002, because Diluted EPS calculated in accordance with
Statement of Financial Accounting Standards (SFAS) No. 128,
"Earnings Per Share," for our loss from continuing operations,
results in a lesser loss per share than the Basic EPS
calculation does. The provisions of SFAS No. 128 prohibit
this "anti-dilution" of earnings per share, and require
that the larger Basic loss per share also be reported as
the Diluted loss per share amount.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 3 - Investments
--------------------
Investment Activity. The following table summarizes our
investment purchases, sales and maturities (excluding short-term
investments) for the six months ended June 30, 2003 and 2002.
Six Months
Ended June 30
----------------
(in millions) 2003 2002
----- -----
Purchases:
Fixed income $1,660 $3,168
Equities 332 537
Real estate and mortgage loans - 3
Venture capital 65 119
Other investments 63 7
----- -----
Total purchases 2,120 3,834
----- -----
Proceeds from sales and
maturities:
Fixed income 2,277 2,502
Equities 422 1,376
Real estate and mortgage loans 9 55
Venture capital 46 36
Other investments 29 6
----- -----
Total sales and maturities 2,783 3,975
----- -----
Net sales $ 663 $ 141
===== =====
Change in Unrealized Appreciation. The change in unrealized
appreciation or depreciation of investments recorded in common
shareholders' equity and other comprehensive income was as
follows:
Six Twelve
Months Ended Months Ended
June 30 December 31
(in millions) 2003 2002
----------- ------------ ------------
Pretax:
Fixed income $ 219 $ 446
Equities 55 (17)
Venture capital (24) (88)
Other 15 8
----- -----
Total increases in pretax
unrealized appreciation 265 349
Increase in deferred taxes (90) (120)
----- -----
Total change in unrealized
appreciation, net of taxes $ 175 $ 229
===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 4 - Income Taxes
---------------------
The components of income tax expense (benefit) on income from
continuing operations were as follows:
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(in millions) 2003 2002 2003 2002
----------- ----- ----- ----- -----
Income tax expense (benefit):
Federal current $ 22 $ (67) $ 150 $ (29)
Federal deferred 66 (85) 2 (82)
----- ----- ----- -----
Total federal income tax
expense (benefit) 88 (152) 152 (111)
Foreign 3 4 7 8
State 2 2 4 5
----- ----- ----- -----
Total income tax expense
(benefit) on continuing
operations $ 93 $(146) $ 163 $ (98)
===== ===== ===== =====
Note 5 - Commitments, Contingencies and Guarantees
--------------------------------------------------
Commitments - We have long-term commitments to fund venture
capital investments through one of our subsidiaries, St. Paul
Venture Capital VI, LLC, as well as through new and existing
partnerships and certain other venture capital entities. During
the first six months of 2003, payments made in the ordinary
course of funding these venture capital investments reduced our
total future estimated obligations by $68 million from year-end
2002. For further information regarding these and other
commitments, refer to Note 17 on pages 82 to 84 of our 2002
Annual Report to Shareholders.
Contingencies - In the ordinary course of conducting business, we
(and certain of our subsidiaries) have been named as defendants
in various lawsuits. Some of these lawsuits attempt to establish
liability under insurance contracts issued by our underwriting
operations, including but not limited to liability under
environmental protection laws and for injury caused by exposure
to asbestos products. Plaintiffs in these and other lawsuits are
seeking money damages that in some cases are substantial or extra
contractual in nature or are seeking to have the court direct the
activities of our operations in certain ways.
Although the ultimate outcome of these matters is not presently
determinable, it is possible that the resolution of one or more
matters may be material to our results of operations. However,
we do not believe that the total amounts that we and our
subsidiaries may ultimately have to pay in all of these lawsuits
will have a material effect on our liquidity or overall financial
position.
Note 17 on page 83 of our 2002 Annual Report to Shareholders
includes a summary of certain litigation matters with
contingencies, including the following two matters for which
there were additional developments in 2003.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 5 - Commitments, Contingencies and Guarantees (continued)
-------------------------------------------------------------
Asbestos Settlement Agreement - On June 3, 2002, we announced
that we and certain of our subsidiaries had entered into an
agreement settling all existing and future claims arising from
any insuring relationship of United States Fidelity and Guaranty
Company ("USF&G"), St. Paul Fire and Marine Insurance Company
("Fire and Marine") and their affiliates and subsidiaries,
including us, with any of MacArthur Company, Western MacArthur
Company, and Western Asbestos Company (together, the "MacArthur
Companies"). There can be no assurance that this agreement will
receive bankruptcy court approval. For a full discussion of the
Western MacArthur settlement agreement, refer to Note 3 to the
financial statements on pages 68 and 69 of our 2002 Annual Report
to Shareholders.
In the first quarter of 2003, we made a payment of $747 million,
(which included $7 million interest), related to the Western
MacArthur settlement agreement. This amount, along with $60
million of an initial $235 million payment made in the second
quarter of 2002, is being held in escrow pending final bankruptcy
court approval of the settlement agreement as part of a broader
plan for the reorganization of the MacArthur Companies (the
"Plan"). At least $60 million from the initial payment and the
$747 million paid in 2003 would be returned to us if the Plan is
not approved by the bankruptcy court. Accordingly, as of June
30, 2003, these payments remain recorded in the amounts of $807
million in both "Other Assets" and "Other Liabilities" pending
approval of the Plan.
Purported Class Action Shareholder Suit - In the fourth quarter
of 2002, several purported class action lawsuits were filed
against our chief executive officer, our chief financial officer,
and us. In the first quarter of 2003, the lawsuits were
consolidated into a single action which makes various allegations
relating to the adequacy of our previous public disclosures and
reserves relating to the Western MacArthur asbestos litigation,
and seeks unspecified damages and other relief. We view this
action as without merit and are contesting it vigorously.
In addition, in 2003, lawsuits have been filed in Texas and Ohio
(Boson v. Union Carbide Corp., et al; and Abernathy v. Ace
American Ins. Co., et al) 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.
Guarantees - In prior periods we provided certain guarantees for
agency loans, issuances of debt securities, third party loans
related to venture capital investments, and certain tax
indemnifications related to our swap agreements. In addition, we
provided various guarantees and indemnifications in the ordinary
course of selling business entities, as well as guarantees and
indemnifications in connection with the transfer of ongoing
reinsurance operations to Platinum Underwriters Holdings, Ltd.
See Note 2 in our Annual Report to Shareholders for a more
detailed description of the Platinum transfer. During the second
quarter of 2003, we paid $13 million to Metropolitan Property and
Casualty Insurance Company pursuant to a reserve guarantee
entered into in connection with the sale of our standard personal
lines insurance business. (see Note 12 for a more detailed
description of that sale). In addition, guarantee expirations or
reductions in outstanding obligations resulted in an additional
$12 million decline in outstanding guarantees. These decreases
in guarantees were partially offset by a decline in the U.S.
dollar against other currencies. All of these factors resulted
in a net decrease of $21 million in potential obligations for
guarantees that existed as of December 31, 2002. For a full
description of the nature and amount of these guarantees and
indemnifications, refer to Note 17 on pages 82 to 84 of our 2002
Annual Report to Shareholders.
In May 2003, we entered into a contingent consideration agreement
as part of our purchase of the right to seek to renew certain
business from Kemper Insurance Companies ("Kemper") See Note 11
in this report for further explanation of the terms of the Kemper
transaction.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 6 - Debt
-------------
Debt consisted of the following at June 30, 2003 and December 31, 2002:
June 30, 2003 December 31, 2002
--------------- -----------------
(in millions) Book Fair Book Fair
----------- Value Value Value Value
----- ----- ----- -----
5.75% senior notes $ 499 $ 535 $ 499 $ 515
Medium-term notes 482 529 523 559
5.25% senior notes 443 471 443 461
7.875% senior notes 249 276 249 274
8.125% senior notes 249 303 249 280
Commercial paper 154 154 379 379
Nuveen line of credit borrowings 130 130 55 55
Zero coupon convertible notes 110 112 107 110
7.125% senior notes 80 88 80 87
Variable rate borrowings 64 64 64 64
----- ----- ----- -----
Total debt obligations 2,460 2,662 2,648 2,784
Fair value of interest
rate swap agreements 75 75 65 65
----- ----- ----- -----
Total debt reported
on balance sheet $2,535 $2,737 $2,713 $2,849
===== ===== ===== =====
During the first quarter of 2003, Nuveen Investments repaid $145
million it had previously borrowed from The St. Paul under an
intercompany revolving line of credit, and The St. Paul used the
proceeds to repay a like amount of its commercial paper
outstanding. Nuveen Investments funded the repayment to us by
borrowing $145 million under its revolving bank line of credit,
of which $70 million was repaid in the second quarter.
At June 30, 2003, we were party to a number of interest rate swap
agreements related to several of our debt securities outstanding.
The notional amount of these swaps, all of which qualified for
hedge accounting, totaled $730 million. Their aggregate fair
value at June 30, 2003 was recorded as an asset of $75 million,
with the same amount included in the carrying value of our debt.
Note 7 - Segment Information
----------------------------
In the first quarter of 2003, we revised our property-liability
insurance business segment reporting structure to reflect the
manner in which those businesses are now managed. In 2003, our
property-liability underwriting operations consist of two
segments constituting our ongoing operations (Specialty
Commercial and Commercial Lines), and one segment comprising our
runoff operations (Other). All data for 2002 included in this
report has been restated to be consistent with the new reporting
structure in 2003. The following is a summary of changes made to
our segments in the first quarter of 2003.
- Our Surety & Construction operations, previously reported
together as a separate specialty segment, are now separate
components of our Specialty Commercial segment.
- Our ongoing International operations and our ongoing
operations at Lloyd's, previously reported together as a
separate specialty segment, are now separate components of our
Specialty Commercial segment.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
---------------------------------------
- Our Health Care, Reinsurance and Other operations, each
previously reported as a separate runoff business segment,
have been combined into a single Other runoff segment and are
now under common management. "Runoff" means that we have
ceased or plan to cease underwriting business as soon as
possible.
- The results of our participation in voluntary insurance
pools, as well as loss development on business underwritten
prior to 1980 (prior to 1988 for business acquired in our
merger with USF&G Corporation in 1998), previously included in
our Commercial Lines segment, are now included in the Other
segment. That prior year business includes the majority of
our environmental and asbestos liability exposures. The
oversight of these exposures is the responsibility of the same
management team responsible for oversight of the other
components of the Other segment.
In accordance with provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," since Surety
& Construction, International & Lloyd's, Health Care, and
Reinsurance were reported as separate segments during 2002 and
are considered to be of continuing significance in analyzing the
results of our operations, we continue to separately present and
discuss (as appropriate) in this note to our consolidated
financial statements information about those businesses in 2003
and the corresponding period of 2002.
In addition to our property-liability business segments, we also
have a property-liability investment operation segment, as well
as an asset management segment, consisting of our majority
ownership in Nuveen Investments.
The accounting policies of these segments are the same as those
described in Note 1 in our 2002 Annual Report to Shareholders.
We evaluate performance based on underwriting results for our
property-liability insurance segments, investment income and
realized gains for our investment operations segment, and on
pretax income for our asset management segment. Property-
liability underwriting assets are reviewed and managed in total
for purposes of decision-making. We do not allocate assets to
specific underwriting segments. Assets are specifically
identified for our asset management segment.
After the revisions to our segment structure described above, our
reportable segments in our property-liability operations
consisted of the following:
The Specialty Commercial segment includes our combined Surety &
Construction operation, our ongoing International & Lloyd's
operations, and the following nine specialty business centers
that in total comprise the "Specialty" component of this segment:
Technology, Financial and Professional Services, Marine, Personal
Catastrophe Risk, Public Sector Services, Discover Re, Excess &
Surplus Lines, Specialty Programs and Oil & Gas. These business
centers are considered specialty operations because each provides
products and services requiring specialty expertise and focuses
on the respective customer group served. Our Surety business
center underwrites surety bonds, which are agreements under which
one party (the surety) guarantees to another party (the owner or
obligee) that a third party (the contractor or principal) will
perform in accordance with contractual obligations. The
Construction business center offers a variety of products and
services, including traditional insurance and risk management
solutions, to a broad range of contractors and parties
responsible for construction projects. Our ongoing International
operations consist of our specialty underwriting operations in
Canada (other than Surety), the United Kingdom and the Republic
of Ireland, and the international exposures of most U.S.
underwriting business. At Lloyd's, our ongoing operations are
comprised of the following types of insurance coverage we
underwrite through a single wholly-owned syndicate: Aviation,
Marine, Global Property and Personal Lines.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
---------------------------------------
The Commercial Lines segment includes our Small Commercial,
Middle Market Commercial and Property Solutions business centers,
as well as the results of our limited involvement in involuntary
insurance pools. The Small Commercial business center services
commercial firms that typically have between one and fifty
employees through its proprietary St. Paul Mainstreet (SM) and
St. Paul Advantage (SM) products, with a particular focus on
offices, wholesalers, retailers, artisan contractors and other
service risks. The Middle Market Commercial business center
offers comprehensive insurance coverages for a wide variety of
manufacturing, wholesale, service and retail exposures. This
business center also offers loss-sensitive casualty programs,
including significant deductible and self-insured retention
options, for the higher end of the middle market sector. The
Property Solutions business center combines our Large Accounts
Property business with the commercial portion of our catastrophe
risk business and allows us to take a unified approach to large
property risks.
The Other segment includes the results of the lines of business
we placed in runoff in late 2001 and early 2002, including our
former Health Care and Reinsurance segments, and the results of
the following international operations: our runoff operations at
Lloyd's; Unionamerica, the London-based underwriting unit
acquired as part of our purchase of MMI in 2000; and
international operations we decided to exit at the end of 2001.
This segment also includes the results of our participation in
voluntary insurance pools, as well as loss development on
business underwritten prior to 1980 (prior to 1988 for business
acquired in our merger with USF&G Corporation in 1998). That
prior year business includes the majority of our environmental
and asbestos liability exposures. Our Health Care operation
historically provided a wide range of medical liability insurance
products and services throughout the entire health care delivery
system. Our Reinsurance operations historically underwrote
treaty and facultative reinsurance for a wide variety of property
and liability exposures. As described in more detail on page 24
of our 2002 Annual Report to Shareholders, in November 2002 we
transferred our ongoing reinsurance operations to Platinum
Underwriters Holdings, Ltd.
The summary below presents revenue and pretax income from
continuing operations for our reportable segments. The revenues
of our asset management segment include investment income and
realized investment gains.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
---------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(in millions) 2003 2002 2003 2002
----------- ----- ----- ----- -----
Revenues from Continuing Operations:
Underwriting:
Specialty Commercial:
Specialty $ 551 $ 438 $1,053 $ 867
Surety and Construction 312 291 624 566
International and Lloyd's 253 205 546 356
----- ----- ----- -----
Total Specialty Commercial 1,116 934 2,223 1,789
Commercial Lines 476 424 938 850
----- ----- ----- -----
Total Ongoing
Insurance Operations 1,592 1,358 3,161 2,639
----- ----- ----- -----
Other:
Health Care 11 140 43 300
Reinsurance 69 305 173 682
Other Runoff 28 153 52 293
----- ----- ----- -----
Total Other 108 598 268 1,275
----- ----- ----- -----
Total Runoff
Insurance Operations 108 598 268 1,275
----- ----- ----- -----
Total Underwriting 1,700 1,956 3,429 3,914
----- ----- ----- -----
Investment operations:
Net investment income 274 283 554 573
Realized investment
gains (losses) 71 (38) 38 (77)
----- ----- ----- -----
Total investment operations 345 245 592 496
----- ----- ----- -----
Other 22 38 62 65
----- ----- ----- -----
Total property-
liability insurance 2,067 2,239 4,083 4,475
----- ----- ----- -----
Asset management 106 90 208 184
----- ----- ----- -----
Total reportable segments 2,173 2,329 4,291 4,659
Parent company and other
operations (2) 15 (6) 19
----- ----- ----- -----
Total revenues $2,171 $2,344 $4,285 $4,678
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
---------------------------------------
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(in millions) 2003 2002 2003 2002
----------- ----- ----- ----- -----
Income (Loss) from Continuing
Operations Before Income Taxes and
Cumulative Effect of Accounting Change:
Underwriting result:
Specialty Commercial:
Specialty $ 82 $ 52 $ 141 $ 61
Surety and Construction (87) 4 (73) 6
International and Lloyd's 17 17 62 0
----- ----- ----- -----
Total Specialty Commercial 12 73 130 67
Commercial Lines 36 48 74 43
----- ----- ----- -----
Total Ongoing
Insurance Operations 48 121 204 110
----- ----- ----- -----
Other:
Health Care (16) (96) (33) (93)
Reinsurance (15) (5) 3 11
Other Runoff (18) (611) (118) (630)
----- ----- ----- -----
Total Other (49) (712) (148) (712)
----- ----- ----- -----
Total Runoff
Insurance Operations (49) (712) (148) (712)
----- ----- ----- -----
Total Underwriting result (1) (591) 56 (602)
Investment operations:
Net investment income 274 283 554 573
Realized investment
gains (losses) 71 (38) 38 (77)
----- ----- ----- -----
Total investment operations 345 245 592 496
----- ----- ----- -----
Other (20) (12) (53) (38)
----- ----- ----- -----
Total property-
liability insurance 324 (358) 595 (144)
----- ----- ----- -----
Asset management:
Pretax income, before minority interest 56 50 109 99
Minority interest (12) (11) (23) (22)
----- ----- ----- -----
Total asset management 44 39 86 77
----- ----- ----- -----
Total reportable segments 368 (319) 681 (67)
Parent company and other
operations (60) (45) (122) (101)
----- ----- ----- -----
Total income (loss) from
continuing operations before
income taxes and cumulative
effect of accounting change $ 308 $ (364) $ 559 $ (168)
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 7 - Segment Information (continued)
---------------------------------------
Elimination of Reporting Lag - Lloyd's
--------------------------------------
In the first quarter of 2003, we eliminated the one-quarter
reporting lag for our underwriting operations at Lloyd's to
coincide with the timing of reporting for all of our other
international operations. As a result, our consolidated results
in the first six months of 2003 included the results of those
operations for the fourth quarter of 2002 and the first six
months of 2003, whereas our results for the six months ended June
30, 2002 included the results of those operations for the fourth
quarter of 2001 and the first quarter of 2002. The year-to-date
incremental impact on our property-liability operations of
eliminating the reporting lag was as follows.
