-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Ez5/XamvSzMPerLddJTe7zpgPCpNhTJZ+jIlufFHBF6i3PknTO2bv6VBrUT/nwTR 6J4r4LTh6jGnfEGfatykkQ== 0000950112-96-001455.txt : 19960514 0000950112-96-001455.hdr.sgml : 19960514 ACCESSION NUMBER: 0000950112-96-001455 CONFORMED SUBMISSION TYPE: 424B5 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19960513 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRAVELERS AETNA PROPERTY CASUALTY CORP CENTRAL INDEX KEY: 0001010551 STANDARD INDUSTRIAL CLASSIFICATION: LIFE INSURANCE [6311] IRS NUMBER: 061445591 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 424B5 SEC ACT: 1933 Act SEC FILE NUMBER: 333-02684 FILM NUMBER: 96561835 BUSINESS ADDRESS: STREET 1: ONE TOWER SQUARE CITY: HARTFORD STATE: CT ZIP: 06183 BUSINESS PHONE: 8602770111 MAIL ADDRESS: STREET 1: 388 GREENWICH STREET CITY: NEW YORK STATE: NY ZIP: 10013 424B5 1 TRAVELERS Filed pursuant to Rule 424(b)(5) Registration No. 333-2684 PROSPECTUS SUPPLEMENT (TO PROSPECTUS DATED APRIL 24, 1996) 4,000,000 TRUST PREFERRED SECURITIES TRAVELERS P&C CAPITAL II 8% TRUST PREFERRED SECURITIES (LIQUIDATION AMOUNT $25 PER TRUST PREFERRED SECURITY) GUARANTEED TO THE EXTENT SET FORTH HEREIN BY Travelers/Aetna Property Casualty Corp. A Member of TravelersGroup[LOGO] ------------ The 8% Trust Preferred Securities (the "Preferred Securities") offered hereby represent preferred undivided beneficial interests in the assets of Travelers P&C Capital II, a statutory business trust formed under the laws of the State of Delaware ("TAP Capital" or the "Trust"). Travelers/Aetna Property Casualty Corp., a Delaware corporation ("TAP"), will directly or indirectly own all the common securities (the "Common Securities" and, together with the Preferred Securities, the "Trust Securities") representing undivided beneficial interests in the assets of TAP Capital. TAP Capital exists for the sole purpose of issuing the Preferred Securities and Common Securities and investing the proceeds thereof in an equivalent amount of 8% Junior Subordinated Deferrable Interest Debentures due May 15, 2036 (the "Junior Subordinated Debt Securities") of TAP. (continued on next page) SEE "RISK FACTORS RELATING TO THE PREFERRED SECURITIES" BEGINNING ON PAGE S-9 FOR A DISCUSSION OF FACTORS RELATING TO THE PREFERRED SECURITIES THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS, INCLUDING THE PERIOD AND CIRCUMSTANCES DURING AND UNDER WHICH PAYMENTS OF DISTRIBUTIONS ON THE PREFERRED SECURITIES MAY BE DEFERRED AND THE RELATED UNITED STATES FEDERAL INCOME TAX CONSEQUENCES OF SUCH DEFERRAL. IN ADDITION, SEE "RISK FACTORS RELATING TO THE COMPANY" BEGINNING ON PAGE 15 OF THE ACCOMPANYING PROSPECTUS FOR A DISCUSSION OF FACTORS RELATING TO THE COMPANY THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE PREFERRED SECURITIES. The Preferred Securities have been approved for listing on the New York Stock Exchange, Inc. (the "New York Stock Exchange"), subject to official notice of issuance. Trading of the Preferred Securities on the New York Stock Exchange is expected to commence within a 30-day period after the initial delivery of the Preferred Securities. See "Underwriting." ------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS TO WHICH IT RELATES. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. [CAPTION] INITIAL PUBLIC UNDERWRITING PROCEEDS TO TAP OFFERING PRICE(1) COMMISSIONS(2) CAPITAL(3)(4) Per Preferred Security $25.00 (3) $25.00 Total $100,000,000 (3) $100,000,000
(1) Plus accrued distributions, if any, from May 15, 1996. (2) For information regarding indemnification of the Underwriter, see "Underwriting." (3) Because the proceeds of the sale of the Preferred Securities will be invested in the Junior Subordinated Debt Securities, TAP has agreed to pay to the Underwriter, as compensation ("Underwriter's Compensation") for arranging the investment therein of such proceeds, $.7875 per Preferred Security ($3,150,000 in the aggregate); provided, that such compensation for sales of 10,000 or more Preferred Securities to a single purchaser will be $.50 per Preferred Security. Therefore, to the extent of such sales, the actual amount of Underwriter's Compensation will be less than the aggregate amount specified in the preceding sentence. See "Underwriting." (4) Expenses of the offering, which are payable by TAP, are estimated to be $200,000. ------------ The Preferred Securities offered hereby are being offered by the Underwriter, subject to prior sale, when, as and if accepted by the Underwriter and subject to certain conditions. It is expected that delivery of the Preferred Securities will be made only in book-entry form through the facilities of The Depository Trust Company, on or about May 15, 1996. ------------ SMITH BARNEY INC. May 10, 1996 (continued from previous page) TAP was formed in January 1996 to hold the property and casualty insurance subsidiaries of The Travelers Insurance Group Inc. ("TIGI"), an indirect wholly owned subsidiary of Travelers Group Inc. ("Travelers Group"). On April 2, 1996, TAP acquired the domestic property and casualty insurance subsidiaries of Aetna Life and Casualty Company (the "Acquisition"). For a discussion of the financing of the Acquisition, see "Recent History." The accompanying Prospectus contains detailed information about the operations of TAP, a newly formed Company which has not previously filed reports with the Securities and Exchange Commission. The accompanying Prospectus also includes audited financial statements for both TAP and the insurance subsidiaries of Aetna Life and Casualty Company acquired by TAP in the Acquisition. Upon the event of a default under the Declaration (as defined herein), the holders of Preferred Securities will have a preference over the holders of the Common Securities with respect to payments in respect of distributions and payments upon redemption, liquidation and otherwise. Holders of the Preferred Securities are entitled to receive cumulative cash distributions at an annual rate of 8% of the liquidation amount of $25 per Preferred Security, accruing from, and including, the date of original issuance and payable quarterly in arrears on March 31, June 30, September 30 and December 31 of each year, commencing June 30, 1996 ("distributions"). The payment of distributions out of monies held by TAP Capital and payments on liquidation of TAP Capital or the redemption of Preferred Securities out of monies held by TAP Capital, as set forth below, are guaranteed by TAP (the "Guarantee") to the extent described under "Description of Guarantee." The Guarantee covers payments of distributions and other payments on the Preferred Securities only if and to the extent that TAP has made a payment of interest or principal or other payments on the Junior Subordinated Debt Securities held by TAP Capital as its sole asset. The Guarantee, when taken together with TAP's obligations under the Junior Subordinated Debt Securities, the indenture pursuant to which the Junior Subordinated Debt Securities are issued and its obligations under the Declaration (as defined herein), including its liabilities to pay costs, expenses, debts and liabilities of TAP Capital (other than with respect to the Trust Securities), provides a full and unconditional guarantee of amounts due on the Preferred Securities. The obligations of TAP under the Guarantee rank (i) subordinate and junior in right of payment to all other liabilities of TAP, (ii) pari passu with the most senior preferred or preference stock now or hereafter issued by TAP and with any guarantee now or hereafter entered into by TAP in respect of any preferred or preference stock of any affiliate of TAP and (iii) senior to TAP's common stock. The obligations of TAP under the Junior Subordinated Debt Securities are subordinate and junior in right of payment to all present and future Senior Indebtedness (as defined herein) of TAP, which, after giving effect to the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings (each as defined herein) and the application of the proceeds thereof, would have aggregated approximately $1.521 billion at December 31, 1995. The distribution rate and the distribution