(in millions)
----------- Specialty
Commercial Other Total
---------- ------ ------
Net written premiums $ 52 $ 2 $ 54
Decrease in unearned premiums (14) (4) (18)
----- ----- -----
Net earned premiums 66 6 72
Incurred losses and
underwriting expenses 63 11 74
----- ----- -----
Underwriting result 3 (5) (2)
Net investment income 1 1 2
Other expenses (2) (1) (3)
----- ----- -----
Total pretax income (loss) $ 2 $ (5) $ (3)
===== ===== =====
Reclassification of Lloyd's Commission Expenses
-----------------------------------------------
In the first quarter of 2003, we reclassified certain commission
expenses related to our operations at Lloyd's. In prior years,
we determined commission expense based on premiums reported by
the Lloyd's market (net of commissions) using an estimated
average commission rate. Until recently, gross premiums (prior
to reduction for commissions) were not available from the Lloyd's
market. That information is now available for current and prior
periods, and in the first quarter of 2003, we began recording
actual commission expense for our Lloyd's business. We
reclassified prior period results to record actual commission
expense on a basis consistent with that implemented in the first
quarter of 2003. There was no impact to net income or
shareholders' equity as previously reported for any prior
periods, because the reclassification had the impact of
increasing previously reported premiums and commission expense in
equal and offsetting amounts. For the second quarter and first
six months of 2003, this reclassification had the impact of
increasing both net earned premiums and policy acquisition costs
by $14 million and $39 million, respectively, compared with what
would have been recorded under our prior method of estimation.
In addition, net written premiums increased by $3 million and $79
million, respectively (a portion of which was due to the
elimination of the one-quarter reporting lag). For the second
quarter and first six months of 2002, the impact was an increase
to both net earned premiums and policy acquisition costs of $37
million and $60 million, respectively, and an increase to net
written premiums of $55 million and $66 million, respectively.
Note 8 - Reinsurance
--------------------
Our consolidated financial statements reflect the effects of
assumed and ceded reinsurance transactions. Assumed reinsurance
refers to our acceptance of certain insurance risks that other
insurance companies have underwritten. Ceded reinsurance
involves transferring certain insurance risks (along with the
related written and earned premiums) we have underwritten to
other insurance companies who agree to share these risks. The
primary purpose of ceded reinsurance is to protect us against
earnings volatility and from potential losses in excess of the
amount we are prepared to accept.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 8 - Reinsurance (continued)
-------------------------------
We expect those with whom we have ceded reinsurance to honor
their obligations. In the event these companies are unable to
honor their obligations, we will pay these amounts. We have
established allowances for possible nonpayment of amounts due to
us.
The effect of assumed and ceded reinsurance on premiums written,
premiums earned and insurance losses and loss adjustment expenses
was as follows:
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(in millions) 2003 2002 2003 2002
---- ---- ---- ----
Premiums written
Direct $2,017 $1,773 $4,039 $3,746
Assumed 275 691 998 1,350
Ceded (498) (621) (1,266) (1,135)
----- ----- ----- -----
Net premiums written $1,794 $1,843 $3,771 $3,961
===== ===== ===== =====
Premiums earned
Direct $1,900 $1,869 $3,832 $3,684
Assumed 361 675 903 1,265
Ceded (561) (588) (1,306) (1,035)
----- ----- ----- -----
Net premiums earned $1,700 $1,956 $3,429 $3,914
===== ===== ===== =====
Insurance losses and loss
adjustment expenses
Direct $1,274 $2,204 $2,520 $3,716
Assumed 317 428 627 776
Ceded (399) (646) (819) (1,113)
----- ----- ----- -----
Net insurance losses
and loss adjustment
expenses $1,192 $1,986 $2,328 $3,379
===== ===== ===== =====
In conjunction with the transfer of our continuing reinsurance
business (previously operating under the name "St. Paul Re") to
Platinum Underwriters Holdings, Ltd. ("Platinum") in November
2002, we entered into various agreements with Platinum and its
subsidiaries, including quota share reinsurance agreements by
which Platinum reinsured substantially all of the reinsurance
contracts entered into by St. Paul Re on or after January 1,
2002. This transfer (based on September 30, 2002 balances)
included $125 million of unearned premium reserves (net of ceding
commissions), $200 million of existing loss and loss adjustment
expense reserves and $24 million of other reinsurance-related
liabilities. The transfer of unearned premium reserves to
Platinum was accounted for as prospective reinsurance, while the
transfer of existing loss and loss adjustment expense reserves
was accounted for as retroactive reinsurance.
Data in the foregoing table for 2003 include amounts related
to the quota share reinsurance agreements with Platinum, as
detailed in Note 16 of this report.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 8 - Reinsurance (continued)
-------------------------------
As noted above, the transfer of reserves to Platinum at the
inception of the quota share reinsurance agreements was based on
the September 30, 2002 balances. In March 2003, we transferred
to Platinum $137 million of additional insurance reserves,
consisting of $72 million in unearned premiums (net of ceding
commissions) and $65 million in existing reserves for losses and
loss adjustment expenses. We also transferred cash and other
assets having a value equal to the additional insurance reserves
transferred. This transfer of additional assets and liabilities
reflected business activity between September 30, 2002 and the
November 2, 2002 inception date of the quota share reinsurance
agreements, and our estimate of amounts due under the adjustment
provisions of the quota share reinsurance agreements. Our
insurance reserves at December 31, 2002 included our estimate, at
that time, of amounts due to Platinum under the quota share
reinsurance agreements, which totaled $54 million. The $83
million increase in our estimate of amounts due to Platinum under
the quota share reinsurance agreements resulted in a pretax
underwriting loss of $6 million in the first quarter of 2003.
During the second quarter of 2003, we reached final agreement
with Platinum regarding the adjustment provisions of the quota
share reinsurance agreements and no further adjustments to the
transferred assets and liabilities will occur.
Note 9 - Restructuring Charges
------------------------------
Fourth Quarter 2001 Strategic Review - In December 2001, we
announced the results of a strategic review of all of our
operations, which included a decision to exit a number of
businesses and countries. Note 5 in our 2002 Annual Report to
Shareholders provides more detailed information on this strategic
review. Related to this review, we recorded a pretax charge of
$62 million, including $46 million of employee-related costs
(related to the elimination of approximately 700 positions), $9
million of occupancy-related costs, $4 million of equipment
charges and $3 million of legal costs. Note 18 on pages 84 and
85 of our 2002 Annual Report to Shareholders provides more
information on this charge.
The following presents a rollforward of activity related to
this accrual:
(in millions)
----------- Original Reserve Reserve
Charges to Pre-tax at Dec. 31, at June 30,
earnings: Charge 2002 Payments Adjustments 2003
-------- ---------- -------- ----------- ----------
Employee-
related $ 46 $ 14 $ (2) $ (1) $ 11
Occupancy-
related 9 8 (1) - 7
Equipment
charges 4 N/A N/A N/A N/A
Legal costs 3 - - - -
----- ----- ----- ----- -----
Total $ 62 $ 22 $ (3) $ (1) $ 18
===== ===== ===== ===== =====
Other Restructuring Charges - Since 1997, we have recorded
several restructuring and other charges related to acquisitions,
mergers and actions taken to improve our operations. Note 18 in
our 2002 Annual Report to Shareholders also provides more
detailed information regarding these other charges. All actions
have been taken and all obligations had been met regarding these
other restructuring charges, with the exception of certain
remaining lease commitments. The lease commitment charges
related to excess space created by the elimination of employee
positions. We expect to be obligated under certain lease
commitments for approximately seven years.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 9 - Restructuring Charges (continued)
-----------------------------------------
The following presents a rollforward of activity related to these
lease commitments:
(in millions)
----------- Original Reserve Reserve
Pre-tax at Dec. 31, at June 30,
Charge 2002 Payments Adjustments 2003
-------- ---------- -------- ----------- ----------
Lease
commitments
charged to
earnings: $ 91 $ 24 $ (4) - $ 20
===== ===== ===== ===== =====
Note 10 - Goodwill and Other Intangible Assets
----------------------------------------------
In the first quarter of 2002, we implemented the provisions of
SFAS No. 142, "Goodwill and Other Intangible Assets," which
established financial accounting and reporting for acquired
goodwill and other intangible assets. As a result of
implementing the provisions of this statement, we did not record
any goodwill expense in 2002 or 2003. Amortization expense
associated with intangible assets totaled $7 million for the
second quarter of 2003 and $12 million for year to date 2003,
compared with $5 million and $9 million, in the same respective
2002 periods.
The following presents a summary of our acquired intangible
assets.
As of June 30, 2003
(in millions) -------------------------------------------
----------- Gross Foreign
Amortizable Carrying Accumulated Exchange Net
intangible assets: Amount Amortization Effects Amount
-------- ------------ -------- ------
Present value
of future profits $ 70 $ (22) $ 5 $ 53
Customer
relationships 67 (7) - 60
Renewal rights 43 (9) - 34
Internal use software 2 (1) - 1
----- ----- ---- ----
Total $ 182 $ (39) $ 5 $ 148
===== ===== ==== ====
At June 30, 2003, we estimated our amortization expense for the
next five years to be as follows: $18 million in 2004, $17
million in 2005, $15 million in 2006, $12 million in 2007, and
$12 million in 2008.
The changes in the carrying value of goodwill on our balance
sheet were as follows.
(in millions)
-----------
Balance at Balance at
Goodwill by Dec. 31, Goodwill Impairment June 30,
Segment 2002 Acquired Losses 2003
----------- -------- -------- --------- ---------
Specialty Commercial $ 80 $ 3 $ - $ 83
Commercial Lines 33 - - 33
Asset Management 752 17 - 769
Property-Liability
Investment Operations 9 - - 9
----- ----- ----- -----
Total $ 874 $ 20 $ - $ 894
===== ===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 10 - Goodwill and Other Intangible Assets (continued)
---------------------------------------------------------
The increase in goodwill in our Asset Management segment was a
result of Nuveen Investments' purchase of shares from minority
shareholders, as well as an additional payment of $2 million for
contingent consideration related to a prior period acquisition.
The increase in goodwill in our Specialty Commercial segment was
due to the effects of foreign exchange rates applied to existing
goodwill balances.
In the second quarter of 2003, we peformed our annual evaluation
for impairment of recorded goodwill in accordance with provisions
of SFAS No. 142. That evaluation concluded that none of our
goodwill was impaired. For further information regarding our
accounting for goodwill and intangible assets, refer to Note 1 on
page 9 of this report.
Note 11 - Purchase of Renewal Rights
------------------------------------
In May 2003, we purchased the right to seek renewal of several
lines of insurance business previously underwritten by Kemper
Insurance Companies. The initial payment for this right
was recorded as an intangible asset (characterized as
renewal rights) and will be amortized on an accelerated basis
over four years. The portfolio of business involved in this
transaction includes the following lines: technology, small
commercial, middle market commercial, inland and ocean marine,
and architects' and engineers' professional liability. We did
not assume any past liabilities with this purchase; however, we
may be obligated to make an additional payment in June 2004 based
on the amount of premium volume we ultimately renew during the
twelve months subsequent to this purchase. We believe it is
highly unlikely that any additional payment would exceed $30
million.
Note 12 - Discontinued Operations
---------------------------------
Standard Personal Insurance - In 1999, we sold our standard
personal insurance operations to Metropolitan Property and
Casualty Insurance Company ("Metropolitan"). Metropolitan
purchased Economy Fire & Casualty Company and subsidiaries
("Economy"), and the rights and interests in those non-Economy
policies constituting the remainder of our standard personal
insurance operations. Those rights and interests were
transferred to Metropolitan by way of a reinsurance and facility
agreement. We guaranteed the adequacy of Economy's loss and loss
expense reserves, and we remain liable for claims on non-Economy
policies that result from losses occurring prior to the September
30, 1999 closing date. Under the reserve-related agreements, we
agreed to pay for any deficiencies in those reserves and would
share in any redundancies that developed by September 30, 2002.
Any losses incurred by us under these agreements were reflected
in discontinued operations in the period during which they were
incurred. At December 31, 2002, our analysis indicated that we
owed Metropolitan $13 million related to the reserve agreements,
which was paid in April 2003. In the first six months of 2003
and 2002, we recorded pretax losses of $300,000 and $6 million,
respectively, in discontinued operations, related to claims in
respect of pre-sale losses.
Note 13 - Derivative Financial Instruments
------------------------------------------
We have the following derivative instruments, which have been
designated into one of three categories based on their intended
use:
Fair Value Hedges: We have several pay-floating, receive-fixed
interest rate swaps, with notional amounts totaling $730 million.
They are designated as fair value hedges for a portion of our
medium-term and senior notes, as they were entered into for the
purpose of managing the effect of interest rate fluctuations on
this debt. The terms of the
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 13 - Derivative Financial Instruments (continued)
-----------------------------------------------------
swaps match those of the debt instruments, and the swaps are
therefore considered 100% effective. The balance sheet impact
related to the movements in interest rates for the six months
ended June 30, 2003 and June 30, 2002 was a $10 million increase
and a $13 million increase, respectively, in the fair value of
the swaps and the related debt on the balance sheet. The impacts
within the statement of operations are offsetting.
Cash Flow Hedges: We have entered into forward foreign currency
contracts that are designated as cash flow hedges. They are
utilized to reduce our exposure to foreign exchange rate
fluctuations that may impact our expected foreign currency
payments, or the settlement of our foreign currency payables and
receivables. In the six months ended June 30, 2003, we
recognized a $3 million gain on the cash flow hedges, which is
included in "Other Comprehensive Income." The comparable amount
for the six months ended June 30, 2002 was a $2 million gain.
The amounts included in Other Comprehensive Income will be
realized in earnings concurrent with the timing of the hedged
cash flows. We do not anticipate any Other Comprehensive Income
will be reclassified into earnings within the next twelve months.
In the six months ended June 30, 2003 and June 30, 2002, the
ineffective portion of the hedge resulted in a gain of less than
$1 million in both periods.
Non-Hedge Derivatives: We have entered into a variety of other
financial instruments that are considered to be derivatives, but
which are not designated as hedges. Included in investments are
stock purchase warrants of Platinum Underwriters Holdings, Ltd.,
received as partial consideration from the sale of our
reinsurance business in 2002, and stock warrants in our venture
capital business. We recorded $5 million and $2 million of
income in continuing operations for the six months ended June 30,
2003 and June 30, 2002 respectively, relating to the change in
the market value of these warrants during the period. We also
recorded a $21 million loss in discontinued operations for the
six months ended June 30, 2002 relating to non-hedge derivatives
associated with the sale of our life business.
Note 14 - Variable Interest Entities
------------------------------------
In January 2003, the Financial Accounting Standards Board
("FASB") issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires
consolidation of all variable interest entities ("VIE") by the
primary beneficiary, as these terms are defined in FIN 46,
effective immediately for VIEs created after January 31, 2003.
The consolidation requirements apply to VIEs existing on January
31, 2003 for reporting periods beginning after June 15, 2003. In
addition, it requires expanded disclosure for all VIEs.
The following discusses VIE's which may be subject to the
consolidation or disclosure provisions of FIN 46 once compliance
with those provisions becomes required with respect to those
VIE's:
Municipal Trusts: We have purchased interests in certain
unconsolidated trusts holding highly rated municipal
securities that were formed for the purpose of enabling the
company to more flexibly generate investment income in a
manner consistent with our investment objectives and tax
position. As of June 30, 2003, there were 36 of such
trusts, which held a combined total market value of $455
million in municipal securities. We own approximately 100%
of 28 of these trusts, which are reflected in our financial
statements. The remaining 8 trusts, which represent $84
million in market value of securities, are not currently
consolidated in our results.
Joint Ventures: Our subsidiary, Fire and Marine, is a
party to six separate joint ventures, in each of which Fire
and Marine is a 50% owner of various real estate holdings
and does not exercise control over the joint ventures,
financed by non-recourse mortgage notes. Because we own
only 50% of the holdings, we do not consolidate these
entities and the joint venture debt does not appear on our
balance sheet. Our maximum exposure under each of these
joint ventures, in the event of foreclosure of a property,
is limited to our carrying value in the joint venture,
ranging individually up to $28 million, and cumulatively
totaling $60 million at June 30, 2003. The total assets
included in these joint ventures as of June 30, 2003 were
$191 million, and total debt was $232 million.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 14 - Variable Interest Entities (continued)
-----------------------------------------------
Below Investment Grade Asset-Backed Securities. We have
investments in certain asset-backed securities that are
below investment grade and have variable interests. We
carry these investments at their fair value and their
current carrying value is $14 million on our consolidated
balance sheet.
Private Equity Investments. We have investments in certain
private equity investments that have a carrying value of
$547 million. We anticipate some of these entities may
require consolidation upon adoption of the Interpretation
in the third quarter.