payment date and other payment dates for the Preferred Securities will correspond to the interest rate and interest payment dates and other payment dates on the Junior Subordinated Debt Securities, which will be the sole assets of TAP Capital. As a result, if principal or interest is not paid on the Junior Subordinated Debt Securities by TAP, no amounts will be paid on the Preferred Securities because TAP Capital will not have sufficient funds to make distributions on the Preferred Securities. In such event, the Guarantee will not apply to such distributions until TAP Capital has sufficient funds available therefor. TAP has the right to defer payments of interest on the Junior Subordinated Debt Securities by extending the interest payment period on the Junior Subordinated Debt Securities at any time for up to 20 consecutive quarters (each, an "Extension Period"), provided, that no Extension Period may extend beyond the maturity of the Junior Subordinated Debt Securities. If interest payments are so deferred, distributions on the Preferred Securities will also be deferred. During such Extension Period, distributions on the Preferred Securities will continue to accrue with interest thereon (to the extent permitted by applicable law) at an annual rate of 8% per annum compounded quarterly, and during any Extension Period, holders of Preferred Securities will be required to include deferred interest income in their gross income for United States federal income tax purposes in advance of receipt of the cash distributions with respect to such deferred interest payments. There could be up to 80 Extension Periods of varying lengths throughout the term of the Junior Subordinated Debt Securities. See "Description of the Junior Subordinated Debt Securities--Option to Extend Interest Payment Period," "Risk Factors Relating to the Preferred Securities--Option to Extend Interest Payment Period" and "United States Federal Income Taxation--Original Issue Discount." The Junior Subordinated Debt Securities are redeemable by TAP, in whole or in part, from time to time, on or after May 15, 2001, or at any time, in whole or in part, in certain circumstances upon the occurrence of a Tax Event (as defined herein). If TAP redeems Junior Subordinated Debt Securities, TAP Capital must redeem Trust Securities having an aggregate liquidation amount equal to the aggregate principal amount of the Junior Subordinated Debt Securities so redeemed at $25 per Trust Security plus accrued and unpaid distributions thereon S-2 (the "Redemption Price") to the date fixed for redemption. See "Description of the Preferred Securities--Mandatory Redemption of Trust Securities." The Preferred Securities will be redeemed upon maturity of the Junior Subordinated Debt Securities. The Junior Subordinated Debt Securities mature on May 15, 2036. In addition, upon the occurrence of a Special Event arising from a change in law or a change in legal interpretation regarding tax or investment company matters, unless the Junior Subordinated Debt Securities are redeemed in the limited circumstances described herein, TAP Capital shall be dissolved, with the result that the Junior Subordinated Debt Securities will be distributed to the holders of the Trust Securities, on a pro rata basis, in lieu of any cash distribution. See "Description of the Preferred Securities--Special Event Redemption or Distribution." In certain circumstances, TAP will have the right to redeem the Junior Subordinated Debt Securities prior to May 15, 2001, which would result in the redemption by TAP Capital of Trust Securities in the same amount on a pro rata basis. If the Junior Subordinated Debt Securities are distributed to the holders of the Preferred Securities, TAP will use its best efforts to have the Junior Subordinated Debt Securities listed on the New York Stock Exchange or on such other exchange as the Preferred Securities are then listed. See "Description of the Preferred Securities--Special Event Redemption or Distribution" and "Description of the Junior Subordinated Debt Securities." In the event of the involuntary or voluntary dissolution, winding up or termination of TAP Capital, the holders of the Preferred Securities will be entitled to receive for each Preferred Security a liquidation amount of $25 plus accrued and unpaid distributions thereon (including interest thereon) to the date of payment, unless, in connection with such dissolution, the Junior Subordinated Debt Securities are distributed to the holders of the Preferred Securities. See "Description of the Preferred Securities--Liquidation Distribution Upon Dissolution." Following the initial distribution of Preferred Securities, Smith Barney Inc. ("Smith Barney"), an indirect wholly owned subsidiary of Travelers Group and an affiliate of TAP and of TAP Capital, may offer and sell previously issued Preferred Securities in the course of its business as a broker-dealer (subject to obtaining any necessary approval of the New York Stock Exchange for any such offers and sales). Smith Barney may act as a principal or agent in such transactions. This Prospectus Supplement, together with an appropriate Prospectus, may be used by Smith Barney in connection with offers and sales of an indeterminate amount of the Preferred Securities in market-making transactions at negotiated prices related to prevailing market prices at the time of sale. Smith Barney may act as principal or agent in such transactions. ------------------- FOR NORTH CAROLINA INVESTORS: THE COMMISSIONER OF INSURANCE OF THE STATE OF NORTH CAROLINA HAS NOT APPROVED OR DISAPPROVED THIS OFFERING NOR HAS SUCH COMMISSIONER RULED UPON THE ACCURACY OR THE ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS. IN CONNECTION WITH THIS OFFERING, THE UNDERWRITER MAY OVER-ALLOT OR EFFECT TRANSACTIONS THAT STABILIZE OR MAINTAIN THE MARKET PRICE OF THE SECURITIES OFFERED HEREBY AT LEVELS ABOVE THOSE THAT MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE, IN THE OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING TRANSACTIONS, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. S-3 SUMMARY The following information is qualified in its entirety by the more detailed information and financial statements, including the notes thereto, appearing elsewhere in this Prospectus Supplement and the accompanying Prospectus. Travelers/Aetna Property Casualty Corp., a Delaware corporation ("TAP"), was formed in January 1996 to hold the property and casualty insurance subsidiaries of The Travelers Insurance Group Inc. ("TIGI"), an indirect wholly owned subsidiary of Travelers Group Inc. The information contained in this Prospectus Supplement and the accompanying Prospectus gives effect to the April 2, 1996 acquisition (the "Acquisition") by TAP of the domestic property and casualty insurance subsidiaries of Aetna Life and Casualty Company ("Aetna") and to the other Transactions described under "Recent History." TAP is a holding company and has no direct operations. TAP's principal asset is the capital stock of its insurance subsidiaries. As used in this Prospectus Supplement and the accompanying Prospectus, unless the context otherwise requires, "Travelers P&C" refers to The Travelers Indemnity Company ("Travelers Indemnity") and its subsidiaries; "Aetna P&C" refers to The Aetna Casualty and Surety Company ("Aetna Casualty") and The Standard Fire Insurance Company ("Standard Fire") and their subsidiaries; and the "Company" means, subsequent to the Acquisition, TAP together with its consolidated subsidiaries (comprised of Travelers P&C and Aetna P&C), and, prior to the Acquisition, the combined business of Travelers P&C and Aetna P&C operating as wholly owned subsidiaries of TIGI and Aetna, respectively. Consolidated financial statements presented in the accompanying Prospectus for TAP for periods prior to the Acquisition consist of financial statements for Travelers Indemnity and its subsidiaries. Statistical data provided in this Prospectus Supplement and the accompanying Prospectus for the "Company" for all periods prior to the Acquisition is based on combined data for Travelers P&C and Aetna P&C. See "Glossary of Selected Insurance