Lloyd's Syndicates. In the normal course of business, we
invest in various syndicates at Lloyds. In some cases,
predominantly prior to 2002, we have provided less than
100% of the syndicate's capacity, sharing the risks and
rewards proportionately with the other capital providers.
Other Investments. We have investments in insurance, low-
income housing and real estate entities in which we are
not a majority owner, but as a result of other variable
interests, consolidation or disclosure may be necessary
upon adoption of FIN 46 in the third quarter. We are
currently in the process of determining our maximum
exposure to loss with regard to these entities.
Collateralized Bond Obligations (CBO's). We hold two CBO's
which are VIE's in which we may be considered the Primary
Beneficiary. The carrying value of these CBO's as of June
30, 2003 was zero.
Note 15 - Health Care Exposures
-------------------------------
During 2002, we concluded that the impact of settling Health Care
claims in a runoff environment was causing abnormal effects on
our average paid claims, average outstanding claims, and the
amount of average case reserves established for new claims - all
of which are traditional statistics used by our actuaries to
develop indicated ranges of expected loss. Considering these
changing statistics, we developed varying interpretations of the
underlying data, which added more uncertainty to our evaluation
of these reserves. It is our belief that this additional data,
when evaluated in light of the impact of our migration to a
runoff environment, supports our view that we will realize
significant savings on our ultimate Health Care claim costs.
In the fourth quarter of 2002, we established specific tools and
metrics to more explicitly monitor and validate our key
assumptions supporting our Health Care reserve conclusions since
we believe that our traditional statistics and reserving methods
needed to be supplemented in order to provide a more meaningful
analysis. The tools we developed track the three primary
indicators which are influencing our expectations and include:
a) newly reported claims, b) reserve development on known claims
and c) the "redundancy ratio," which compares the cost of
resolving claims to the reserve established for that individual
claim.
In the first quarter of 2003, we evaluated the adequacy of our
previously established medical malpractice reserves in the
context of the three indicators described above. The dollar
amount of newly reported claims in the quarter totaled $118
million, approximately 25% less than we anticipated in our
original estimate of the required level of redundancy at year-end
2002. With regard to development on known claims, loss activity
in the first quarter of 2003 was within our expectations. Case
development on incurred years 2001 and prior was minimal, and
case development on the 2002 incurred year totaled $39 million,
within our year-end 2002 estimate of no more than 3% of
development. For the first quarter of 2003, our redundancy ratio
was within our expected range of between 35% and 40%.
In the second quarter of 2003, the dollar amount of newly
reported claims totaled $127 million, approximately 5% higher
than we anticipated in our original estimate of the required
level of reserves at year-end 2002. Nevertheless, through
the first half of 2003, the dollar amount of newly reported
claims was approximately 12% lower than we anticipated.
Loss development on known claims during the second quarter of
2003 was negative,
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements, Continued
Note 15 - Health Care Exposures (continued)
------------------------------------------
but not as negative as we anticipated. Our actual
redundancy ratio continued to improve in the second
quarter of 2003; however, since newly reported claims and loss
development on known claims did not improve as much as we
expected in the second quarter, the required reserve redundancy
has increased modestly from the previously estimated range of
35% to 40%.
The three indicators described above are related such that if one
deteriorates, additional improvement on another is necessary for
us to conclude that further reserve strengthening is not
necessary. While the recent results of these indicators support
our current view that we have recorded a reasonable provision for
our medical malpractice exposures as of June 30, 2003, there is a
reasonable possibility that we may incur additional unfavorable
prior-year loss development if these indicators significantly
change from our current expectations. If these indicators
deteriorate, we believe that a reasonable estimate of an
additional loss provision could amount to up to $250 million.
However, our analysis as of this point in time continues to
support our belief that we will realize favorable effects in our
ultimate costs and that our current loss reserves will prove to
be a reasonable provision.
Note 16 - Related Party Transaction - Platinum Underwriters Holdings, Ltd.
--------------------------------------------------------------------------
Under the quota share reinsurance agreements with Platinum
described in more detail in Note 8 of this report, we ceded the
following amounts to Platinum in first six months of 2003.
(in millions)
-----------
Net written premiums $ 265
Decrease in unearned premiums (43)
----
Net earned premiums 308
Incurred losses and loss
adjustment expenses 205
Underwriting expenses 79
----
Net ceded result $ 24
====
The following Platinum-related balances were included in our
consolidated balance sheet at June 30, 2003.
(in millions)
-----------
Assets:
Reinsurance recoverable-paid losses $ 23
Reinsurance recoverable-unpaid losses $427
Ceded unearned premiums $117
Liabilities:
Funds held for reinsurers $ 18
Ceded premiums payable $161
Note 17 - Surety Claim
----------------------
We had previously reported in a Current Report on Form 8-K dated
April 30, 2003 that in April 2003 we began to receive surety
claim notices related to one of our accounts that was in
bankruptcy. In the second quarter of 2003, we recorded an $86
million pretax loss provision (net of reinsurance) related to
that account's inability to perform its bonded obligations. In
April 2003, a bankruptcy court approved the sale of substantially
all of the assets of the account. Following that approval, we
received claim notices with respect to approximately $120 million
of bonds securing certain workers' compensation and retiree
health benefit obligations of the account. The $86 million net
pretax loss provision recorded in the second quarter of 2003
represents our estimated loss in this matter. We reported this
loss in a Current Report on Form 8-K dated July 25, 2003.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Forward-Looking Statement Disclosure and Certain Risks
------------------------------------------------------
This report contains certain forward-looking statements within
the meaning of the Private Litigation Reform Act of 1995.
Forward-looking statements are statements other than historical
information or statements of current condition. Words such as
"expects," "anticipates," "intends," "plans," "believes," "seeks"
or "estimates," or variations of such words, and similar
expressions are intended to identify forward-looking statements.
Examples of these forward-looking statements include statements
concerning:
- market and other conditions and their effect on future
premiums, pricing, revenues, earnings, cash flow and
investment income;
- price increases, improved loss experience, and expense
savings resulting from the restructuring and other actions
and initiatives announced in recent years;
- statements concerning the anticipated bankruptcy court
approval of the Western MacArthur asbestos litigation
settlement;
- statements concerning our expectations in our Health Care
operation as we settle claims in a runoff environment; and
- statements concerning claims made on surety bonds and the
amounts we may ultimately pay with respect to these claims.
In light of the risks and uncertainties inherent in future
projections, many of which are beyond our control, actual results
could differ materially from those in forward-looking statements.
These statements should not be regarded as a representation that
anticipated events will occur or that expected objectives will be
achieved. Risks and uncertainties include, but are not limited
to, the following:
- changes in the demand for, pricing of, or supply of our
products;
- our ability to effectively implement price increases;
- general economic conditions, including changes in interest
rates and the performance of financial markets;
- additional statement of operations charges if our loss
reserves are insufficient;
- our exposure to natural catastrophic events, which are
unpredictable, with a frequency or severity exceeding our
estimates, resulting in material losses;
- the possibility that claims cost trends that we anticipate
in our businesses may not develop as we expect;
- the impact of the September 11, 2001 terrorist attack and
the ensuing global war on terrorism on the insurance and
reinsurance industry in general, the implementation of the
Terrorism Risk Insurance Act and potential further
intervention in the insurance and reinsurance markets to
make available insurance coverage for acts of terrorism;
- risks relating to our potential exposure to losses arising
from acts of terrorism and sabotage;
- risks relating to our continuing ability to obtain
reinsurance covering catastrophe, surety and other exposures
at appropriate prices and/or in sufficient amounts;
- risks relating to the collectibility of reinsurance and
adequacy of reinsurance to protect us against losses;
- risks relating to actual and potential credit exposures,
including to derivatives counterparties and related to co-
surety arrangements;
- risks and uncertainties relating to international political
developments, including the possibility of warfare, and
their potential effect on economic conditions;
- changes in domestic and foreign laws, tax laws and changes
in the regulation of our businesses, which affect our
profitability and our growth, including risks relating to
possible Federal legislation regarding asbestos-related
claims;
- the possibility of downgrades in our ratings significantly
adversely affecting us, including, but not limited to,
reducing the number of insurance policies we write,
generally, or causing clients who require an insurer with a
certain rating level to use higher-rated insurers or causing
us to borrow at higher interest rates;
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Forward-Looking Statement Disclosure and Certain Risks (continued)
-----------------------------------------------------------------
- the risk that our investment portfolio suffers reduced
returns or investment losses, which could reduce our
profitability;
- the effect of financial market and interest rate conditions
on pension plan assumptions, asset valuations and
contribution levels;
- the impact of assessments and other surcharges for guaranty
funds and second-injury funds and other mandatory pooling
arrangements;
- risks related to the business underwritten on our policy
forms on behalf of Platinum Underwriters Holdings, Ltd.
("Platinum") and fully reinsured to Platinum pursuant to the
quota share reinsurance agreements entered into in
connection with the transfer of our ongoing reinsurance
operations to Platinum in 2002;
- loss of significant customers;
- risks relating to the decision of the bankruptcy court with
respect to the approval of the settlement of the Western
MacArthur matter;
- changes in our estimate of insurance industry losses
resulting from the September 11, 2001 terrorist attack;
- unfavorable developments in non-Western MacArthur related
asbestos litigation (including claims that certain asbestos-
related insurance policies are not subject to aggregate
limits);
- unfavorable developments in environmental litigation
involving policy coverage and liability issues;
- the effects of emerging claim and coverage issues on our
business, including developments relating to issues such as
mold conditions, construction defects and changes in
interpretation of the named insured provision with respect
to the uninsured/underinsured motorist coverage in
commercial automobile policies;
- the growing trend of plaintiffs targeting property-liability
insurers, including us, in purported class action litigation
relating to claim-handling and other practices;
- the risk that our subsidiaries may be unable to pay
dividends to us in sufficient amounts to enable us to meet
our obligations and pay future dividends;
- the cyclicality of the property-liability insurance
industry causing fluctuations in our results;
- risks relating to our asset management business, including
the risk of material reductions to assets under management
from a significant rise in interest rates, declining equity
markets or poor investment performance;
- our dependence on the business provided to us by agents and
brokers;
- our implementation of new strategies and initiatives;
- and various other matters.
Item 2. Management's Discussion and Analysis of Financial
------ Condition and Results of Operations.
-----------------------------------
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
June 30, 2003
The St. Paul Companies, Inc. ("The St. Paul") is incorporated as
a general business corporation under the laws of the State of
Minnesota. The St. Paul and its subsidiaries constitute one of
the oldest insurance organizations in the United States, dating
back to 1853. We are a management company principally engaged,
through our subsidiaries, in providing commercial property-
liability insurance products and services. We also have a
presence in the asset management industry through our 79%
majority ownership of Nuveen Investments, Inc. As a management
company, we oversee the operations of our subsidiaries and
provide them with capital, management and administrative
services. Based on total revenues in 2002, we ranked No. 207 on
the Fortune 500 list of the largest companies in the United
States. Our Internet website address is stpaul.com. We make
available, free of charge, on or through our website, annual
reports on Form 10-K, quarterly reports on Form 10-Q and current
reports on Form 8-K and amendments to those reports filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934 as soon as reasonably practicable after we
electronically file such material with, or furnish it to, the
Securities and Exchange Commission. Our website address is an
inactive textual reference only and the contents of the website
are not part of this report.
Consolidated Highlights
-----------------------
The following table summarizes our results for the three months
and six months ended June 30, 2003 and 2002.
Three Months Six Months
Ended June 30 Ended June 30
------------- -------------
(in millions, except 2003 2002 2003 2002
per-share amounts) ---- ---- ---- ----
-----------------
Pretax income (loss) before cumulative
effect of accounting change:
Property-liability insurance:
Underwrit ing result $ (1) $(591) $ 56 $(602)
Net investment income 274 283 554 573
Realized investment gains (losses) 71 (38) 38 (77)
Other expenses (20) (12) (53) (38)
---- ---- ---- ----
Total property-
liability insurance 324 (358) 595 (144)
Asset management 44 39 86 77
Parent and other operations (60) (45) (122) (101)
---- ---- ---- ----
Income (loss) from
continuing operations before
income taxes and cumulative
effect of accounting change 308 (364) 559 (168)
Income tax expense (benefit) 93 (146) 163 (98)
---- ---- ---- ----
Income (loss) from
continuing operations before
cumulative effect of accounting
change 215 (218) 396 (70)
Cumulative effect of accounting
change, net of taxes - - - (6)
---- ---- ---- ----
Income (loss) from
continuing operations 215 (218) 396 (76)
Discontinued operations,
net of taxes (1) (5) (1) (14)
---- ---- ---- ----
Net income (loss) $ 214 $(223) $ 395 $ (90)
==== ==== ==== ====
Net income (loss)
per common share (basic) $0.93 $(1.09) $1.70 $(0.47)
==== ==== ==== ====
Net income (loss)
per common share (diluted) $0.89 $(1.09) $1.64 $(0.47)
==== ==== ==== ====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Consolidated Results
--------------------
Our pretax income from continuing operations of $308 million in
the second quarter of 2003, which included an $86 million pretax
loss provision related to a surety exposure (described in more
detail on page 44 of this report), was significantly better than
our pretax loss of $364 million in the same period of 2002, which
included a $585 million pretax loss provision related to a
settlement agreement with respect to certain asbestos litigation
(described in more detail on pages 35 and 36 of this report).
Excluding the impact of that $585 million loss provision in 2002,
our second-quarter 2003 pretax income was over $85 million higher
than the adjusted 2002 income of $221 million, driven in large
part by realized investment gains in our property-liability
operations. Through the first half of 2003, our pretax income
from continuing operations totaled $559 million, compared with
pretax income of $417 million (adjusted to exclude that $585 million
impact of the asbestos litigation loss provision) in the same
2002 period. The improvement resulted from a $115 million
increase in realized investment gains in our property-liability
operations, and significant improvement in underwriting results
generated by our two ongoing underwriting segments - Specialty
Commercial and Commercial Lines. Our asset management
subsidiary, Nuveen Investments, Inc., also contributed to
the improvement in our second-quarter and year-to-date results
in 2003. In our "Parent and other operations," pretax losses
in the second quarter and first half of 2003 exceeded those
in the same periods of 2002 primarily due to an increase
in realized investment losses.
Presentation of Certain Information Based on Statutory Accounting Principles
----------------------------------------------------------------------------
Our U.S. property-liability insurance operations comprise the
majority of our operations. These operations are required under
applicable state insurance legislation and regulations to
publicly report information on the basis of Statutory Accounting
Principles ("SAP"), including net written premiums, statutory
loss and loss adjustment expense ratio, and statutory
underwriting expense ratio information. We provide in this
report selected SAP information for all of our property-liability
underwriting operations, as well as certain GAAP information for
such operations. The types of SAP information included herein
are common measures of the performance of a property-liability
insurer, and we believe the inclusion of such information will
aid investors in comparing our results with those of our peers in
the industry. In addition, management uses this SAP information
to monitor our financial performance. Definitions of the
statutory information included herein are included under
"Definitions of Certain Statutory Accounting Terms" on page 60 of
this report.
Elimination of Reporting Lag - Lloyd's
--------------------------------------
In the first quarter of 2003, we eliminated the one-quarter
reporting lag for our underwriting operations at Lloyd's to
coincide with the timing of reporting for all of our other
international operations. As a result, our consolidated results
in the first six months of 2003 included the results of those
operations for the fourth quarter of 2002 and the first six
months of 2003, whereas our results for the six months ended June
30, 2002 included the results of those operations for the fourth
quarter of 2001 and the first quarter of 2002. The year-to-date
incremental impact on our property-liability operations of
eliminating the reporting lag was as follows.
(in millions)
----------- Specialty
Commercial Other Total
---------- ------ ------
Net written premiums $ 52 $ 2 $ 54
Decrease in unearned premiums (14) (4) (18)
----- ----- -----
Net earned premiums 66 6 72
Incurred losses and
underwriting expenses 63 11 74
----- ----- -----
Underwriting result 3 (5) (2)
Net investment income 1 1 2
Other expenses (2) (1) (3)
----- ----- -----
Total pretax income (loss) $ 2 $ (5) $ (3)
===== ===== =====
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Since the elimination of the one-quarter reporting lag in our
Lloyd's operations makes the information for the first six months
of 2003 not comparable to the information for the same period of
2002, we have presented information adjusted to remove the effect
of the elimination in this Management's Discussion and Analysis.
We believe that investors will find it helpful to have this
information, as well as information prepared in accordance with
United States generally accepted accounting principles ("GAAP"),
when reviewing our results for the first half of 2003. Such
adjusted information is reconciled to the information reported in
accordance with GAAP whenever it is presented.
Reclassification of Lloyd's Commission Expenses
-----------------------------------------------
In the first quarter of 2003, we reclassified certain commission
expenses related to our operations at Lloyd's. In prior years,
we determined commission expense based on premiums reported by
the Lloyd's market (net of commissions) using an estimated
average commission rate. Until recently, gross premiums (prior
to reduction for commissions) were not available from the Lloyd's
market. That information is now available for current and prior
periods, and in the first quarter of 2003, we began recording
actual commission expense for our Lloyd's business. We
reclassified prior period results to record actual commission
expense on a basis consistent with that implemented in the first
quarter of 2003. There was no impact to net income or
shareholders' equity as previously reported for any prior
periods, because the reclassification had the impact of
increasing previously reported premiums and commission expense in
equal and offsetting amounts. For the second quarter and first
six months of 2003, this reclassification had the impact of
increasing both net earned premiums and policy acquisition costs
by $14 million and $39 million, respectively, compared with what
would have been recorded under our prior method of estimation.
In addition, net written premiums increased by $3 million and $79
million, respectively (a portion of which was due to the
elimination of the one-quarter reporting lag). For the second
quarter and first six months of 2002, the impact was an increase
to both net earned premiums and policy acquisition costs of $37
million and $60 million, respectively, and an increase to net
written premiums of $55 million and $66 million, respectively.
Sale of Baltimore Office Campus
-------------------------------
In April 2003, we completed the sale of our 68-acre office campus
in Baltimore, MD. We recorded a pretax impairment writedown of
$14 million in the first quarter of 2003 related to the sale,
which was recorded as an operating expense in our property-
liability operations. On an after-tax basis at the statutory
Federal tax rate of 35%, the writedown totaled $9 million, or
$0.04 per common share (diluted).
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.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
As noted above, the transfer of reserves to Platinum at the
inception of the quota share reinsurance agreements was based on
the September 30, 2002 balances. In March 2003, we transferred
to Platinum $137 million of additional insurance reserves,
consisting of $72 million in unearned premiums (net of ceding
commissions) and $65 million in existing reserves for losses and
loss adjustment expenses. We also transferred cash and other
assets having a value equal to the additional insurance reserves
transferred. This transfer of additional assets and liabilities
reflected business activity between September 30, 2002 and the
November 2, 2002 inception date of the quota share reinsurance
agreements, and our estimate of amounts due under the adjustment
provisions of the quota share reinsurance agreements. Our
insurance reserves at December 31, 2002 included our estimate, at
that time, of amounts due to Platinum under the quota share
reinsurance agreements, which totaled $54 million. The $83
million increase in our estimate of amounts due to Platinum under
the quota share reinsurance agreements resulted in a pretax
underwriting loss of $6 million in the first quarter of 2003.
During the second quarter of 2003, we reached final agreement
with Platinum regarding the adjustment provisions of the quota
share reinsurance agreements and no further adjustments to the
transferred assets and liabilities will occur.
For business underwritten in the United States and the United
Kingdom, until October 31, 2003, Platinum has the right to
underwrite specified reinsurance business on our behalf in cases
where Platinum is unable to underwrite that business because it
has yet to obtain necessary regulatory licenses or approval to do
so, or Platinum has not yet been approved as a reinsurer by the
ceding company. We entered into this agreement solely as a means
to accommodate Platinum through a transition period. Any
business written by Platinum on our policy forms during this
transition period is being fully ceded to Platinum under the
quota share reinsurance agreements.
Our investment in Platinum is included in "Other investments."
The estimated income from our 14% proportionate equity ownership
in Platinum is included in our statement of operations as a
component of "Net investment income." Our option to purchase
additional Platinum shares is carried at market value ($59
million at June 30, 2003), with changes in its fair value
recorded as other realized gains or losses in our statement of
operations. In the first six months of 2003, we recorded a net
pretax realized loss of $2 million related to this option,
including a $4 million pretax gain in the second quarter.
Revisions to Business Segment Reporting Structure
-------------------------------------------------
In the first quarter of 2003, we revised our property-liability
insurance business segment reporting structure to reflect the
manner in which those businesses are now managed. Our property-
liability underwriting operations now consist of two segments
constituting our ongoing operations (Specialty Commercial and
Commercial Lines), and one segment comprising our runoff
operations (Other). The composition of those respective segments
is described in greater detail in the analysis of their results
on pages 42 through 52 of this discussion. All data for 2002
included in this report were restated to be consistent with the
new reporting structure in 2003. The following is a summary of
changes made to our segments in the first quarter of 2003.
- Our Surety & Construction operations, previously reported
together as a separate specialty segment, are now separate
components of our Specialty Commercial segment.
- Our ongoing International operations and our ongoing
operations at Lloyd's, previously reported together as a
separate specialty segment, are now separate components of our
Specialty Commercial segment.
- Our Health Care, Reinsurance and Other operations, each
previously reported as a separate runoff business segment,
have been combined into a single Other runoff segment and are
under common management. "Runoff" means that we have ceased
or plan to cease underwriting business as soon as possible.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
- The results of our participation in voluntary insurance
pools, as well as loss development on business underwritten
prior to 1980 (prior to 1988 for business acquired in our
merger with USF&G Corporation in 1998), previously included in
our Commercial Lines segment, are now included in the Other
segment. That prior year business included the majority of
our environmental and asbestos liability exposures. The
oversight of these exposures is the responsibility of the same
management team responsible for oversight of the other
components of the Other segment.
In accordance with provisions of SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information," since Surety
& Construction, International & Lloyd's, Health Care, and
Reinsurance were reported as separate segments during 2002 and
are considered to be of continuing significance in analyzing the
results of our operations, we continue to separately present and
discuss (as appropriate) in Note 7 to our consolidated financial
statements and in Management's Discussion and Analysis,
information about those businesses in 2003 and the corresponding
periods of 2002.
Our operations in runoff do not qualify as "discontinued
operations" for accounting purposes. For the six months ended
June 30, 2003, these runoff operations collectively accounted for
$268 million, or 8%, of our reported net earned premiums, and
generated underwriting losses totaling $148 million (an amount
that does not include investment income from the assets
maintained to support these operations). For the six months
ended June 30, 2002, these runoff operations collectively
accounted for $1.28 billion, or 33%, of our net earned premiums,
and generated underwriting losses totaling $712 million, an
amount that included the $585 million pretax loss provision
related to the asbestos litigation settlement agreement.
Terrorism Risk and Legislation
------------------------------
On November 26, 2002, President Bush signed into law the
Terrorism Risk Insurance Act of 2002, or TRIA. TRIA establishes
a temporary federal program which requires U.S. and other
insurers to offer coverage in their commercial property and
casualty policies for losses resulting from terrorists' acts
committed by foreign persons or interests in the United States or
with respect to specified U.S. air carriers, vessels or missions
abroad. The coverage offered may not differ materially from the
terms, amounts and other coverage limitations applicable to other
policy coverages. These requirements terminate at the end of
2004 unless the Secretary of the Treasury extends them to 2005.
Under TRIA, the U.S. Secretary of the Treasury determines whether
an act is a covered terrorist act, and if it is covered, losses
resulting from that act ultimately are shared among insurers, the
federal government and policyholders. Generally, insurers pay
all losses to policyholders, retaining a defined "deductible" and
10% of losses above that deductible. The federal government will
reimburse insurers for 90% of losses above the deductible and,
under certain circumstances, the federal government will require
insurers to levy surcharges on policyholders to recoup for the
federal government its reimbursements paid. An insurer's
deductible in 2003 is 7% of the insurer's 2002 direct earned
premiums, and rises to 10% of 2003 direct earned premiums in 2004
and, if the program continues in 2005, 15% of 2004 direct earned
premiums in 2005. Federal reimbursement of the insurance
industry is limited to $100 billion in each of 2003, 2004 and
2005, and no insurer that has met its deductible shall be liable
for the payment of its portion of the aggregate industry insured
loss that exceeds $100 billion, thereby capping the insurance
industry's and each insurer's ultimate exposure to terrorist acts
covered by TRIA.
TRIA voided terrorist exclusions in policies in-force on November
26, 2002 to the extent of the TRIA coverage required to be
offered and imposed requirements on insurers to offer the TRIA
coverage to policyholders at rates chosen by the insurers on
policies in-force on November 26, 2002 and all policies renewed
or newly offered thereafter. Policyholders may accept or decline
coverage at the offered rate and, with respect to policies in-
force on November 26, 2002, TRIA coverage remains in effect until
the policyholder fails to purchase the coverage within a
specified period following the insurer's rate quotation for the
TRIA coverage. We have fully implemented our interim, or in some
cases long-term, rating plans in all states. In states where we
have not implemented long-term rating plans, such long-term
rating plans have been developed to replace the interim plans and
will be filed. Six states have outstanding questions on our interim
TRIA filings, and we continue to work with those states to
resolve their questions about our filings.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
We believe it is too early to determine TRIA's impact on the
insurance industry generally or on us. Our domestic insurance
subsidiaries are subject to TRIA and, in the event of a terrorist
act covered by TRIA, coverage would attach after losses of
approximately $430 million (calculated based on 7% of our TRIA-
qualifying calendar year 2002 direct earned premium total)
Accordingly, TRIA's federal reimbursement provisions alone do not
protect us from losses from foreign terrorist acts that could be
material to our results of operations or financial condition.
Furthermore, there is substantial uncertainty in determining the
appropriate rates for offering TRIA coverage (and coverage for
terrorist acts generally), and our quoted rates could be too low
and attract poor risks or, alternatively, could be higher than
our competitors and result in the loss of business. There are
numerous interpretive issues in connection with TRIA's
implementation by the Secretary of the Treasury that remain to be
resolved, including the timing of federal reimbursement for TRIA
losses, the standards for obtaining the federal reimbursement and
the mechanisms for allocating losses exceeding insurers'
deductibles. We currently have property reinsurance that would
cover only a portion of our deductible. In April 2003, we
renewed our terrorism reinsurance coverage, as described in the
following discussion. There can be no assurance TRIA will
achieve its objective of creating a viable private insurance
market for terrorism coverage prior to TRIA's expiration, and
rates and forms used by us and our competitors may vary widely in
the future.
Regardless of TRIA, some state insurance regulators do not permit
terrorism exclusions in various coverages we write, and
currently, we have not excluded coverage for terrorist acts by
domestic terrorists (e.g., the Oklahoma bombing) in our domestic
coverages, or resulting from terrorist acts occurring outside the
United States from our international coverages. Accordingly, our
exposure to losses from terrorist acts is not limited to TRIA
coverages. Losses from terrorists' acts, whether arising under
TRIA coverages or otherwise, could be material to our results of
operations and financial condition.
Purchase of Terrorism Coverage and Exposure to Future Terrorist Events
----------------------------------------------------------------------
After the terrorist attacks in September 2001, reinsurers, in
general, specifically excluded terrorism coverage from property
reinsurance treaties that subsequently renewed. As a result, in
the second quarter of 2002, we purchased limited specific
terrorism coverage in the form of two separate property
reinsurance treaties. Those treaties expired on April 1, 2003,
on which date we renewed our coverage in the form of a combined
per-risk and catastrophe terrorism occurrence treaty. The treaty
provides both certified and non-certified TRIA coverage. (To be
TRIA certified, the terrorist act must be sponsored by an
international group or state and damage caused must exceed a
financial threshold, whereas non-certified coverage refers to
acts of domestic terrorism). In addition, we secured non-
certified TRIA terrorism coverage in our standard property
reinsurance treaty renewals in April 2003 as part of our overall
ceded reinsurance program. We renewed the majority of our
reinsurance treaties covering workers' compensation in July 2003,
and the majority of treaties covering general liability business
in August 2002; those renewals included coverage for terrorism.
Our reinsurance treaties do not cover acts of terrorism involving
nuclear, biological or chemical events. There can be no
assurance that we will be able to secure terrorism reinsurance
coverage on expiring treaties each year.
Asbestos Settlement Agreement
-----------------------------
On June 3, 2002, we announced that we and certain of our
subsidiaries had entered into an agreement settling all existing
and future claims arising from any insuring relationship of
United States Fidelity and Guaranty Company ("USF&G"), St. Paul
Fire and Marine Insurance Company and their affiliates and
subsidiaries, including us (collectively, the "USF&G Parties")
with any of MacArthur Company, Western MacArthur Company
("Western MacArthur"), and Western Asbestos Company ("Western
Asbestos") (together, the "MacArthur Companies"). For a full
description of the circumstances leading up to the agreement,
refer to Note 3 on pages 68 and 69 of our 2002 Annual Report to
Shareholders.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Pursuant to the provisions of the settlement agreement, on
November 22, 2002, the MacArthur Companies filed voluntary
petitions under Chapter 11 of the Bankruptcy Code to permit the
channeling of all current and future asbestos-related claims
solely to a trust to be established pursuant to Section 524(g) of
the Bankruptcy Code. Consummation of most elements of the
settlement agreement is contingent upon bankruptcy court approval
of the settlement agreement as part of a broader plan for the
reorganization of the MacArthur Companies (the "Plan"). Approval
of the Plan involves substantial uncertainties that include the
need to obtain agreement among existing asbestos plaintiffs, a
person who has been appointed to represent the interests of
unknown, future asbestos plaintiffs, the MacArthur Companies and
the USF&G Parties as to the terms of such Plan. Accordingly,
there can be no assurance that bankruptcy court approval of the
Plan will be obtained.
Upon final approval of the Plan, the MacArthur Companies will
release the USF&G Parties from any and all asbestos-related
claims for personal injury, and all other claims in excess of $1
million in the aggregate, that may be asserted relating to or
arising from, directly or indirectly, any alleged coverage
provided by any of the USF&G Parties to any of the MacArthur
Companies, including any claim for extra contractual relief.
The after-tax impact on our net income for the three months and
six months ended June 30, 2002, net of expected reinsurance
recoveries and the re-evaluation and application of asbestos and
environmental reserves, was a loss of approximately $380 million.
In the fourth quarter of 2002, we revised upward our estimated
reinsurance recoverables related to this settlement, reducing the
after-tax impact of the settlement on calendar year 2002 net
income to a loss of $307 million. This calculation reflected
payments of $235 million during the second quarter of 2002, and
$747 million on January 16, 2003 (including interest). The $747
million payment, together with at least $60 million of the
original $235 million, shall be returned to USF&G Parties if the
Plan is not finally approved. Accordingly, as of June 30, 2003
we had recorded those payments of $807 million in both "Other
Assets" and "Other Liabilities," since the Plan had not yet been
approved. The settlement agreement also provided for the USF&G
Parties to pay $13 million (which was paid in the second quarter
of 2002) and to advance certain fees and expenses incurred in
connection with the settlement, bankruptcy proceedings,
finalization of the Plan and efforts to achieve approval of the
Plan, subject to a right of reimbursement in certain
circumstances of amounts advanced.
As a result of the settlement, pending litigation with the
MacArthur Companies has been stayed pending final approval of the
Plan. Whether or not the Plan is approved, up to $175 million of
the $235 million will be paid to counsel for the MacArthur
Companies, and persons holding judgments against the MacArthur
Companies as of June 3, 2002 and their counsel, and the USF&G
Parties will be released from claims by such holders to the
extent of $110 million paid to such holders.
Possible Asbestos Legislation
-----------------------------
A number of asbestos reform bills have been introduced in the U.S.
Congress. A proposed law sponsored by Senator Orrin Hatch would
replace most of the current asbestos personal injury litigation
with a statutory compensation program funded by contributions
from companies that formerly manufactured, distributed or sold
asbestos products and insurers that underwrote certain asbestos
risks. Current reform efforts would not cover asbestos property
damage claims and may not cover other categories of asbestos
exposure including future personal injury claims if the
compensation fund ultimately proves insufficient. The prospects
for the passage of an asbestos reform bill remain uncertain and
the effect of any such future asbestos legislative reform on us
will depend upon a variety of factors including the total size of
the compensation fund, the portion allocated to each commercial
group and the formula for allocating contributions among
insurers. In the event of any future asbestos legislative reform,
our contribution allocation could be significantly larger than our
current asbestos reserve.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Cumulative Effect of Accounting Change
--------------------------------------
In the first quarter of 2002, we began implementing the
provisions of SFAS No. 142, "Goodwill and Other Intangible
Assets," which established financial accounting and reporting for
acquired goodwill and other intangible assets. The statement
changed prior accounting practice in the way intangible assets
with indefinite useful lives, including goodwill, are tested for
impairment on an annual basis. Generally, it also required that
those assets meeting the criteria for classification as
intangible with finite useful lives be amortized to expense over
those lives, while intangible assets with indefinite useful lives
and goodwill are not to be amortized. In the second quarter of
2002, we completed our initial evaluation for impairment of our
recorded goodwill in accordance with provisions of SFAS No. 142.
That evaluation concluded that none of our goodwill was impaired.
In connection with our reclassification of certain assets
previously accounted for as goodwill to other intangible assets
in 2002, we established a deferred tax liability of $6 million in
the second quarter of 2002. That provision was classified as a
cumulative effect of accounting change effective as of January 1,
2002. In accordance with SFAS No. 142, we restated our
previously reported results for the first quarter of 2002,
reducing net income for that period from the originally reported
$139 million, or $0.63 per common share (diluted) to $133
million, or $0.60 per common share (diluted).
In the second quarter of 2003, we peformed our annual evaluation
for impairment of recorded goodwill in accordance with provisions
of SFAS No. 142. That evaluation concluded that none of our
goodwill was impaired.
As a result of implementing the provisions of SFAS No. 142, we no
longer amortize our goodwill assets. Amortization expense
associated with intangible assets totaled $12 million in the
first six months of 2003, compared with $9 million in the same
2002 period.
September 11, 2001 Terrorist Attack
-----------------------------------
In 2001, we recorded estimated net pretax losses totaling $941
million related to the September 11, 2001 terrorist attack in the
United States. We regularly evaluate the adequacy of our
estimated net losses related to the attack, weighing all factors
that may impact the total net losses we will ultimately incur.
During 2002, we recorded an additional loss provision of $20
million, and a $33 million reduction in our estimated provision
for uncollectible reinsurance related to the attack. In the
second quarter of 2003, we recorded a $24 million reduction in
losses related to the attack, virtually all of which was recorded
in our reinsurance operations, the results of which are reported
in our runoff "Other" segment. Through June 30, 2003, we have
made net loss payments totaling $452 million related to the
attack since it occurred, of which $145 million were made in the
first half of 2003. For further information regarding the impact
of the terrorist attack on our operations, refer to Note 4 on
page 69 of our 2002 Annual Report to Shareholders.