Terms" in the accompanying Prospectus for the definitions of certain insurance-related terms. Unless otherwise indicated, all data in this Prospectus Supplement and the accompanying Prospectus assumes that the over-allotment option granted to the U.S. Underwriters in connection with the Equity Offering is not exercised, and all share data in this Prospectus Supplement and the accompanying Prospectus has been adjusted to reflect the Transactions. See "Recent History." Unless otherwise indicated, financial information and operating statistics applicable to the Company set forth in this Prospectus Supplement and the accompanying Prospectus are based on United States generally accepted accounting principles ("GAAP") and not statutory accounting practices. In conformity with industry practice, data derived from A.M. Best Company, Inc. ("A.M. Best") and the National Association of Insurance Commissioners ("NAIC") sources, generally used herein for industry comparisons, are based on statutory accounting practices. THE COMPANY The Company is the fourth largest property and casualty insurance company in the United States, based on 1994 direct written premiums published by A.M. Best, after giving effect to the acquisition of Aetna P&C and recent industry consolidation. The Company provides a wide range of commercial and personal property and casualty insurance products and services to businesses, government units, associations and individuals. Commercial coverages and personal coverages accounted for 76% and 24%, respectively, of the Company's combined net written premiums and premium in 1995 of $10.5 billion (including premium equivalents for Travelers P&C). After giving pro forma effect to the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings, at December 31, 1995 the Company had total assets and stockholders' equity of $49.5 billion and $6.1 billion, respectively. On April 2, 1996, TAP acquired the domestic property and casualty insurance subsidiaries of Aetna. The Company believes that the businesses of Aetna P&C and Travelers P&C provide complementary product offerings and distribution systems. The Company believes that it can effectively integrate these businesses, which will enable it to capitalize on the strengths of Travelers P&C and Aetna P&C and to create a stronger leadership position in the property and casualty insurance industry. The Company further believes that it has the following competitive advantages: (i) brand names that are among the most broadly recognized in the industry; (ii) a management team selected from the most qualified professionals, primarily at Travelers P&C and Aetna P&C, including certain senior managers who have worked together for several years at Travelers P&C and have achieved significant increases in profitability at Travelers P&C through cost reductions, effective underwriting and pricing practices S-4 and catastrophe exposure management policies; (iii) nationally leading market shares in several important commercial and personal product lines; and (iv) a strong financial position. The Company is the third largest writer of commercial lines insurance in the United States based on 1994 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. The Company's commercial lines ("Commercial Lines") offers a broad array of property and casualty insurance and insurance-related services. The Company distributes its commercial products through approximately 6,000 brokers and independent agencies located throughout the United States. The commercial coverages marketed by the Company include workers' compensation, general liability (including product liability), multiple peril, commercial automobile, property (including fire and allied lines), fidelity and surety and several other miscellaneous coverages. The Company underwrites specialty coverages including general liability for selected product liability risks, medical malpractice, umbrella and excess liability coverage, directors and officers liability insurance, errors and omissions insurance, fidelity and surety and fiduciary liability insurance and other professional liability insurance. In addition, the Company offers various risk management services, generally including claims settlement, loss control and engineering services, to businesses that choose to self-insure certain exposures, to states and insurance carriers that participate in state involuntary workers' compensation pools and to employers seeking to manage workers' compensation medical and disability costs. In 1995, Commercial Lines generated combined net written premiums of approximately $5.1 billion and, for Travelers P&C, premium equivalents of $2.8 billion. See "Business--Commercial Lines" in the accompanying Prospectus. The Company is the largest writer of personal lines insurance through independent agents and the sixth largest writer of personal lines insurance overall in the United States based on 1994 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. The Company's personal lines ("Personal Lines") primarily offers personal automobile and homeowners insurance. The Company distributes its Personal Lines products through approximately 5,500 independent agents located throughout the United States. The Company is pursuing a number of initiatives to broaden its distribution of Personal Lines products, including developing special products for affinity groups, employee groups and other sponsoring organizations and establishing co-marketing arrangements with other insurers. Travelers P&C has recently begun marketing personal automobile and homeowners insurance through the independent agents of Primerica Financial Services ("PFS"), an affiliate of the Company. This program was established in 14 states as of December 31, 1995, and is expected to reach approximately 75% of all states by the end of 1996. PFS agents are currently selling approximately 1,500 new automobile and homeowners policies each month. In 1995, Personal Lines generated combined net written premiums of approximately $2.5 billion. See "Business--Personal Lines" in the accompanying Prospectus. ------------------- The Company's executive offices are located at One Tower Square, Hartford, Connecticut 06183 and its telephone number is (860) 277-0111. TAP CAPITAL TAP Capital is a statutory business trust formed under Delaware law pursuant to (i) a declaration of trust, dated as of March 15, 1996, executed by TAP, as sponsor (the "Sponsor"), and the trustees of TAP Capital (as described below) and (ii) the filing of a certificate of trust with the Secretary of State of the State of Delaware on March 15, 1996. Such declaration will be amended and restated in its entirety (as so amended and restated, the "Declaration") substantially in the form filed as an exhibit to the Registration Statement of which this Prospectus Supplement and the accompanying Prospectus form a part. The Declaration has been qualified as an indenture under the Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"). Upon issuance of the Preferred Securities, the purchasers thereof will own all of the Preferred Securities. See "Description of the Preferred Securities--Book-Entry Only Issuance--The Depository Trust Company." TAP will directly or indirectly acquire Common Securities in an aggregate liquidation amount equal to 3% or more of the total capital of TAP Capital. TAP Capital exists for the exclusive purposes of (i) issuing the Trust Securities representing undivided beneficial interests in the assets of the Trust, (ii) investing the gross proceeds of the Trust Securities in the Junior Subordinated Debt Securities and (iii) engaging in only those other activities necessary or incidental thereto. TAP Capital's business and affairs are conducted by its trustees, each appointed by TAP as holder of the Common Securities. Pursuant to the Declaration, the number of trustees of TAP Capital will be four: The Chase S-5 Manhattan Bank, N.A., a national banking association that is unaffiliated with TAP, as the institutional trustee (the "Institutional Trustee"), The Chase Manhattan Bank (USA), a banking association with its principal place of business in the State of Delaware, as the Delaware trustee (the "Delaware Trustee"), and two individual trustees (the "Regular Trustees" and, together with the Institutional Trustee and the Delaware Trustee, the "TAP Trustees") will be persons who are employees or officers of, or who are affiliated with TAP. Initially, the Regular Trustees will be William P. Hannon and George A. Ryan, each of whom is an officer of TAP. The Institutional Trustee will act as the sole indenture trustee under the Declaration for purposes of compliance with the Trust Indenture Act until removed or replaced by the holder of the Common Securities. The Chase Manhattan Bank, N.A. will also act as indenture trustee (the "Guarantee Trustee") under the Guarantee. See "Description of Guarantees" and "Description of Junior Subordinated Debt Securities" in the accompanying Prospectus. The Institutional Trustee will hold title to the Junior Subordinated Debt Securities for the benefit of the holders of the Trust Securities and, in its capacity as the holder, the Institutional Trustee will have the power to exercise all rights, powers and privileges under the indenture pursuant to which the Junior Subordinated Debt Securities are issued. In addition, the Institutional Trustee will maintain exclusive control of a segregated non- interest bearing bank account (the "Property Account") to hold all payments made in respect of the Junior Subordinated Debt Securities for the benefit of the holders of the Trust Securities. The Institutional Trustee will make payments of distributions and payments on liquidation, redemption and otherwise to the holders of the Trust Securities out of funds from the Property Account. The Guarantee Trustee will hold the Guarantee for the benefit of the holders of the Preferred Securities. TAP, as the direct or indirect holder of all the Common Securities, will have the right, subject to certain restrictions contained in the Declaration, to appoint, remove or replace any TAP Trustee and to increase or decrease the number of TAP Trustees. TAP will pay all fees and expenses related to TAP Capital and the offering of the Trust Securities. See "Description of the Junior Subordinated Debt Securities--Miscellaneous." The rights of the holders of the Preferred Securities, including economic rights, rights to information and voting rights, are set forth in the Declaration, the Delaware Business Trust Act (the "Trust Act") and the Trust Indenture Act. See "Description of the Preferred Securities." PREFERRED SECURITIES OFFERING
General...................... The Preferred Securities represent undivided beneficial interests in TAP Capital's assets, which will consist of the Junior Subordinated Debt Securities. The Junior Subordinated Debt Securities, in which the proceeds of the Preferred Securities offered hereby will be invested, mature on May 15, 2036, unless the Junior Subordinated Debt Securities are redeemed by TAP prior to such maturity as described under "Description of the Preferred Securities--Mandatory Redemption of Trust Securities" and "Description of the Preferred Securities--Special Event Redemption or Distribution." Distributions................ The distributions payable on each Preferred Security will be fixed at a rate per annum of 8% of the stated liquidation amount of $25 per Preferred Security, will be cumulative, will accrue from May 15, 1996, the date of issuance of the Preferred Securities, and will be payable quarterly in arrears, on March 31, June 30, September 30 and December 31 of each year, commencing June 30, 1996. See "Description of the Preferred Securities--Distributions." Option to Extend Interest Payment Period............... TAP has the right, at any time, to defer payments of interest on the Junior Subordinated Debt Securities for a period not exceeding 20 consecutive quarters; provided, that no Extension Period may extend beyond the maturity date of the Junior Subordinated Debt Securities. As a consequence of TAP's extension of the interest payment period, quarterly distributions on the Preferred Securities would be deferred (though such distributions would continue to accrue with interest thereon compounded quarterly, since interest would continue to accrue on the Junior Subordinated Debt Securities) during any such extended interest payment period. In the event that TAP exercises its
S-6 right to extend an interest payment period, then (a) TAP shall not declare or pay any dividend on, make any distributions with respect to, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock or make any guarantee payment with respect thereto, and (b) TAP shall not make any payment of interest on or principal of (or premium, if any, on), or repay, repurchase or redeem, any debt securities issued by TAP which rank pari passu with or junior to the Junior Subordinated Debt Securities. The foregoing, however, will not apply (i) to any stock dividends paid by TAP where the dividend stock is the same stock as that on which the dividend is being paid or (ii) in certain other limited events. Prior to the termination of any Extension Period, TAP may further extend such Extension Period, provided that such Extension Period together with all such previous and further extensions thereof may not exceed 20 consecutive quarters. Upon the termination of any Extension Period and the payment of all amounts then due, TAP may commence a new Extension Period, subject to the foregoing requirements. See "Description of the Junior Subordinated Debt Securities--Option to Extend Interest Payment Period." Should an Extension Period occur, Preferred Security holders will continue to recognize interest income for United States federal income tax purposes. As a result, such holders will be required to include such interest in gross income for United States federal income tax purposes in advance of the receipt of cash, and such holders will not receive the cash from TAP Capital related to such income if such holders dispose of Preferred Securities prior to the record date for payment of distributions. See "United States Federal Income Taxation-- Original Issue Discount." Mandatory Redemption......... Upon the repayment of the Junior Subordinated Debt Securities, whether at maturity or upon earlier redemption as provided in the Indenture, the proceeds from such repayment will be applied by the Institutional Trustee to redeem a like amount of Trust Securities, upon the terms and conditions described herein. See "Description of the Preferred Securities--Mandatory Redemption of Trust Securities." Optional Redemption.......... TAP has the right to redeem the Junior Subordinated Debt Securities (a) on or after May 15, 2001, in whole at any time or in part from time to time, subject to the conditions described in "Description of the Junior Subordinated Debt Securities--Optional Redemption" or (b) at any time, in whole or in part, in certain circumstances upon the occurrence of a Tax Event (as defined herein) as described under "Description of the Preferred Securities--Special Event Redemption or Distribution," in each case at a redemption price equal to 100% of the principal amount of Junior Subordinated Debt Securities being redeemed, together with any accrued but unpaid interest, to but not including the redemption date. See "Description of the Junior Subordinated Debt Securities--Optional Redemption." If TAP redeems any Junior Subordinated Debt Securities, the proceeds from such redemption will be applied by the Institutional Trustee to redeem a like amount of Trust Securities. Special Event Distribution... Subject to certain conditions and except in limited circumstances, if at any time a Special Event (as defined herein) shall occur and be continuing, TAP Capital shall be dissolved with the result that Junior Subordinated Debt Securities with an aggregate principal amount equal to the aggregate stated liquidation amount of, with an interest rate identical to the distribution rate of, and with accrued and unpaid interest thereon equal to accrued and unpaid distributions on, the Trust Securities outstanding at such time, would be distributed to the holders of the Trust Securities in liquidation of such holders' interests in TAP Capital on a pro rata basis within 90 days following the