Discontinued Operations
-----------------------
Standard Personal Insurance - In 1999, we sold our standard
personal insurance operations to Metropolitan Property and
Casualty Insurance Company ("Metropolitan"). Metropolitan
purchased Economy Fire & Casualty Company and subsidiaries
("Economy"), and the rights and interests in those non-Economy
policies constituting the remainder of our standard personal
insurance operations. Those rights and interests were
transferred to Metropolitan by way of a reinsurance and facility
agreement. We guaranteed the adequacy of Economy's loss and loss
expense reserves, and we remain liable for claims on non-Economy
policies that result from losses occurring prior to the September
30, 1999 closing date. Under the reserve-related agreements, we
agreed to pay for any deficiencies in those reserves and would
share in any redundancies that developed by September 30, 2002.
Any losses incurred by us under these agreements were reflected
in discontinued operations in the period during which they were
incurred. At December 31, 2002, our analysis indicated that we
owed Metropolitan $13 million related to the reserve agreements,
which was paid in April 2003. In the first six months of 2003
and 2002, we recorded pretax losses of $300,000 and $6 million,
respectively, in discontinued operations, related to claims in
respect of pre-sale losses.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
Critical Accounting Policies
----------------------------
Overview - On pages 30 through 32 of our 2002 Annual Report to
Shareholders, we identified and described the critical accounting
policies related to accounting estimates that 1) require us to
make assumptions about highly uncertain matters and 2) could
materially impact our consolidated financial statements if we
made different assumptions. Those policies were unchanged at
June 30, 2003, except for a change related to the recognition of
premium revenue as described below.
In 2003, we changed the method by which we recognize premium
revenue at our operations at Lloyd's. Prior to 2003, such
revenue was recognized using the "one-eighths" method, which
reflected the fact that we converted Lloyd's syndicate accounts
to U.S. GAAP on a quarterly basis. Since Lloyd's accounting does
not recognize the concept of earned premium, we calculated earned
premium as part of the conversion to GAAP, assuming business was
written at the middle of each quarter, effectively breaking the
calendar year into earnings periods of eighths. In 2003, we
began recognizing Lloyd's premium revenue in a manner that more
accurately reflects the underlying policy terms and exposures and
is more consistent with the method by which we recognize premium
revenue in our non-Lloyd's business. This change did not have a
material impact on our consolidated financial statements for the
three months or six months ended June 30, 2003.
The following discussion provides an update to various financial
disclosures related to critical accounting policies pertaining to
our investments.
We continually monitor the difference between our cost and the
estimated fair value of our investments, which involves
uncertainty as to whether declines in value are temporary in
nature. If we believe a decline in the value of a particular
investment is temporary, we record the decline as an unrealized
loss in our common shareholders' equity. If we believe the
decline is "other than temporary," we write down the carrying
value of the investment and record a realized loss on our
statement of operations. Our assessment of a decline in value
includes our current judgment as to the financial position and
future prospects of the entity that issued the investment
security. If that judgment changes in the future we may
ultimately record a realized loss after having originally
concluded that the decline in value was temporary. The following
table summarizes the total pretax gross unrealized loss recorded
in our common shareholders' equity at June 30, 2003 and Dec. 31,
2002, by invested asset class.
(in millions)
----------- June 30, Dec. 31,
2003 2002
------- -------
Fixed income (including
securities on loan) $ 25 $ 52
Equities 10 37
Venture capital 114 119
----- -----
Total unrealized loss $149 $208
===== =====
At June 30, 2003 and December 31, 2002, the carrying value of our
consolidated invested asset portfolio included $1.30 billion and
$1.03 billion of net pretax unrealized gains, respectively.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Consolidated Highlights (continued)
----------------------------------
The following table summarizes, for all securities in an
unrealized loss position at June 30, 2003 and Dec. 31, 2002, the
aggregate fair value and gross unrealized loss by length of time
those securities have been continuously in an unrealized loss
position.
June 30, 2003 December 31, 2002
------------------- -------------------
(in millions) Gross Gross
----------- Fair Unrealized Fair Unrealized
Value Loss Value Loss
----- ---------- ----- ----------
Fixed income
(including securities
on loan):
0 - 6 months $ 686 $ 8 $ 673 $ 27
7 - 12 months 103 11 198 9
Greater than
12 months 79 6 198 16
----- ----- ----- -----
Total 868 25 1,069 52
----- ----- ----- -----
Equities:
0 - 6 months 63 8 144 15
7 - 12 months 2 -* 80 20
Greater than
12 months 13 2 4 2
----- ----- ----- -----
Total 78 10 228 37
----- ----- ----- -----
Venture capital:
0 - 6 months 15 11 60 49
7 - 12 months 46 36 39 25
Greater than
12 months 76 67 44 45
----- ----- ----- -----
Total 137 114 143 119
----- ----- ----- -----
Total $1,083 $ 149 $1,440 $ 208
===== ===== ===== =====
*Total unrealized losses on these securities were less than $1
million at June 30, 2003.
At June 30, 2003, our fixed income investment portfolio included
non-investment grade securities and nonrated securities that in
total comprised approximately 2% of the portfolio. Included in
those categories at that date were securities in an unrealized
loss position that, in the aggregate, had an amortized cost of
$94 million and a fair value of $84 million, resulting in a net
pretax unrealized loss of $10 million. These securities
represented 1% of the total amortized cost and fair value of the
fixed income portfolio at June 30, 2003, and accounted for 40% of
the total pretax unrealized loss in the fixed income portfolio.
Included in those categories at Dec. 31, 2002 were securities in
an unrealized loss position that, in the aggregate, had an
amortized cost of $160 million and a fair value of $140 million,
resulting in a net pretax unrealized loss of $20 million. These
securities represented 1% of the total amortized cost and fair
value of the fixed income portfolio at Dec. 31, 2002, and
accounted for 38% of the total pretax unrealized loss in the
fixed income portfolio.
The following table presents information regarding fixed income
investments that were in an unrealized loss position at June 30,
2003, by remaining period to maturity date.
(in millions) Amortized Estimated
----------- Cost Fair Value
--------- ----------
Remaining period to maturity date:
One year or less $ 101 $ 99
Over one year through five years 114 111
Over five years through ten years 213 208
Over ten years 191 187
Asset/mortgage-backed securities
with various maturities 274 263
------ ------
Total $ 893 $ 868
====== ======
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance
----------------------------
Overview
--------
Our consolidated second-quarter written premiums of $1.79 billion
were 3% below comparable 2002 premiums of $1.84 billion. In the
first six months of 2003, reported premium volume of $3.77
billion was 5% lower than reported 2002 six-month volume of $3.96
billion. The decline in both periods of 2003 was concentrated in
our runoff "Other" segment and was primarily due to our November
2002 transfer of ongoing reinsurance operations to Platinum. In
our ongoing Specialty Commercial and Commercial Lines segments,
total net written premium volume of $1.71 billion in the second
quarter was 13% ahead of comparable 2002 premiums of $1.51
billion. The rate of growth in second-quarter 2003 premiums over
the same 2002 period was impacted by the one-quarter reporting
lag elimination. Our second-quarter 2003 ongoing operations
included $81 million of premium volume from our Lloyd's
operations for the three months ended June 30, 2003, which is
historically a period of low premium volume at Lloyd's. Our
second-quarter 2002 ongoing operations, however, were reported on
a one-quarter lag and therefore included $217 million of premium
volume from our operations at Lloyd's for the three months ended
March 31, 2002, which is historically a high volume period at
Lloyd's due to the timing of coverage renewals. Our year-to-date
ongoing operations' premium volume of $3.58 billion was 23%
higher than the 2002 six-month total of $2.92 billion. The
strong growth in 2003 was driven by price increases and new
business throughout our ongoing operations. That year-to-date
2003 ongoing total also included $52 million of incremental
premium volume resulting from the elimination of the one-quarter
reporting lag at our operations at Lloyd's.
Our consolidated statutory loss ratio, which measures insurance
losses and loss adjustment expenses as a percentage of earned
premiums, was 69.4 in the second quarter of 2003, compared with a
loss ratio of 101.5 in the same 2002 period. The 2002 ratio
included a 29.9-point impact from the $585 million loss provision
related to the asbestos litigation settlement described on pages
35 and 36 of this report, which was recorded in our runoff
"Other" segment. In our ongoing operations, the second-quarter
2003 loss ratio of 66.9 was over five points worse than the
comparable 2002 loss ratio of 61.7, primarily due to an $86
million loss provision recorded in our Surety business center
related to one of our insureds (discussed in more detail on page
44 of this report). Excluding that surety loss in 2003, our
ongoing operations' loss ratio of 61.4 was slightly improved over
the comparable 2002 loss ratio of 61.7. Through the first six
months of 2003, our ongoing segments' loss ratio excluding that
surety loss was 61.1, nearly five points better than the
comparable 2002 loss ratio of 66.0. That improvement reflected
the impact of price increases in recent years and our efforts to
upgrade the quality of our business, both of which have resulted
in a significant reduction in current-year loss activity
throughout the majority of our ongoing operations.
Effective January 1, 2003, we changed our disclosure regarding
catastrophe losses. We no longer classify all losses from
Insurance Services Office (ISO)-defined catastrophes as
"catastrophe losses." We revised our definition of losses
reported as "catastrophes" to include only those events that
generate losses beyond a level normally expected in our business.
This revised definition has no impact on recorded results for
either the current or prior period. Catastrophe losses reported
in prior periods have been reclassified to conform to our new
definition. In the first six months of 2003, we recorded a net
$21 million reduction in the provision for catastrophes incurred
in prior years, nearly all of which was recorded in our runoff
Reinsurance operations and was related to the September 11, 2001
terrorist attack. In the first six months of 2002, we recorded a
net $3 million reduction in the provision for catastrophe losses
incurred in prior years.
Our consolidated statutory expense ratio, measuring underwriting
expenses as a percentage of net written premiums, was 28.4 in the
second quarter of 2003, compared with the 2002 second-quarter
ratio of 30.9. In our ongoing operations, the second-quarter
2003 expense ratio of 28.4 was over a point better than the
comparable 2002 expense ratio of 29.7. The improvement in 2003
reflected the positive effects of strong price increases and our
expense reduction efforts. Through the first six months of 2003,
our ongoing operations' expense ratio of 29.4 was slightly higher
than the 2002 six-month expense ratio of 29.2, primarily due to
the impact of the reclassification of Lloyd's commission expense,
and the impact on that commission expense of eliminating the one-
quarter reporting lag.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Prior-Year Loss Development
---------------------------
"Prior-year loss development" refers to the calendar year income
statement impact of changes in the provision for losses and loss
adjustment expenses for claims incurred in prior accident years.
The following table summarizes net loss and loss adjustment
expense ("LAE") reserves at December 31, 2002 and June 30, 2003
for each of our property-liability segments (and the material
components thereof), and the amount of unfavorable (favorable)
prior-year loss development recorded in those respective
operations in the first six months of 2003.
Net Loss and LAE Reserves
-------------------------
Year-to-date
Dec. 31, June 30, Prior-Year Loss
(in millions) 2002 2003 Development
----------- ------- ------- ----------------
Ongoing operations:
Specialty Commercial:
Specialty $ 2,043 $ 2,229 $ 1
Surety & Construction 1,369 1,504 -
International & Lloyd's 987 1,165 1
------ ------ ----
Total Specialty
Commercial 4,399 4,898 2
------ ------ ----
Commercial Lines 2,495 2,486 2
------ ------ ----
Total Ongoing
Operations 6,894 7,384 4
------ ------ ----
Runoff Operations:
Other:
Health Care 1,970 1,575 (1)
Reinsurance 3,043 2,600 (22)
Other Runoff 2,942 2,271 70
------ ------ ----
Total Runoff
Operations 7,955 6,446 47
------ ------ ----
Total Underwriting $14,849 $13,830 $ 51
====== ====== ====
Specific circumstances leading to the reserve development
recorded in the first six months of 2003 are discussed in more
detail in the respective segment discussions that follow.
The table on the following page summarizes key financial results
(from continuing operations) by property-liability underwriting
business segment (underwriting results are presented using GAAP
measures; combined ratios are presented on a statutory accounting
basis). In the first quarter of 2003, we implemented a new
segment reporting structure for our property-liability
underwriting operations. Data for 2002 in the table have been
reclassified to be consistent with the new segment reporting
structure.
Following the table is a detailed discussion of the results for
each segment for the three months and six months ended June 30,
2003 and 2002. In addition to "prior-year loss development," we
sometimes refer to "current-year loss development" or "current
accident year loss activity," which refers to the calendar year
income statement impact of recording the provision for losses and
LAE for losses incurred in the current accident year.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
% of Total Three Months Ended Six Months Ended
Premiums June 30 June 30
---------- ------------------ ----------------
($ in millions) 2003 2002 2003 2002
------------- ------ ------ ------ ------
Specialty Commercial
Net written premiums 68% $1,214 $1,122 $2,546 $2,033
Underwriting result $12 $73 $130 $67
Combined ratio 96.6 91.8 94.1 95.4
Commercial Lines
Net written premiums 27% $494 $384 $1,029 $883
Underwriting result $36 $48 $74 $43
Combined ratio 92.3 91.3 91.2 95.1
Other
Net written premiums 5% $86 $337 $196 $1,045
Underwriting result $(49) $(712) $(148) $(712)
Combined ratio 135.6 228.3 153.7 158.7
--- ------ ------ ------ ------
Total Property-
Liability Insurance
Net written premiums 100% $1,794 $1,843 $3,771 $3,961
==== ====== ====== ====== ======
Underwriting result $(1) $(591) $56 $(602)
====== ====== ====== ======
Statutory Combined Ratio
Loss and loss adjustment
expense ratio 69.4 101.5 67.4 86.3
Underwriting expense
ratio 28.4 30.9 30.2 29.5
------ ------ ------ ------
Combined Ratio 97.8 132.4 97.6 115.8
====== ====== ====== ======
Specialty Commercial
--------------------
The Specialty Commercial segment includes our combined Surety &
Construction operation, our ongoing International & Lloyd's
operations, and the following nine specialty business centers
that in total comprise the "Specialty" component of this segment:
Technology, Financial and Professional Services, Marine, Personal
Catastrophe Risk, Public Sector Services, Discover Re, Excess &
Surplus Lines, Specialty Programs and Oil & Gas. These business
centers are considered specialty operations because each provides
products and services requiring specialty expertise and focuses
on the respective customer group served. Our Surety business
center underwrites surety bonds, which are agreements under which
one party (the surety) guarantees to another party (the owner or
obligee) that a third party (the contractor or principal) will
perform in accordance with contractual obligations. The
Construction business center offers a variety of products and
services, including traditional insurance and risk management
solutions, to a broad range of contractors and parties
responsible for construction projects. Our ongoing International
operations consist of our specialty underwriting operations in
Canada (other than surety), the United Kingdom and the Republic
of Ireland, and the international exposures of most U.S.
underwriting business. At Lloyd's, our ongoing operations are
comprised of the following types of insurance coverage we
underwrite through a single wholly-owned syndicate: Aviation,
Marine, Global Property and Personal Lines. The following table
provides supplemental information for this segment for the three
months and six months ended June 30, 2003 and 2002.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
($ in millions) 2003 2002 2003 2002
------------- ------ ------ ------ ------
SPECIALTY
Net written premiums $632 $438 $1,164 $911
Percentage increase over 2002 44% 28%
Underwriting result $82 $52 $141 $61
Statutory combined ratio:
Loss and loss adjustment
expense ratio 60.4 63.9 61.3 67.9
Underwriting expense ratio 23.6 23.5 24.2 24.1
------ ------ ------ ------
Combined ratio 84.0 87.4 85.5 92.0
====== ====== ====== ======
SURETY & CONSTRUCTION
Net written premiums $341 $328 $673 $673
Percentage increase over 2002 4% -%
Underwriting result $(87) $4 $(73) $6
Statutory combined ratio:
Loss and loss adjustment
expense ratio 91.0 62.5 76.8 63.1
Underwriting expense ratio 33.4 34.8 33.3 33.0
------ ------ ------ ------
Combined ratio 124.4 97.3 110.1 96.1
====== ====== ====== ======
INTERNATIONAL & LLOYD'S
Net written premiums $241 $356 $709 $449
Percentage change from 2002 (32%) 58%
Underwriting result $17 $17 $62 $-
Statutory combined ratio:
Loss and loss adjustment
expense ratio 61.1 64.2 57.4 70.4
Underwriting expense ratio 29.3 28.5 34.2 30.5
------ ------ ------ ------
Combined ratio 90.4 92.7 91.6 100.9
====== ====== ====== ======
TOTAL SPECIALTY
COMMERCIAL SEGMENT
Net written premiums $1,214 $1,122 $2,546 $2,033
Percentage increase over 2002 8% 25%
Underwriting result $12 $73 $130 $67
Statutory combined ratio:
Loss and loss adjustment
expense ratio 69.2 63.5 64.7 66.9
Underwriting expense ratio 27.4 28.3 29.4 28.5
------ ------ ------ ------
Combined ratio 96.6 91.8 94.1 95.4
====== ====== ====== ======
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Specialty
---------
Virtually all business centers in the Specialty category
contributed to the strong premium growth over the second quarter
and first half of 2002. The pace of premium growth for the first
six months of 2003 was less than that in the second quarter of
the year due to the impact of increased ceded reinsurance costs
in the first quarter of the year. Financial and Professional
Services' second-quarter 2003 premiums of $154 million were 72%
higher than in the same period of 2002, driven by price increases
and new business principally generated by our December 2002
acquisition of the right to seek to renew the professional and
financial risk practice business of Royal & SunAlliance.
Specialty Programs' written premiums of $62 million in the second
quarter were nearly double the comparable 2002 total of $33
million, primarily due to price increases and new business.