S-7 occurrence of such Special Event. See "Description of the Preferred Securities--Special Event Redemption or Distribution." Voting Rights................ Generally, the holders of the Preferred Securities will not have any voting rights. See "Description of the Preferred Securities--Voting Rights." Subject to certain conditions, including that the Institutional Trustee obtain the opinion of counsel described under "Description of the Preferred Securities--Voting Rights" prior to taking certain actions, the holders of a majority in aggregate liquidation amount of the Preferred Securities have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Institutional Trustee, or direct the exercise of any trust or power conferred upon the Institutional Trustee under the Declaration including the right to direct the Institutional Trustee, as holder of the Junior Subordinated Debt Securities, to (i) exercise the remedies available under the Indenture with respect to the Junior Subordinated Debt Securities, (ii) waive any past Indenture Event of Default that is waivable under the Indenture (as defined herein), (iii) exercise any right to rescind or annul a declaration that the principal of all the Junior Subordinated Debt Securities shall be due and payable, or (iv) consent to any amendment, modification or termination of the Indenture or the Junior Subordinated Debt Securities where such consent shall be required; provided, however, that, where a consent or action under the Indenture would require the consent or act of a Super Majority (as defined herein) of holders of the Junior Subordinated Debt Securities affected thereby, only the holders of at least such Super Majority in aggregate liquidation amount of the Preferred Securities may direct the Institutional Trustee to give such consent or take such action. See "Description of the Preferred Securities--Voting Rights." Use of Proceeds.............. The proceeds from the sale of the Preferred Securities offered hereby will be used by TAP Capital to purchase the Junior Subordinated Debt Securities issued by TAP. TAP expects to use such proceeds to redeem certain outstanding preferred stock. Any remaining proceeds will be used for general corporate purposes. See "Use of Proceeds." Listing...................... The Preferred Securities have been approved for listing on the New York Stock Exchange, subject to official notice of issuance. Trading of the Preferred Securities on the New York Stock Exchange is expected to commence within a 30-day period after the initial delivery of the Preferred Securities.
RISK FACTORS Prospective investors should consider carefully, in addition to the other information contained in this Prospectus Supplement and the accompanying Prospectus, the matters set forth under the captions "Risk Factors Relating to the Preferred Securities" in this Prospectus Supplement and "Risk Factors Relating to the Company" in the accompanying Prospectus before purchasing the Preferred Securities offered hereby. S-8 RISK FACTORS RELATING TO THE PREFERRED SECURITIES Prospective investors should consider carefully, in addition to the other information contained in this Prospectus Supplement and the accompanying Prospectus, the following risk factors relating to the Preferred Securities and the risk factors relating to the Company set forth in the accompanying Prospectus before purchasing the Preferred Securities offered hereby. RANKING OF SUBORDINATE OBLIGATIONS UNDER THE JUNIOR SUBORDINATED DEBT SECURITIES AND THE GUARANTEE The obligations of TAP under the Junior Subordinated Debt Securities are subordinate and junior in right of payment to all present and future Senior Indebtedness of TAP. No payment of principal (including redemption payments, if any), premium, if any, or interest on the Junior Subordinated Debt Securities may be made if (i) any Senior Indebtedness of TAP is not paid when due and any applicable grace period with respect to such default has ended with such default not having been cured or waived or ceasing to exist, or (ii) the maturity of any Senior Indebtedness of TAP has been accelerated because of a default. As of May 10, 1996, Senior Indebtedness of TAP aggregated approximately $1.4 billion. TAP's obligations under the Guarantee rank (i) subordinate and junior in right of payment to all other liabilities of TAP, (ii) pari passu with the most senior preferred or preference stock now or hereafter issued by TAP and with any guarantee now or hereafter entered into by TAP in respect of any preferred or preference stock of any affiliate of TAP and (iii) senior to TAP's Common Stock. There are no terms in the Preferred Securities, the Junior Subordinated Debt Securities or the Guarantee that limit TAP's ability to incur additional indebtedness, including indebtedness that ranks senior to the Junior Subordinated Debt Securities and the Guarantee. See "Description of Guarantee--Status of the Guarantee," "Description of the Junior Subordinated Debt Securities" in the accompanying Prospectus, and "Description of the Junior Subordinated Debt Securities--Subordination." STRUCTURAL SUBORDINATION The Junior Subordinated Debt Securities will be obligations of TAP exclusively. Since substantially all of TAP's operations are conducted through subsidiaries, substantially all of TAP's cash flow and, consequently, its ability to service debt, including the Junior Subordinated Debt Securities, is dependent upon the earnings of its subsidiaries and the transfer of funds by those subsidiaries to TAP in the form of dividends or other transfers, supplemented with borrowings. In addition, because TAP's principal asset is the capital stock of its insurance subsidiaries, the ability of these subsidiaries to pay dividends to TAP in the future will depend on their statutory surplus, on their statutory earnings and on regulatory restrictions. See "Risk Factors Relating to the Company--Holding Company Structure; Dividend Restrictions" in the accompanying Prospectus. In addition, creditors of TAP's subsidiaries would be entitled to a claim on the assets of such subsidiaries prior to any claims by TAP. Consequently, in the event of a liquidation or reorganization of any subsidiary, creditors of such subsidiary are likely to be paid in full before any distribution is made to TAP, except to the extent that TAP itself is recognized as a creditor of such subsidiary, in which case the claims of TAP would still be subordinate to any security interest in the assets of such subsidiary and any indebtedness of such subsidiary senior to that held by TAP. At December 31, 1995, TAP's subsidiaries had, on a pro forma combined basis, $35 million of indebtedness and $40.971 billion of total liabilities, excluding indebtedness. See "Unaudited Pro Forma Financial Information" in the accompanying Prospectus. RIGHTS UNDER THE GUARANTEE The Guarantee has been qualified as an indenture under the Trust Indenture Act. The Chase Manhattan Bank, N.A. will act as indenture trustee under the Guarantee for the purposes of compliance with the provisions of the Trust Indenture Act. The Guarantee Trustee will hold the Guarantee for the benefit of the holders of the Preferred Securities. The Guarantee guarantees to the holders of the Preferred Securities the payment of (i) any accrued and unpaid distributions that are required to be paid on the Preferred Securities, to the extent TAP Capital has funds available therefor, (ii) the Redemption Price with respect to Preferred Securities called for redemption by TAP Capital, to the extent TAP Capital has funds available therefor, and (iii) upon a voluntary or involuntary dissolution, winding-up or termination of TAP Capital (other than in connection with the distribution of Junior S-9 Subordinated Debt Securities to the holders of Preferred Securities or a redemption of all the Preferred Securities), the lesser of (a) the aggregate of the liquidation amount and all accrued and unpaid distributions on the Preferred Securities to the date of the payment and (b) the amount of assets of TAP Capital remaining available for distribution to holders of the Preferred Securities