Personal Catastrophe Risk second-quarter net premiums of $51
million were significantly higher than those in the same 2002 period,
due to a change in our reinsurance program related to this
business that has resulted in less business being ceded to other
insurers.
The improvements in both second-quarter and year-to-date 2003
underwriting results compared with the same periods of 2002
occurred in virtually every business center in the Specialty
category, reflecting the impact of price increases in recent
quarters and the addition of profitable new business.
Surety & Construction
---------------------
Net written premiums generated by our Surety business center
totaled $147 million in the second quarter of 2003, compared with
$140 million in the same 2002 period. Through the first half of
2003, Surety's written premium volume of $240 million was 3%
below the comparable 2002 total of $247 million, primarily due to
the closing of certain field offices, the impact of underwriting
actions to improve the risk profile of our book of business, and
increased reinsurance costs.
The Surety underwriting loss totaled $88 million in the second
quarter of 2003, compared with an underwriting loss of $2 million
in the same 2002 period. We had previously reported in a Current
Report on Form 8-K dated April 30, 2003 that in April 2003 we
began to receive surety claim notices related to one of our
accounts that was in bankruptcy. In the second quarter of 2003,
we recorded an $86 million pretax loss provision (net of
reinsurance) related to that account's inability to perform its
bonded obligations. In April 2003, a bankruptcy court approved
the sale of substantially all of the assets of the account.
Following that approval, we received claim notices with respect
to approximately $120 million of bonds securing certain workers'
compensation and retiree health benefit obligations of the
account. The $86 million net pretax loss provision recorded in
the second quarter of 2003 represents our estimated loss in this
matter. We reported that loss in a Current Report on Form 8-K
dated July 25, 2003.
In our Surety operation, we continue to experience an increase in
the frequency of reported losses, primarily resulting from the
continuing economic downturn in North America. Certain segments
of our surety business tend to be characterized by low frequency
but potentially high severity losses.
Within our commercial surety segments, we have exposures related
to a small number of accounts, which are now in various stages of
bankruptcy proceedings. In addition, certain other accounts have
experienced deterioration in creditworthiness since we issued
bonds to them. Given the current economic climate and its impact
on these companies, we may experience an increase in claims and,
possibly, incur high severity losses. Such losses would be
recognized in the period in which the claims are filed and
determined to be a valid loss under the provisions of the surety
bond issued.
With regard to commercial surety bonds issued on behalf of
companies operating in the energy trading sector, our aggregate
pretax exposure, net of facultative reinsurance, is with five
companies for a total of approximately $396 million ($328 million
of which is from gas supply bonds), an amount that will decline
over the contract periods. The largest individual exposure
approximates $187 million (pretax). These companies all continue
to perform their bonded obligations and, therefore, no claims
have been filed.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
In addition to our largest exposure discussed above with respect
to energy trading companies, our commercial surety business as of
June 30, 2003 included seven accounts with gross pretax bond
exposures greater than $100 million each, before reinsurance.
The majority of these accounts have investment grade ratings, and
all accounts continue to perform their bonded obligations.
In 2003, we secured excess of loss reinsurance coverage for our
commercial surety exposures in the form of two new treaties
providing $500 million of aggregate loss limits over a five-year
period, with a maximum recovery of $100 million per principal for
gas supply bonds and $150 million per principal for other bonds.
The reinsurance program does not extend coverage to the small
number of commercial surety accounts which were in bankruptcy at
the inception of the reinsurance treaties.
We continue with our intention to exit the segments of the
commercial surety market discussed above by ceasing to write new
business and, where possible, terminating the outstanding bonds.
Since October 2000, when we made a strategic decision to
significantly reduce the exposures in these segments, our total
commercial surety gross open bond exposure has decreased by over
50% as of June 30, 2003. We will continue to be a market for
traditional commercial surety business, which includes low-limit
business such as license and permit, probate, public official,
and customs bonds.
In our contract surety business, creditworthiness is a primary
underwriting consideration and the underwriting process involves
a number of factors, including consideration of a contractor's
financial position, experience and management. Our risk in
respect of a contract surety bond changes over time. Such risk
tends to decrease as the related construction project is
completed, but may increase to the extent the financial condition
of the contractor deteriorates or difficulties arise during the
course of the project. While our contract surety business
typically has not been characterized by high severity losses, it
is possible, given the current economic climate, that significant
losses could occur.
Some of our contract surety business, particularly with respect
to larger accounts, is written on a co-surety basis with other
surety underwriters in order to manage and limit our aggregate
exposure. Certain of these sureties have experienced, and may
continue to experience, deterioration in their financial
condition and financial strength ratings. If a loss is incurred
and a co-surety fails to meet its obligations under the bond, the
other co-surety or co-sureties on the bond typically are jointly
and severally liable for such obligations. As a result, our
losses could significantly increase.
In our Construction business center, net written premiums of $194
million were slightly higher than net written premium volume of
$188 million in the second quarter of 2002, while year-to-date
premiums of $433 million were 2% higher than premiums of $426
million in the same 2002 period. The impact on written premiums
from higher prices during 2003 was largely offset by a
reduction in new business. Construction's second-quarter 2003
underwriting profit totaled $1 million, compared with a profit of
$6 million in the same 2002 period. Through the first half of
2003, the underwriting profit of $25 million was significantly
higher than the comparable 2002 profit of $7 million, primarily
due to an improvement in current-year loss experience.
International & Lloyd's
-----------------------
Net written premiums of $241 million in the second quarter were
32% below comparable 2002 premiums of $356 million. The decline
was primarily due to the effects of the elimination of the one-
quarter reporting lag at our Lloyd's operations. Reported
results for the second quarter of 2003 represent activity for the
quarter ended June 30, 2003, which is typically a low premium
volume quarter at Lloyd's, whereas reported results for the
second quarter of 2002 represent activity for the quarter ended
March 31, 2002, which is typically a high-volume quarter for
Lloyd's due to the timing of coverage renewals. Also impacting
second-quarter 2003 volume was a reduction in estimated
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
premiums recorded in prior periods for certain Lloyd's business.
For the six months ended June 30, 2003, written premium volume of
$709 million for the International & Lloyd's category included
$52 million of incremental premiums from the elimination of the
one-quarter reporting lag at Lloyd's (the remaining $2 million of
incremental premiums described on page 31 of this report were
recorded in our runoff Other segment). Excluding that additional
$52 million, premium volume in 2003 of $657 million was 46% higher
than 2002 six-month written premiums of $449 million. The
significant growth was concentrated in our operations at Lloyd's,
due to price increases, new business and our increased
participation in Lloyd's following the consolidation of most of
our Lloyd's operations into one wholly-owned syndicate in 2002.
Our International operations also achieved strong growth over
2002, recording premiums of $160 million and $262 million for the
three months and six months ended June 30, 2003, respectively,
compared with premiums of $139 million and $209 million in the
respective periods of 2002. Price increases, new business and
favorable foreign currency translation effects were all factors
contributing to the growth in premiums in the first half of 2003.
The International & Lloyd's underwriting profit of $17 million in
the second quarter of 2003 was level with the underwriting profit
in the same 2002 period. For the first half of 2003, the
underwriting profit of $62 million, which included a $3 million
benefit attributable to the elimination of the one-quarter
reporting lag, was significantly improved over the break-even
underwriting result in the same period of 2002. The improvement
in 2003 results was largely due to strong results from our
operations in Canada and the United Kingdom, as well as from our
Lloyd's operations.
Commercial Lines
----------------
The Commercial Lines segment includes our Small Commercial,
Middle Market Commercial and Property Solutions business centers,
as well as the results of our limited involvement in involuntary
insurance pools. The Small Commercial business center services
commercial firms that typically have between one and fifty
employees through its proprietary St. Paul Mainstreet (SM) and
St. Paul Advantage (SM) products, with a particular focus on
offices, wholesalers, retailers, artisan contractors and other
service risks. The Middle Market Commercial business center
offers comprehensive insurance coverages for a wide variety of
manufacturing, wholesale, service and retail exposures. This
business center also offers loss-sensitive casualty programs,
including significant deductible and self-insured retention
options, for the higher end of the middle market sector. The
Property Solutions business center combines our Large Accounts
Property business with the commercial portion of our catastrophe
risk business and allows us to take a unified approach to large
property risks. The following table summarizes key financial
data for this segment for the three months and six months ended
June 30, 2003 and 2002.
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
($ in millions) 2003 2002 2003 2002
------------- ------ ------ ------ ------
Net written premiums $494 $384 $1,029 $883
Percentage increase over 2002 29% 17%
Underwriting result $36 $48 $74 $43
Statutory combined ratio:
Loss and loss adjustment
expense ratio 61.5 57.8 61.7 64.2
Underwriting expense ratio 30.8 33.5 29.5 30.9
------ ------ ------ ------
Combined ratio 92.3 91.3 91.2 95.1
====== ====== ====== ======
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
All business centers in this segment contributed to the growth in
net written premiums in the second quarter and first six months
of 2003. Although the pace of price increases continued to slow
in the second quarter, we achieved significant growth throughout
this segment while maintaining strong levels of profitability.
Written premiums of $173 million in the Small Commercial business
center were 16% higher than comparable second-quarter 2002 volume
of $149 million. In the Middle Market business center, second-
quarter written premiums of $288 million increased 34% over the
same period of 2002, driven by strong growth in our Large
Casualty and Inland Marine business. Property Solutions' written
premiums of $23 million in the second quarter were 68% higher
than the comparable 2002 total. Our business retention levels
increased slightly over 2002, and new business throughout the
Commercial Lines segment has been a significant contributor to
premium growth in 2003.
The decline in underwriting profitability in the second quarter
of 2003 compared with the same period of 2002 was influenced in
part by an increase in weather-related losses. Through the first
half of 2003, however, underwriting profits were $31 million
higher than the same period of 2002, driven by continued
improvement in our current-year loss experience in each of the
business centers comprising this segment. We have been
successful in adding new business in the first six months of 2003
that meets our pricing and underwriting criteria while
maintaining strict control over expense growth. The 1.4-point
improvement in the expense ratio compared with the first six
months of 2002 reflected the combined impact of a decline in net
commission expense and our expense control efforts.
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 operations: our runoff operations at Lloyd's;
Unionamerica, the London-based underwriting unit acquired as part
of our purchase of MMI in 2000; and international operations we
decided to exit at the end of 2001. We have a management team in
place for these operations, seeking to ensure that our
outstanding claim obligations are settled in an expeditious and
economical manner. This segment also includes the results of our
participation in voluntary insurance pools, as well as loss
development on business underwritten prior to 1980 (prior to 1988
for business acquired in our merger with USF&G Corporation in
1998). That prior year business includes the majority of our
environmental and asbestos liability exposures. The oversight of
these exposures is the responsibility of the same management team
responsible for oversight of the other components of the Other
segment. Our Health Care operation historically provided a wide
range of medical liability insurance products and services
throughout the entire health care delivery system. Our
Reinsurance operations historically underwrote treaty and
facultative reinsurance for a wide variety of property and
liability exposures. As described in more detail on pages 32 and
33 of this report, in November 2002 we transferred our ongoing
reinsurance operations to Platinum Underwriters Holdings, Ltd.
The following table summarizes key financial data for the Other
segment for the three months and six months ended June 30, 2003
and 2002. The table excludes statutory ratios, as they are less
meaningful in a runoff environment because of the significant
decline in net written and earned premiums.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
($ in millions) 2003 2002 2003 2002
------------- ------ ------ ------ ------
HEALTH CARE
Net written premiums $7 $32 $26 $142
Percentage decline from 2002 (78%) (82%)
Underwriting result $(16) $(96) $(33) $(93)
REINSURANCE
Net written premiums $63 $201 $128 $663
Percentage decline from 2002 (69%) (81%)
Underwriting result $(15) $(5) $3 $11
OTHER RUNOFF
Net written premiums $16 $104 $42 $240
Percentage decline from 2002 (85%) (83%)
Underwriting result $(18) $(611) $(118) $(630)
----- ----- ----- -----
TOTAL OTHER SEGMENT
Net written premiums $86 $337 $196 $1,045
===== ===== ===== =====
Percentage decline from 2002 (74%) (81%)
Underwriting result $(49) $(712) $(148) $(712)
===== ===== ===== =====
Other Segment Overview
----------------------
The Other segment in total generated a $49 million underwriting
loss in the second quarter of 2003, compared with a loss of $712
million in the same 2002 period that included the $585 million
provision related to the asbestos litigation settlement
agreement. As described in more detail in the following
discussion, the year-to-date segment underwriting loss of $148
million included $47 million of net unfavorable prior-period loss
development, including $8 million that emerged in the second
quarter of the year. The remainder of the six-month underwriting
loss primarily resulted from provisions for losses on current
accident year business, and expenses associated with the runoff
lines of business in this segment.
Health Care
-----------
We announced our decision to exit the medical liability insurance
market at the end of 2001. Written premiums for all periods
presented in the foregoing table primarily consisted of premiums
generated by extended reporting endorsements and professional
liability coverages underwritten prior to our nonrenewal
notifications becoming effective in several states. We are
required to offer reporting endorsements to claims-made
policyholders at the time their policies are nonrenewed. These
endorsements cover losses incurred in prior periods that have not
yet been reported. Unlike typical policies, premiums on these
endorsements are fully earned, and the expected losses are
recorded, at the time the endorsement is written.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
In 2000 and 2001, we recorded cumulative prior-year reserve
charges of $225 million and $735 million, respectively, in our
Health Care operations, ultimately leading to our decision at the
end of 2001 to exit this market. In general, the reserve
increases primarily resulted from claim payments being greater
than anticipated due to the recent escalation of large jury
awards, which included substantially higher than expected pain
and suffering awards. This affected our view of not only those
cases going to trial, but also our view of all cases where
settlements are negotiated and the threat of a large jury verdict
aids the plaintiff bar in the negotiation process. The recent
escalation in claim costs that resulted from these developments
was significantly higher than originally projected trends (which
had not forecasted the change in the judicial environment), and
has now been considered in our actuarial analysis and the
projection of ultimate loss costs. In addition, a portion of the
reserve increase in the fourth quarter of 2001 resulted from
information obtained from the work of a Health Care Claims Task
Force, created during the first half of 2001, which focused
resolution efforts on our largest claims with the intent of
lowering our ultimate loss costs.
The following presents a summary of trends we observed within our
Health Care operation for each quarter of 2002 and the first two
quarters of 2003. For a discussion of quarterly trends observed
in 2000 and 2001, refer to page 40 of our 2002 Annual Report to
Shareholders.
2002
----
Following the cumulative prior-year reserve charges of $735
million in 2001, activity in the first quarter of 2002 developed
according to projections. Average paid claims for the full year
of 2001 for medical malpractice lines had been $117,000,
including a fourth quarter average of $124,000. The phrase
"average paid claims" as used herein excludes claims which were
settled or closed for which no loss or loss expense was paid. In
the first quarter of 2002, the average paid loss was down to
$111,000. We interpreted this as a positive sign that prior year
reserve charges up to this point had been adequate. The average
outstanding case reserve increased slightly from $141,000 in the
fourth quarter of 2001 to $144,000 in the first quarter of 2002,
but this was interpreted as a relatively benign change, given
inflation and the promising decrease in average payment amounts.
No additional reserve action was taken.
In the second quarter of 2002, average paid claims for medical
malpractice lines were somewhat above expectations, rising to
$130,000 for the quarter. This, coupled with an additional
increase in the average outstanding case reserve to $148,000,
prompted management to reflect these new increased averages in
its reserve analysis and record a reserve increase of $97
million.
Throughout 2002, we initiated significant changes to our Health
Care claims organization and resolution process. During the
third quarter of 2002, we began to see the results of executing
this strategy. Specifically, caseloads per adjuster had begun to
decline substantially and the process for providing oversight on
high exposure cases had been streamlined, enabling a more
expeditious approach to our handling of these medical malpractice
claims - including the establishment of stronger case reserves.
We also added staff with expertise in high exposure litigation
management to assist claim handlers in aggressively pursuing
appropriate resolutions on a file-by-file basis. This allowed us
to establish more effective resolution strategies to either
resolve claims prior to going to trial or, for those claims
deemed as non-meritorious, maintain an aggressive defense. We
have also become more selective in determining which cases are
taken to trial and more willing to make use of our right to
select defense counsel in those instances that we decide to
litigate. This has caused our ratio of defense verdicts to
plaintiff verdicts to improve over prior years. We began to more
effectively manage our claim disposition strategies to limit the
number of catastrophic verdicts. We believe that executing this
strategy has increased our ability to reduce our ultimate
indemnity losses.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
As noted above, as part of our focus on claim resolution, we have
increased our emphasis on routinely reviewing our case reserves
and have put in place a process where managers actively review
each adjuster's entire inventory of pending files to assure,
among other things, that case reserves are adequate to support
settlement values. In addition, as we have moved further into
runoff, our mix of paid and outstanding claims has changed and we
expect that our statistical data will reflect fewer new claims.
We expect our claim counts will go down and the average size of
our outstanding and paid claims will go up since newly reported
claims are often settled at minimal loss or loss expense cost.
In the third quarter of 2002, although our average paid claim
decreased slightly to $126,000, our average outstanding claim
reserve increased to $166,000. We believed that increases in the
average outstanding claim reserve were due to both the claim mix
and case strengthening as described above and were not unexpected
in a runoff environment. Accordingly, we did not record any
reserve charge given the favorable effects we anticipate
realizing in future ultimate payments.
In the fourth quarter of 2002, the average paid claim increased
to $153,000 and the average outstanding case reserve increased to
$181,000, which we believe was attributable to the previously
described observations and was reasonable relative to our
expectations.