in liquidation of TAP Capital. The holders of a majority in liquidation amount of the Preferred Securities have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Guarantee Trustee or to direct the exercise of any trust or power conferred upon the Guarantee Trustee under the Guarantee. If the Guarantee Trustee fails to enforce the Guarantee, any holder of Preferred Securities may directly institute a legal proceeding against TAP to enforce the Guarantee Trustee's rights under the Guarantee without first instituting a legal proceeding against TAP Capital, the Guarantee Trustee or any other person or entity. A holder of Preferred Securities may also directly institute a legal proceeding against TAP to enforce such holder's right to receive payment under the Guarantee without first (i) directing the Guarantee Trustee to enforce the terms of the Guarantee or (ii) instituting a legal proceeding against TAP Capital or any other person or entity. If TAP were to default on its obligation to pay amounts payable on the Junior Subordinated Debt Securities, TAP Capital would lack available funds for the payment of distributions or amounts payable on redemption of the Preferred Securities or otherwise, and, in such event, holders of the Preferred Securities would not be able to rely upon the Guarantee for payment of such amounts. Instead, a holder of the Preferred Securities would rely on the enforcement (1) by the Institutional Trustee of its rights as registered holder of the Junior Subordinated Debt Securities against TAP pursuant to the terms of the Junior Subordinated Debt Securities or (2) by such holder of Preferred Securities of its right against TAP to enforce payments on the Junior Subordinated Debt Securities. See "Description of Guarantees" and "Description of Junior Subordinated Debt Securities" in the accompanying Prospectus. The Declaration provides that each holder of Preferred Securities, by acceptance thereof, agrees to the provisions of the Guarantee, including the subordination provisions thereof, and the Indenture (as defined herein). ENFORCEMENT OF CERTAIN RIGHTS BY HOLDERS OF PREFERRED SECURITIES If a Declaration Event of Default (as defined herein) occurs and is continuing, then the holders of Preferred Securities would rely on the enforcement by the Institutional Trustee of its rights as a holder of the Junior Subordinated Debt Securities against TAP. In addition, the holders of a majority in liquidation amount of the Preferred Securities will have the right to direct the time, method, and place of conducting any proceeding for any remedy available to the Institutional Trustee or to direct the exercise of any trust or power conferred upon the Institutional Trustee under the Declaration, including the right to direct the Institutional Trustee to exercise the remedies available to it as a holder of the Junior Subordinated Debt Securities. If the Institutional Trustee fails to enforce its rights under the Junior Subordinated Debt Securities, any holder of Preferred Securities may directly institute a legal proceeding against TAP to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities without first instituting any legal proceeding against the Institutional Trustee or any other person or entity. If a Declaration Event of Default has occurred and is continuing and such event is attributable to the failure of TAP to pay interest or principal on the Junior Subordinated Debt Securities on the date such interest or principal is otherwise payable (or in the case of redemption, on the redemption date), then a holder of Preferred Securities may also directly institute a proceeding for enforcement of payment to such holder of the principal of or interest on the Junior Subordinated Debt Securities having a principal amount equal to the aggregate liquidation amount of the Preferred Securities of such holder (a "Direct Action") on or after the respective due date specified in the Junior Subordinated Debt Securities without first (i) directing the Institutional Trustee to enforce the terms of the Junior Subordinated Debt Securities or (ii) instituting a legal proceeding against TAP to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities. In connection with such Direct Action, TAP will be subrogated to the rights of such holder of Preferred Securities under the Declaration to the extent of any payment made by TAP to such holder of Preferred Securities in such Direct Action. Consequently, TAP will be entitled to payment of amounts that a holder of Preferred Securities receives in respect of an unpaid distribution that resulted in the bringing of a Direct Action to the extent that such holder receives or has already received full payment with respect to such unpaid distribution from TAP Capital. The holders of Preferred Securities will not be able to exercise directly any other remedy available to the holders of the Junior Subordinated Debt Securities. OPTION TO EXTEND INTEREST PAYMENT PERIOD TAP has the right under the Indenture to defer payments of interest on the Junior Subordinated Debt Securities by extending the interest payment period from time to time on the Junior Subordinated Debt Securities S-10 for an Extension Period not exceeding 20 consecutive quarterly interest periods during which no interest shall be due and payable, provided, that no Extension Period may extend beyond the maturity of the Junior Subordinated Debt Securities. As a consequence of such an extension, quarterly distributions on the Preferred Securities would be deferred (but despite such deferral would continue to accrue with interest thereon compounded quarterly) by TAP Capital during any such extended interest payment period. In the event that TAP exercises this right to defer interest payments, then (a) TAP shall not declare or pay any dividend on, make any distributions with respect to, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock or make any guarantee payment with respect thereto (other than (i) repurchases, redemptions or other acquisitions of shares of capital stock of TAP in connection with any employment contract, benefit plan or other similar arrangement with or for the benefit of employees, officers, directors or consultants, (ii) as a result of an exchange or conversion of any class or series of TAP's capital stock for any other class or series of TAP's capital stock, or (iii) the purchase of fractional interests in shares of TAP's capital stock pursuant to the conversion or exchange provisions of such capital stock or the security being converted or exchanged), and (b) TAP shall not make any payment of interest on or principal of (or premium, if any, on), or repay, repurchase or redeem, any debt securities issued by TAP which rank pari passu with or junior to such Junior Subordinated Debt Securities. The foregoing, however, will not apply to any stock dividends paid by TAP where the dividend stock is the same stock as that on which the dividend is being paid. Prior to the termination of any Extension Period, TAP may further extend such Extension Period; provided, that such Extension Period, together with all such previous and further extensions thereof, may not exceed 20 consecutive quarterly interest periods; provided, further, that no Extension Period may extend beyond the maturity of the Junior Subordinated Debt Securities. Upon the termination of any Extension Period and the payment of all amounts then due, TAP may commence a new Extension Period, subject to the above requirements. Consequently, there could be up to 80 Extension Periods of varying lengths throughout the term of the Junior Subordinated Debt Securities. See "Description of the Preferred Securities--Distributions" and "Description of the Junior Subordinated Debt Securities--Option to Extend Interest Payment Period." The junior subordinated debt securities issued from time to time in connection with the issuance of trust preferred securities by a TAP Trust will contain the same restrictive covenants described in the preceding paragraph. The effect of such restrictive covenants will be to limit the rights of holders of Preferred Securities to receive payments with respect thereto if there has been a deferral of interest under any such junior subordinated debt securities. Should TAP exercise its right to defer payments of interest on the Junior Subordinated Debt Securities by extending the interest payment period, each holder of Preferred Securities will continue to accrue income (as original issue discount ("OID")) in respect of the deferred interest allocable to its Preferred Securities for United States federal income tax purposes, which will be allocated but not distributed, to holders of record of Preferred Securities. As a result, each such holder of Preferred Securities will recognize income for United States federal income tax purposes in advance of the receipt of cash and will not receive the cash from TAP Capital related to such income if such holder disposes of its Preferred Securities prior to the record date for the date on which distributions of such amounts are made. TAP has no current intention of exercising its right to defer payments of interest by extending the interest payment period on the Junior Subordinated Debt Securities. However, should TAP determine to exercise such right in the future, the market price of the Preferred Securities is likely to be affected. A holder that disposes of its Preferred Securities during an Extension Period, therefore, might not receive the same return on its investment as a holder that continues to hold its Preferred Securities. In addition, as a result of the existence of TAP's right to defer interest payments, the market price of the Preferred Securities (which represent an undivided beneficial interest in the Junior Subordinated Debt Securities) may be more volatile than other similar securities where the issuer does not have such rights to defer interest payments. See "United States Federal Income Taxation--Original Issue Discount." SPECIAL EVENT REDEMPTION OR DISTRIBUTION Upon the occurrence of a Special Event (as defined herein), TAP Capital will be dissolved, except in the limited circumstance described below, with the result that the Junior Subordinated Debt Securities will be distributed to the holders of the Trust Securities in connection with the liquidation of TAP Capital. In certain circumstances in connection with a Tax Event, TAP has the right to redeem the Junior Subordinated Debt Securities, in whole or in part, in lieu of a distribution of the Junior Subordinated Debt Securities to holders of Trust Securities by TAP Capital, in which event TAP Capital will redeem the Trust Securities on a pro rata basis S-11 to the same extent as the Junior Subordinated Debt Securities are redeemed by TAP. See "Description of the Preferred Securities--Special Event Redemption or Distribution." Under current United States federal income tax law, a distribution of Junior Subordinated Debt Securities upon the dissolution of TAP Capital would not be a taxable event to holders of the Preferred Securities. Upon the occurrence of a Tax Event, however, a dissolution of TAP Capital in which holders of the Preferred Securities receive cash would be a taxable event to such holders. See "United States Federal Income Taxation--Receipt of Junior Subordinated Debt Securities or Cash Upon Liquidation of TAP Capital." There can be no assurance as to the market prices for the Preferred Securities or the Junior Subordinated Debt Securities that may be distributed in exchange for Preferred Securities if a dissolution or liquidation of TAP Capital were to occur. Accordingly, the Preferred Securities that an investor may purchase, whether pursuant to the offer made hereby or in the secondary market, or the Junior Subordinated Debt Securities that a holder of Preferred Securities may receive on dissolution and liquidation of TAP Capital, may trade at a discount to the price that the investor paid to purchase the Preferred Securities offered hereby. Because holders of Preferred Securities may receive Junior Subordinated Debt Securities upon the occurrence of a Special Event, prospective purchasers of Preferred Securities are also making an investment decision with regard to the Junior Subordinated Debt Securities and should carefully review all the information regarding the Junior Subordinated Debt Securities contained herein and in the accompanying Prospectus. See "Description of the Preferred Securities--Special Event Redemption or Distribution" and "Description of the Junior Subordinated Debt Securities--General." PROPOSED TAX LEGISLATION On March 19, 1996, President Clinton proposed certain tax law changes (the "Proposed Legislation") that would, among other things, generally deny corporate issuers a deduction for interest in respect of certain debt obligations, such as the Junior Subordinated Debt Securities, issued on or after December 7, 1995. On March 29, 1996, Senate Finance Committee Chairman William V. Roth, Jr. and House Ways and Means Committee Chairman Bill Archer issued a joint statement (the "Joint Statement") indicating their intent that the Proposed Legislation, if adopted by either of the tax-writing committees of Congress, would have an effective date that is no earlier than the date of "appropriate Congressional action." Based upon the Joint Statement, it is expected that if the Proposed Legislation were to be enacted, such legislation would not apply to the Junior Subordinated Debt Securities. There can be no assurances, however, that the effective date guidance contained in the Joint Statement will be incorporated into the Proposed Legislation, if enacted, or that other legislation enacted after the date hereof will not otherwise adversely affect the ability of the Company to deduct the interest payable on the Junior Subordinated Debt Securities. Accordingly, there can be no assurance that a Tax Event will not occur. The occurrence of a Tax Event may, among other things, result in a dissolution of TAP Capital in which holders of the Preferred Securities may receive cash, which would be a taxable event to such holders. See "--Special Event Redemption or Distribution" and "Description of the Preferred Securities--Special Event Redemption or Distribution." LIMITED VOTING RIGHTS Holders of Preferred Securities will have limited voting rights and will not be entitled to vote to appoint, remove or replace, or to increase or decrease the number of, TAP Trustees, which voting rights are vested exclusively in the holder of the Common Securities. See "Description of the Preferred Securities--Voting Rights." TRADING PRICE The Preferred Securities may trade at a price that does not fully reflect the value of accrued but unpaid interest with respect to the underlying Junior Subordinated Debt Securities. A holder of Preferred Securities who disposes of its Preferred Securities between record dates for payments of distributions thereon will be required to include accrued but unpaid interest on the Junior Subordinated Debt Securities to the date of disposition in income as ordinary income (i.e., OID), and to add such amount to its adjusted tax basis in its pro rata share of the underlying Junior Subordinated Debt Securities deemed disposed of. To the extent the selling price is less than such holder's adjusted tax basis (which will include, in the form of OID, all accrued but unpaid interest), such holder will recognize a capital loss. Subject to certain limited exceptions, capital losses cannot be applied to offset ordinary income for United States federal income tax purposes. See "United States Federal Income Taxation--Original Issue Discount" and "--Sales of Preferred Securities." S-12 RECENT HISTORY On or before April 2, 1996, the following transactions took place (all of the transactions described herein under "--The Capitalization of TAP and the Acquisition" and "--The Financing of the Acquisition" are collectively referred to as the "Transactions"): The Capitalization of TAP and the Acquisition . TIGI contributed all the outstanding shares of common stock of Travelers Indemnity to TAP. . TAP filed a restated certificate of incorporation and effected a recapitalization as a result of which TIGI's shares of TAP common stock were converted into shares of Class B Common Stock and the authorized capital