Also during the fourth quarter, we determined that our claim
inventory had been reduced considerably and had matured to a
level at which we appropriately began to consider other more
relevant data and statistics suitable for evaluating reserves in
a runoff environment.
During 2002, and as described above, we concluded that the impact
of settling claims in a runoff environment was causing abnormal
effects on our average paid claims, average outstanding claims,
and the amount of average case reserves established for new
claims - all of which are traditional statistics used by our
actuaries to develop indicated ranges of expected loss. Taking
these changing statistics into account, we developed varying
interpretations of our data, which implied added uncertainty to
our evaluation of these reserves. It is our belief that this
data, when appropriately evaluated in light of the impact of our
migration to a runoff environment, supports our view that we will
realize significant savings on our ultimate claim costs.
In the fourth quarter of 2002, we established specific tools and
metrics to more explicitly monitor and validate our key
assumptions supporting our reserve conclusions since we believe
that our traditional statistics and reserving methods needed to
be supplemented in order to provide a more meaningful analysis.
The tools we developed track the three primary indicators which
are influencing our expectations and include: a) newly reported
claims, b) reserve development on known claims and c) the
"redundancy ratio," comparing the cost of resolving claims to the
reserve established for that individual claim.
Emergence of newly reported claims - Our Health Care book of
business was put into runoff at the end of 2001, and our
outstanding exposure has rapidly dropped, as expected. Since
the majority of coverage we offered was on a claims-made
basis and notification of the claim must be made within the
policy period, the potential for unreported claims has
decreased significantly. We expected that the emergence of
newly reported medical malpractice claims, with incurred
years of 2002 or prior, would not exceed 40% of our year-end
2002 outstanding case reserve amount.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Development on known claims - As part of executing our runoff
claims strategy, the inventory of claim-specific case
reserves was reviewed during 2002 in an effort to reserve
each claim as appropriately as possible. This effort is in
its advanced stages, and our expectations for additional
reserve strengthening on known claims is considered to be
minimal. We expected additional case development on medical
malpractice claims would not exceed 3% of year-end 2002 case
reserves.
Case redundancy - While there were claims settlements which
exceeded the claim-specific reserve that had been
established, on the whole, claims are being settled at a
level significantly less than the individual case reserve
previously carried. During 2001, the amount of excess
reserves above settled amounts as a percentage of previously
established reserves (referred to as a redundancy ratio) were
in the range of 25% to 30%. By the end of 2002, the
redundancy ratio had increased to between 35% and 40%. We
expect this ratio to stay within this range to support our
best estimate of a reasonable provision for our loss
reserves.
2003
----
In 2003, we evaluated the adequacy of our previously established
medical malpractice reserves in the context of the three
indicators described above. The dollar amount of newly reported
claims in the first quarter totaled $118 million, approximately
25% less than we anticipated in our original estimate of the
required level of redundancy at year-end 2002. With regard to
development on known claims, loss activity in the first quarter
of 2003 was within our expectations. Case development on
incurred years 2001 and prior was minimal, and case development
on the 2002 incurred year totaled $39 million, within our year-
end 2002 estimate of no more than 3% of development. For the
first quarter of 2003, our redundancy ratio was within our
expected range of between 35% and 40%.
In the second quarter of 2003, the dollar amount of newly
reported claims totaled $127 million, approximately 5% higher
than we anticipated in our original estimate of the required
level of reserves at year-end 2002. Nevertheless, through
the first half of 2003 the dollar amount of newly reported
claims was approximately 12% lower than we anticipated.
Loss development on known claims during the second quarter of
2003 was negative, but not as negative as we anticipated. Our
actual redundancy ratio continued to improve in the second
quarter of 2003; however, since newly reported claims and loss
development on known claims did not improve as much as we
expected in the second quarter, the required reserve redundancy
has increased modestly from the previously estimated range of
35% to 40%.
The three indicators described above are related such that if one
deteriorates, additional improvement on another is necessary for
us to conclude that further reserve strengthening is not
necessary. While the recent results of these indicators support
our current view that we have recorded a reasonable provision for
our medical malpractice exposures as of June 30, 2003, there is a
reasonable possibility that we may incur additional unfavorable
prior year loss development if these indicators significantly
change from our current expectations. If these indicators
deteriorate, we believe that a reasonable estimate of an
additional loss provision could amount to up to $250 million.
However, our analysis as of this point in time continues to
support our belief that we will realize favorable effects in our
ultimate costs and that our current loss reserves will prove to
be a reasonable provision.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Reinsurance
-----------
In November 2002, we transferred our ongoing reinsurance
operations to Platinum Underwriters Holdings, Ltd. ("Platinum")
while retaining liabilities generally for reinsurance contracts
incepting prior to January 1, 2002. Written premium volume
recorded in the second quarter and first half of 2003 consisted
entirely of premium adjustments relating to reinsurance business
underwritten in prior years. The underwriting loss of $15
million recorded in the second quarter of 2003 was driven by $4
million of net unfavorable development on losses incurred in
prior years on North American casualty classes of business,
losses recorded related to premiums received from prior
underwriting years and expenses associated with operating in a
runoff environment. The second-quarter 2003 underwriting result
also included the impact of $24 million of favorable development
related to the September 11, 2001 terrorist attack, which was
substantially offset by unfavorable development in other
coverages in the Reinsurance category of the Other segment.
On a year-to-date basis, the underwriting profit of $3 million in
2003 was driven by favorable development recorded in the first
quarter on losses incurred in prior years. Results for the first
half of 2003 also included a $6 million underwriting loss related
to the transfer of additional assets and reserves to Platinum
pursuant to an adjustment mechanism (as described in more detail
on pages 32 and 33 of this report). Underwriting results for the
three months and six months ended June 30, 2002 benefited from
the absence of significant catastrophes and favorable development
on catastrophe losses incurred in prior years.
Other Runoff
------------
This category includes the results of the following operations:
our runoff operations at Lloyd's; Unionamerica, the London-based
underwriting unit acquired as part of our purchase of MMI in
2000; and international operations we decided to exit at the end
of 2001. The $118 million underwriting loss in the first six
months of 2003 in this category included $35 million of loss
provisions to increase prior-year reserves in our runoff
syndicates at Lloyd's in the first quarter of 2003. The
unfavorable development was concentrated in North American
casualty coverages, as well as specific lines associated with
Financial Institutions and Professional coverages. We
experienced deterioration in those same syndicates throughout
2002, leading us to increase reserve levels. In the first
quarter of 2003, further analysis undertaken by an independent
party on our behalf in connection with Lloyds' compliance with
annual regulatory requirements provided us with additional
information and analyses, which led us to record the $35 million
loss provision.
Also contributing to the underwriting loss in this segment in the
first half of 2003 was $31 million of unfavorable prior-year
development recorded in the first quarter primarily related to
several specific large losses in a number of countries within our
exited international operations where we have ceased underwriting
business. In the second quarter, we recorded $4 million of
adverse prior-year development resulting from a single large loss
in one of our operations in runoff. The remainder of the year-to-
date underwriting loss was the result of provisions for losses on
current accident year business, and expenses associated with the
runoff lines of business in this segment.
The significant underwriting losses in this category for the
second quarter and first half of 2002 were driven by the $585
million loss provision related to the Western MacArthur asbestos
litigation settlement agreement, described in more detail on
pages 35 and 36 of this report.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Property-Liability Insurance (continued)
---------------------------------------
Investment Operations
---------------------
Pretax net investment income in our property-liability insurance
operations totaled $274 million in the second quarter of 2003, 4%
below pretax investment income of $283 million in the same period
of 2002. Through the first half of 2003, pretax investment
income of $554 million was 3% lower than the comparable 2002
total of $573 million. Our investment income in recent quarters
has been negatively impacted by declining yields on new
investments and a reduction in funds available for investment due
to significant cash payments for insurance losses and loss
adjustment expenses, including payments related to our runoff
operations. In addition, we made a planned payment of $747
million (including interest) in mid-January 2003 related to the
settlement of the Western MacArthur asbestos litigation, further
reducing our invested asset base in 2003. Since the end of 1999,
average new money rates on taxable and tax-exempt fixed-income
securities have fallen from 7.2% and 5.4%, respectively, to 4.2%
and 3.8%, respectively, at June 30, 2003.
The market value of our $15.7 billion fixed income portfolio
exceeded its cost by $1.23 billion at June 30, 2003.
Approximately 96% of that portfolio is rated at investment grade
(BBB or above). The weighted average pretax yield on those
investments was 6.0% at June 30, 2003, down from 6.5% a year
earlier.
Net pretax realized investment gains in our property-liability
insurance operations totaled $71 million in the second quarter of
2003, compared with realized losses of $38 million in the same
2002 period. The gains in 2003 were concentrated in venture
capital and were almost entirely the result of the sale in May
2003 of a portion of our investment in Select Comfort
Corporation, a manufacturer of adjustable air-supported beds,
which generated a pretax gain of $69 million. In the second
quarter of 2002, realized investment losses originated primarily
from our equity investments, as we made a strategic decision to
liquidate a substantial portion of that portfolio and redeploy
those funds in fixed income securities.
On a year-to-date basis, net pretax realized investment gains
totaled $38 million in 2003, compared with realized losses of $77
million in the same 2002 period. In the first half of 2003, we
sold fixed income securities with a cumulative amortized cost of
$478 million, generating gross pretax gains of $25 million.
Those gains were partially offset by impairment writedowns
totaling $16 million. Net pretax realized losses generated by
sales from our equity portfolio totaled $4 million in the first
half of 2003. In our venture capital portfolio, pretax realized
gains from the sale of securities totaled $94 million in the
first six months of 2003, an amount that was partially offset by
impairment writedowns totaling $53 million.
In the first half of 2002, we sold fixed income securities with a
cumulative amortized cost of $874 million, generating gross
pretax gains of $24 million. Those gains were partially offset
by impairment writedowns totaling $13 million attributable to
WorldCom Corporation and Adelphia Corporation bonds in our
portfolio. In our venture capital portfolio, impairment
writedowns totaled $28 million in the first half of 2002.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Environmental and Asbestos Claims
---------------------------------
We continue to receive claims, including through lawsuits,
alleging injury or damage from environmental pollution or seeking
payment for the cost to clean up polluted sites. We also receive
asbestos injury claims, including through lawsuits, arising out
of coverages under general liability policies. Most of these
claims arise from policies written many years ago. Significant
legal issues, primarily pertaining to the scope of coverage,
complicate the determination of our alleged liability for both
environmental and asbestos claims. In our opinion, court
decisions in certain jurisdictions have tended to broaden
insurance coverage for both environmental and asbestos matters
beyond the intent of the original insurance policies.
Our ultimate liability for environmental claims is difficult to
estimate because of these legal issues. Insured parties have
submitted claims for losses that in our view are not covered in
their respective insurance policies, and the final resolution of
these claims may be subject to lengthy litigation, making it
difficult to estimate our potential liability. In addition,
variables such as the length of time necessary to clean up a
polluted site, and controversies surrounding the identity of the
responsible party and the degree of remediation deemed necessary,
make it difficult to estimate the total cost of an environmental
claim.
Estimating our ultimate liability for asbestos claims is also
very difficult. The primary factors influencing our estimate of
the total cost of these claims are case law and a history of
prior claim development, both of which continue to evolve and are
complicated by aggressive litigation against insurers, including
us. Estimating ultimate liability is also complicated by the
difficulty of assessing what rights, if any, we may have to seek
contribution from other insurers of any policyholder.
Late in 2001, we hired a new Executive Vice President of Claims,
with extensive experience with environmental and asbestos claims
handling and environmental and asbestos reserves, who conducted a
summary level review of our environmental and asbestos reserves.
As a result of observations made in this review, we undertook
more detailed actuarial and claims analyses of environmental
reserves. No adjustment to reserves was made in the fourth
quarter of 2001, since management did not have a sufficient basis
for making an adjustment until such supplemental analyses were
completed, and we believed our environmental and asbestos
reserves were adequate as of December 31, 2001.
Our historical methodology (through first quarter 2002) for
reviewing the adequacy of environmental and asbestos reserves
utilized a survival ratio method, which considers ending reserves
in relation to calendar year paid losses. When the environmental
reserve analyses were completed in the second quarter of 2002, we
supplemented our survival ratio analysis with the detailed
additional analyses referred to above, and concluded that our
environmental reserves were redundant by approximately $150
million. Based on our additional analyses, we released
approximately $150 million of environmental reserves in the
second quarter of 2002. Had we continued to rely solely on our
survival ratio analysis, we would have recorded no adjustment to
our environmental reserves through the six months ended June 30,
2002.
In the second quarter of 2002, we also supplemented our survival
ratio analysis of asbestos reserves with a detailed claims
analysis. We determined that, excluding the impact of the
Western MacArthur settlement, our asbestos reserves were
adequate; however, including that impact, we determined that our
asbestos reserves were inadequate.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Environmental and Asbestos Claims (continued)
--------------------------------------------
As a result of developments in the asbestos litigation
environment generally, we determined in the first quarter of 2002
that it would be desirable to seek earlier and ultimately less
costly resolutions of certain pending asbestos-related
litigations. As a result, we have decided where possible to seek
to resolve these matters while continuing to vigorously assert
defenses in pending litigations. We are taking a similar
approach to environmental litigations. As discussed in more
detail on pages 35 and 36 of this report, in the second quarter
of 2002 we entered into a definitive agreement to settle asbestos
claims for a total gross cost of $995 million arising from any
insuring relationship we and certain of our subsidiaries may have
had with MacArthur Company, Western MacArthur Company or Western
Asbestos Company.
The table below represents a reconciliation of total gross and
net environmental reserve development for the six months ended
June 30, 2003, and the years ended December 31, 2002 and 2001.
Amounts in the "net" column are reduced by reinsurance
recoverables. The disclosure of environmental reserve
development includes all claims related to environmental
exposures. Additional disclosure has been provided to separately
identify loss payments and reserve amounts related to policies
that were specifically underwritten to cover environmental
exposures, referred to as "Underwritten," as well as amounts
related to environmental exposures that were not specifically
underwritten, referred to as "Not Underwritten." In 1988, we
completed our implementation of a pollution exclusion in our
commercial general liability policies; therefore, activity
related to accident years after 1988 generally relates to
policies underwritten to include environmental exposures.
The amounts presented for paid losses in the following table as
"Underwritten" include primarily exposures related to accident
years after 1988 for policies which the underwriter contemplated
providing environmental coverage. In addition, certain pre-1988
exposures, primarily first party losses, are included since they
too were contemplated by the underwriter to include environmental
coverage. "Not Underwritten" primarily represents exposures
related to accident years 1988 and prior for policies which were
not contemplated by the underwriter to include environmental
coverage.
Six Months Ended
Environmental June 30, 2003 2002 2001
------------- ---------------- ----------- -----------
(in millions) Gross Net Gross Net Gross Net
----------- ----- ---- ----- ---- ----- ----
Beginning reserves $370 $298 $604 $519 $684 $573
Incurred losses 22 (1) (2) (3) 6 21
Reserve reduction - - (150) (150) - -
Paid losses:
Not underwritten (68) (39) (70) (56) (74) (63)
Underwritten (6) (6) (12) (12) (12) (12)
----- ---- ----- ---- ----- ----
Ending reserves $318 $252 $370 $298 $604 $519
===== ==== ===== ==== ===== ====
The $150 million reduction of environmental reserves in 2002
discussed previously was included in the gross and net incurred
losses for 2002.
For 2001, the year-end gross and net environmental "underwritten"
reserves were both $28 million, at December 31, 2002 such gross
and net reserves were both $36 million, and at June 30, 2003,
such gross and net reserves were $38 million and $37 million,
respectively. These reserves relate to policies, which were
specifically underwritten to include environmental exposures.
These "underwritten" reserve amounts are included in the total
reserve amounts in the preceding table.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Environmental and Asbestos Claims (continued)
--------------------------------------------
The following table represents a reconciliation of total gross
and net reserve development for asbestos claims for the six
months ended June 30, 2003 and the years ended December 31, 2002
and 2001. No policies have been underwritten to specifically
include asbestos exposure.
Six Months Ended
Asbestos June 30, 2003 2002 2001
------------- ---------------- ----------- -----------
(in millions) Gross Net Gross Net Gross Net
----------- ----- ---- ----- ---- ----- ----
Beginning reserves $1,245 $778 $577 $387 $471 $315
Incurred losses 23 - 846 482 167 116
Reserve increase - - 150 150 - -
Paid losses (836) (494) (328) (241) (61) (44)
----- ---- ----- ---- ----- ----
Ending reserves $432 $284 $1,245 $778 $577 $387
===== ==== ===== ==== ===== ====
Paid losses in 2003 include $740 million related to the Western
MacArthur litigation settlement. Included in gross incurred
losses in 2002 were $995 million of losses related to the Western
MacArthur settlement. Also included in the gross and net
incurred losses for the year ended December 31, 2002, but
reported separately in the above table, was a $150 million
increase in asbestos reserves. Gross paid losses in 2002 include
the $248 million Western MacArthur payment made in June 2002.
In 2001, we completed a periodic analysis of environmental and
asbestos reserves at one of our subsidiaries in the United
Kingdom. The analysis was based on a policy-by-policy review of
our known and unknown exposure to damages arising from
environmental pollution and asbestos litigation. The analysis
concluded that loss experience for environmental exposures was
developing more favorably than anticipated, while loss experience
for asbestos exposures was developing less favorably than
anticipated. The divergence in loss experience had an offsetting
impact on respective reserves for environmental and asbestos
exposures; as a result, we recorded a $48 million reduction in
net incurred environmental losses in 2001, and an increase in net
incurred asbestos losses for the same amount.
For a discussion of potential Federal asbestos legislation, refer
to the "Possible Asbestos Legislation" section on page 36 of this
report.
Our reserves for environmental and asbestos losses at June 30,
2003 represent our best estimate of our ultimate liability for
such losses, based on all information currently available.
Because of the inherent difficulty in estimating such losses,
however, we cannot give assurances that our ultimate liability
for environmental and asbestos losses will, in fact, match
current reserves. We continue to evaluate new information and
developing loss patterns, as well as the potential impact of our
determination to seek earlier and, we believe, ultimately less
costly resolutions of certain pending asbestos and environmental
related litigations. Future changes in our estimates of our
ultimate liability for environmental and asbestos claims may be
material to our results of operations, but we do not believe they
will materially impact our liquidity or overall financial
position.
Total gross environmental and asbestos reserves of $750 million
at June 30, 2003 represented approximately 4% of gross
consolidated loss reserves of $21.3 billion.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Asset Management
----------------
Our asset management segment consists of our 79% majority
ownership interest in Nuveen Investments, Inc. ("Nuveen
Investments," formerly The John Nuveen Company). Nuveen
Investments provides individually managed accounts, closed-end
exchange-traded funds and mutual funds to the affluent and high-
net-worth market segments through unaffiliated intermediary
firms. Nuveen Investments also provides managed account services
to several institutional market segments and channels.
Highlights of Nuveen Investments' performance for the three
months and six months ended June 30, 2003 and 2002 were as
follows.
Three Months Ended Six Months Ended
June 30 June 30
------------------ ----------------
(in millions) 2003 2002 2003 2002
----------- ------ ------ ------ ------
Revenues $ 106 $ 90 $ 208 $ 184
Expenses 50 40 99 85
------ ------ ------ ------
Pretax earnings 56 50 109 99
Minority interest (12) (11) (23) (22)
------ ------ ------ ------
The St. Paul's share
of pretax earnings $ 44 $ 39 $ 86 $ 77
====== ====== ====== ======
Assets under management $88,258 $68,496
====== ======
Nuveen Investments' gross investment product sales totaled a
record $5.4 billion in the second quarter of 2003, reflecting
expanding relationships with high-end financial advisors and
consultants, as well as improving equity markets. Product sales
in the comparable 2002 period totaled $3.3. billion. The strong
growth over 2002 was driven by an increase in sales of closed-end
exchange-traded funds, which primarily resulted from Nuveen
Investments' introduction of their second preferred and
convertible income fund in June. Retail and institutional
managed accounts, as well as mutual funds, also contributed to
the growth in product sales over 2002. Second-quarter 2003 sales
were comprised of $2.8 billion of closed-end exchange-traded
funds, $2.2 billion of retail and institutional and managed
accounts and $0.4 billion of mutual funds. Nuveen Investments'
net flows (equal to the sum of sales, reinvestments and
exchanges, less redemptions and withdrawals) during the first six
months of 2003 totaled $5.2 billion, more than double comparable
2002 net flows of $2.5 billion. Net flows through the first six
months of 2003 were positive across all product lines.
An increase in assets under management accounted for the growth
in Nuveen Investments' revenues over the second quarter and first
six months of 2002. Assets under management at the end of the
second quarter consisted of $45.3 billion of closed-end exchange-
traded funds, $21.7 billion of retail managed accounts, $12.3
billion of mutual funds and $9.0 billion of institutional
managed accounts. The significant increase in managed assets over
the same time a year ago was driven by Nuveen Investments'
acquisition of NWQ Investment Management Company Inc. in August
2002, positive net flows and market appreciation. Assets under
management at the end of 2002 totaled $79.7 billion.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Capital Resources
-----------------
Common shareholders' equity of $6.21 billion at June 30, 2003
grew $526 million over the year-end 2002 total of $5.68 billion,
driven by our net income of $395 million in the first half of
2003 and a $175 million increase in the after-tax unrealized
appreciation of our investment portfolio. The decline in market
interest rates during the first half of 2003 had a positive
impact on the market value of our fixed income investment
portfolio.
Total debt outstanding at June 30, 2003 of $2.53 billion declined
by $178 million from the year-end 2002 total of $2.71 billion,
largely due to a net $225 million reduction in commercial paper
outstanding. During the first quarter, Nuveen Investments repaid
$145 million it had previously borrowed from The St. Paul under
an intercompany revolving line of credit, and we used the
proceeds to repay a like amount of our commercial paper
outstanding. Nuveen Investments funded its repayment to us by
borrowing $145 million under its revolving bank line of credit,
of which Nuveen repaid $70 million in the second quarter. Debt
outstanding also declined as a result of maturities of medium-
term notes totaling $41 million in the first half of 2003, which
were funded with internally generated funds. Our ratio of total
debt obligations to total capitalization (defined as the sum of
debt obligations, shareholders' equity and redeemable preferred
securities) of 26% at the end of the second quarter was down from
the year-end 2002 ratio of 29%. Net interest expense related to
debt totaled $57 million in the first six months of 2003,
compared with $53 million in the same 2002 period. The increase
was primarily due to our issuance in March 2002 of $500 million
of 5.75% Senior Notes and our issuance in July 2002 of $443
million of 5.25% Senior Notes, which offset a decline in interest
expense related to our floating rate debt.
We made no major capital improvements in the first half of 2003,
and none are anticipated during the remainder of the year.
Our ratio of earnings to fixed charges was 6.05 for the first six
months of 2003, and our ratio of earnings to combined fixed
charges and preferred stock dividend requirements was 5.72. For
the first six months of 2002, our loss from continuing operations
was inadequate to cover "fixed charges" by $168 million and
"combined fixed charges and preferred stock dividend
requirements" by $175 million. Fixed charges consist of interest
expense, distributions on preferred securities and that portion
of rental expense deemed to be representative of an interest
factor.
Liquidity
---------
Liquidity is a measure of our ability to generate sufficient cash
flows to meet the short- and long-term cash requirements of our
business operations. In our insurance operations, short-term
cash needs primarily consist of funds to pay insurance losses and
loss adjustment expenses and day-to-day operating expenses.
Those needs are generally met through cash provided from
operations, which primarily consists of insurance premiums
collected and investment income. As necessary, additional
liquidity is provided by net sales from our investment portfolio
and access to the debt and equity markets.
Net cash flows used by continuing operations totaled $833 million
in the first six months of 2003, compared with cash provided from
continuing operations of $82 million in the same period of 2002.
Operational cash outflows in 2003 were dominated by our January
2003 payment of $747 million related to the Western MacArthur
asbestos litigation settlement. Operational cash flows in the
first half of 2002 were negatively impacted by a $248 million
payment related to the Western MacArthur settlement. Our
operations in runoff, in which we are no longer underwriting new
business but continue to pay insurance losses and loss adjustment
expenses, also contributed to the negative operational cash flows
in 2003. For the second quarter of 2003, however, our
consolidated cash flows from operations were positive (totaling
$72 million), driven by favorable underwriting results from our
ongoing underwriting business segments.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Management's Discussion, Continued
Liquidity (continued)
--------------------
Net loss payments related to the September 11, 2001 terrorist
attack totaled $145 million in the first half of 2003, compared
with payments of $148 million in the same 2002 period.
We expect consolidated operational cash flows during the second
half of 2003 to continue to grow due to continuing price
increases and improvement in the quality of our book of business
in our ongoing business segments. This improvement in ongoing
cash flows, however, will continue to be negatively impacted by
insurance losses and loss adjustment expenses payable related to
our operations in runoff.
In April 2003, Moody's Investors Services, Inc. lowered certain
of our financial ratings and those of our insurance underwriting
subsidiaries and established a stable outlook on the ratings
going forward. In June 2003, A.M. Best Co. also lowered certain
of our financial ratings while affirming those of our insurance
underwriting subsidiaries and maintaining stable outlooks for
both sets of ratings going forward. We believe our financial
strength continues to provide us with the flexibility and
capacity to obtain funds externally through debt or equity
financings on both a short-term and long-term basis. We continue
to maintain an $800 million commercial paper program with $600
million of back-up liquidity, now consisting entirely of bank
credit agreements.
Impact of Accounting Pronouncements to be Adopted in the Future
---------------------------------------------------------------
In January 2003, the Financial Accounting Standards Board
("FASB") issued FASB Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), which requires
consolidation of all variable interest entities ("VIE") by the
primary beneficiary, as these terms are defined in FIN 46,
effective immediately for VIEs created after January 31, 2003.
The consolidation requirements apply to VIEs existing on January
31, 2003 for reporting periods beginning after June 15, 2003. In
addition, it requires expanded disclosure for all VIEs. We
continue the process of evaluating FIN 46 and the related
interpretations, and at this time we are not able to quantify the
impact of adoption on our consolidated financial statements.
However, we believe such adoption may have an impact on our
consolidated financial statements and may affect the structure of
future financial transactions that we may undertake.
In April 2003, the FASB issued Statement of Financial Accounting
Standards ("SFAS") No. 149, "Amendment of Statement 133 on
Derivative Instruments and Hedging Activities," which amends and
clarifies accounting for derivative instruments, including
certain derivative instruments embedded in other contracts, and
for hedging activities under Statement 133. In particular, this
Statement clarifies under what circumstances a contract with an
initial net investment meets the characteristic of a derivative
and clarifies when a derivative contains a financing component
that warrants special reporting in the statement of cash flows.
This Statement is generally effective for contracts entered into
or modified after June 30, 2003 and is to be applied
prospectively. We do not expect the adoption of SFAS No. 149 to
have a material impact on our consolidated financial statements.
In May 2003, the FASB issued SFAS No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both
Liabilities and Equity," which establishes standards for how an
issuer classifies such financial instruments. This Statement
requires that an issuer classify a financial instrument that is
within its scope as a liability (or an asset in some
circumstances). Many of those instruments are currently
classified as equity. This Statement is effective for financial
instruments entered into or modified after May 31, 2003, and
otherwise shall be effective at the beginning of the first
interim period beginning after June 15, 2003. For financial
instruments created before the issuance date of this Statement
and still existing at the beginning of the interim period of
adoption, transition shall be achieved by reporting the
cumulative effect of a change in accounting principle by
initially measuring the financial instruments at fair value or
other measurement attribute required by this Statement. We will
adopt the provisions of this Statement in the quarter ended
September 30, 2003, at which time we will reclassify those
securities currently classified between liabilities and equity as
"Company-obligated mandatorily redeemable preferred securities of
trusts holding solely subordinated debentures of the company" to
our liabilities. We do not expect the cumulative effect of a
change in accounting principle to be recorded in the quarter
ended September 30, 2003 to have a material impact on our
consolidated financial statements.
THE ST. PAUL COMPANIES, INC. AND SUBSIDIARIES
Definitions of Certain Statutory Accounting Terms
-------------------------------------------------
Expense Ratio - We use the statutory definition of expenses in
calculating expense ratios disclosed in this report. Expenses
are divided by net written premiums to arrive at the expense
ratio. "Statutory" expenses differ from "GAAP" expenses
primarily with regard to policy acquisition costs, which are not
deferred and amortized for statutory purposes, but rather
recognized as incurred.
Written and Earned Premiums - Net "written" premiums are a
statutory measure of premium volume that differs from the net
"earned" premiums reported in our GAAP statement of operations.
Written premiums for a period can be reconciled to earned
premiums by adding or subtracting the change in unearned premium
reserves in the period.
Loss Ratio - We use the statutory definition of loss ratio. This
ratio is calculated by dividing the sum of losses and loss
adjustment expenses incurred by net earned premiums. Net earned
premiums, and losses and loss adjustment expenses, are also GAAP
measures.
Combined Ratio - This ratio is the sum of the expense ratio and
the loss ratio.
Underwriting Result - We calculate underwriting results using
statutory financial information adjusted for certain items (such
as the amortization of deferred policy acquisition costs) to
arrive at an underwriting result as calculated with GAAP measures.
Our reported underwriting result is calculated by subtracting
incurred losses and loss adjustment expenses and underwriting
expenses (as adjusted for items such as the impact of deferred
policy acquisition costs) from net earned premiums. This represents
our best measure of profitability for our property-liability
underwriting segments. A reconciliation of statutory
underwriting results to our reported underwriting results can
be found in the statistical supplement available on our web site.
Item 3. Quantitative and Qualitative Disclosures about Market Risk.
------ ----------------------------------------------------------
For a description of our risk management policies and procedures,
see the "Exposures to Market Risk" section of Management's
Discussion and Analysis on pages 54 and 55 of our 2002 Annual
Report to Shareholders.
Item 4. Controls and Procedures.
------ -----------------------
An evaluation was carried out under the supervision and with the
participation of the Company's management, including our Chief
Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure
controls and procedures (as defined in Rule 13a-14(c) under the
Securities Exchange Act of 1934), as of June 30, 2003. Based
upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that the design and operation of
these disclosure controls and procedures were effective.
Since filing its Quarterly Report on Form 10-Q for the period
ended March 31, 2003 on May 15, 2003, the Company has
investigated and identified instances of noncompliance with
existing internal controls and possibly with the Foreign Corrupt
Practices Act relating to its Mexican subsidiary. As of the
date of filing of this Quarterly Report on Form 10-Q, the
Company has not identified that any material adjustment to its
financial statements is necessary as a result of its investigation.
The Company has notified the U.S. Securities and Exchange
Commission, the U.S. Department of Justice and the Mexican
Bonding and Insurance Commission of this matter. This matter
does not affect the conclusions expressed in the preceding
paragraph.
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
The information set forth in the "Contingencies"
section (which updates information in our Annual
Report on Form 10-K for the year ended December 31,
2002 pertaining to the Western MacArthur settlement
agreement and certain purported class action
shareholder lawsuits) of Note 5 to the consolidated
financial statements is incorporated herein by
reference.
Item 2. Changes in Securities.
Not applicable.
Item 3. Defaults Upon Senior Securities.
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
The St. Paul's annual shareholders' meeting was held on
May 6, 2003.
(1) All twelve persons nominated for directors by the
board of directors were named in proxies for the
meeting which were solicited pursuant to Regulation
14A under the Securities Exchange Act of 1934.
There was no solicitation in opposition to the
nominees as listed in the proxy statements. All
twelve nominees were elected by the following votes:
In favor Withheld
----------- ---------
Carolyn H. Byrd 203,146,124 4,030,033
John H. Dasburg 190,849,839 16,326,318
Janet M. Dolan 192,115,009 15,061,148
Kenneth M. Duberstein 191,968,031 15,208,126
Jay S. Fishman 202,673,345 4,502,812
Lawrence G. Graev 202,511,450 4,664,707
Thomas R. Hodgson 203,176,566 3,999,591
William H. Kling 192,015,778 15,160,379
James H. Lawrence 204,144,219 3,031,938
John A. MacColl 203,953,607 3,222,550
Glen D. Nelson 191,990,505 15,185,652
Gordon M. Sprenger 191,960,649 15,215,508
(2) By a vote of 200,722,978 in favor, 5,226,461
against and 1,227,217 abstaining, the shareholders
ratified the selection of KPMG LLP as the
independent auditors for The St. Paul.
(3) By a vote of 10,564,806 in favor, 170,348,645
against and 2,414,693 abstaining, the shareholders
rejected a shareholder proposal to recommend that
the Personnel and Compensation Committee of the
Board of Directors terminate The St. Paul's Senior
Executive Performance Plan.
Item 5. Other Information.
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits. An Exhibit Index is set forth as the
last page in this document.
(b) Reports on Form 8-K.
1) The St. Paul filed in a Form 8-K Current Report dated
April 30, 2003 a press release related to the announcement of
claim notices being received for our largest individual
exposure regarding commercial surety bonds issued on behalf of
companies now in bankruptcy.
2) The St. Paul furnished in a Form 8-K Current Report dated
April 30, 2003 a press release related to the announcement of
financial results for the quarter ended March 31, 2003.
3) The St. Paul furnished in a Form 8-K Current Report dated
July 25, 2003 a press release related to the announcement of
the anticipated impact on second-quarter 2003 financial
results of losses recorded for a surety exposure.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed
on its behalf by the undersigned thereunto duly authorized.
THE ST. PAUL COMPANIES, INC.
---------------------------
(Registrant)
Date: July 30, 2003 By Bruce A. Backberg
------------- -----------------
Bruce A. Backberg
Senior Vice President
(Authorized Signatory)
Date: July 30, 2003 By John C. Treacy
------------- --------------
John C. Treacy
Vice President and
Corporate Controller
(Principal Accounting Officer)
EXHIBIT INDEX
-------------
Exhibit
-------
(2) Plan of acquisition, reorganization, arrangement,
liquidation or succession*.................................
(3) (i) Articles of incorporation*................................
(ii) By-laws*.................................................
(4) Instruments defining the rights of security holders,
including indentures*......................................
(10) Material contracts*...........................................
(11) Statement re computation of per share earnings................(1)
(12) Statement re computation of ratios............................(1)
(15) Letter re unaudited interim financial information*............
(18) Letter re change in accounting principles*....................
(19) Report furnished to security holders*.........................
(22) Published report regarding matters submitted to
vote of security holders*..................................
(23) Consents of experts and counsel*..............................
(24) Power of attorney*............................................
(31) Rule 13a-14(a)/15d-14(a) Certifications
(a) Certification by Jay S. Fishman.....................(1)
(b) Certification by Thomas A. Bradley..................(1)
(32) Section 1350 Certifications
(a) Certification by Jay S. Fishman.....................(1)
(b) Certification by Thomas A. Bradley..................(1)
(99) Additional exhibits*..........................................
* These items are not applicable.
(1) Filed herewith.