of TAP was changed as is described under "Description of Capital Stock" in the accompanying Prospectus. . TAP acquired all of the outstanding shares of common stock of Aetna Casualty and Standard Fire for a purchase price of approximately $4.16 billion in cash. As a result, TAP owns directly 100% of the common stock of Aetna Casualty and Standard Fire. Obligations under insurance policies in effect at the time of the consummation of the Transactions were not affected as a result of the Transactions. . TIGI contributed approximately $1.1 billion to TAP. The Financing of the Acquisition The $4.16 billion purchase price for the Acquisition, including transaction costs and capital contributions totalling $710 million to Aetna P&C, were funded as follows: . $1.1 billion from the purchase of Class B Common Stock by TIGI. . $540 million from the purchase of shares of Series Z Preferred Stock by Travelers Group. . $525 million from the purchase of 33,000,515 shares of Class A Common Stock by the Private Investors (as described under "Certain Transactions--Private Investors" in the accompanying Prospectus). . $2.65 billion from borrowings by TAP under the Credit Agreement. . $18 million from the settlement of receivables from Aetna. The Permanent Financing . TAP issued commercial paper of which approximately $700 million remains outstanding on the date hereof (the "Commercial Paper Offering"). . TAP issued 35,435,740 shares of its Class A Common Stock (the "Equity Offering"), and an additional 3,543,574 shares of its Class A Common Stock pursuant to the exercise of an over-allotment option, in an initial public offering for aggregate net proceeds of approximately $926 million. . TAP issued $200 million of 7 3/4% Notes due April 15, 2026 and $500 million of 6 3/4% Notes due April 15, 2001 in a public offering (the "Recent Debt Offering"). TAP may in the future offer, subject to market conditions, up to an additional $800 million principal amount of senior debt securities in one or more series pursuant to the registration statement registering the securities offered in the Recent Debt Offering (together with the Recent Debt Offering, the "Debt Offerings"). . TAP issued approximately $825 million of 8.08% Junior Subordinated Deferrable Interest Debentures to a subsidiary trust which in turn issued $800 million of preferred securities in a public offering (the "Recent Trust Preferred Securities Offering" and, together with the Preferred Securities offered hereby, the "Trust Preferred Securities Offerings"). All of the net proceeds from the Commercial Paper Offering, the Equity Offering, the Recent Debt Offering and the Recent Trust Preferred Securities Offering were used to repay in full the borrowings under the Credit Agreement and to redeem $440 million of Series Z Preferred Stock. TAP elected to reduce the amounts available to be borrowed under the Credit Agreement to $1.2 billion. S-13 Travelers Indemnity expects to pay in the second quarter of 1996, subject to receipt of any necessary regulatory approval, approximately $300 million to TAP, which amount will then be contributed to Aetna P&C. See "Certain Transactions," "Description of Capital Stock" and "Certain Indebtedness" in the accompanying Prospectus for a more detailed description of certain of the financing transactions described above. RECENT OPERATING RESULTS RECENT OPERATING RESULTS OF TRAVELERS P&C First Quarter Results For the quarter ended March 31, 1996, Travelers P&C net income increased to $98 million compared to $75 million in the first quarter of 1995. Excluding net realized investment gains, earnings were $81 million, up from $79 million. Higher net investment income and favorable loss experience in personal auto lines offset higher catastrophe losses resulting from winter storm-related claims during the quarter and a $13 million after tax charge relating to the settlement of a stop loss insurance arrangement with TIGI. Catastrophe losses, after taxes and reinsurance, totaled $24 million for the three months ended March 31, 1996 compared to $2 million for the three months ended March 31, 1995. Revenues for the quarter ended March 31, 1996 totalled $1.152 billion compared to $1.162 billion for the first quarter of 1995. Net earned premiums of $826 million were down $40 million from a year ago and fee income of $99 million decreased $25 million, largely offset by higher net investment income and realized investment gains. Net written premiums and equivalents in the National Accounts market were $948 million in the first quarter of 1996 compared with $1.039 billion in 1995, reflecting continued decline in the workers' compensation pool service business as involuntary pools continued to depopulate. Net written premiums and equivalents in the Commercial Accounts market were down slightly from a year ago. Travelers P&C has continued to be selective in renewal activity in this highly competitive market. However, specific industry programs have demonstrated continued growth. Select Accounts and Specialty Accounts both experienced modest premium growth in the quarter. Personal Lines net written premiums for the quarter ended March 31, 1996 totalled $342 million. Excluding the effect of a 1995 change in reinsurance coverage, net written premiums improved slightly over 1995, reflecting growth in target markets. RECENT OPERATING RESULTS OF AETNA P&C First Quarter Results For the quarter ended March 31, 1996, Aetna P&C net income increased to $218 million compared to $66 million in the first quarter of 1995. Excluding net realized investment gains, earnings were $18 million in the first quarter of 1996 compared to $61 million in the first quarter of 1995. This decrease in earnings was due to catastrophe losses resulting from winter storms in the first quarter of 1996 totalling $44 million (after tax and after reinsurance) compared to catastrophe losses in the first quarter of 1995 of $13 million. The results for the 1996 first quarter also include reserve strengthening of $26 million after-tax relating to general liability claims other than asbestos and environmental. The 1995 first quarter includes reserve strengthening of $34 million after-tax relating to asbestos and environmental claims. USE OF PROCEEDS All of the net proceeds from the sale of the Preferred Securities offered hereby will be invested by TAP Capital in Junior Subordinated Debt Securities of TAP. TAP will use the proceeds from the sale of the Junior Subordinated Debt Securities to TAP Capital, together with other funds, to redeem the remaining $100 million of Series Z Preferred Stock held by Travelers Group. None of the proceeds will be used for acquisitions. See "Recent History" and "Capitalization" herein and "Description of Capital Stock" and "Certain Indebtedness" in the accompanying Prospectus. S-14 RATIO OF EARNINGS TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS For purposes of computing the historical ratio of earnings to combined fixed charges and preferred stock dividends, "earnings" consist of income from continuing operations before federal income taxes and fixed charges. "Fixed charges" consist of an imputed interest component of rental expense. There were no interest expenses or preferred stock dividends on a historical basis. The pro forma ratio of earnings to combined fixed charges and preferred stock dividends for the year ended December 31, 1995 gives effect to the Transactions, the Equity Offering, the Debt Offerings and Trust Preferred Securities Offerings as if they had occurred on January 1, 1995. For purposes of computing the pro forma ratio of earnings to combined fixed charges and preferred stock dividends, pro forma "earnings" consist of income from continuing operations before federal income taxes and combined fixed charges and preferred stock dividends. Pro forma "fixed charges and preferred stock dividends" consist of interest expense, an imputed interest component of rental expense and preferred stock dividends of the TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts.
YEAR ENDED DECEMBER 31, ----------------------------------------------------------- PRO FORMA HISTORICAL --------- ------------------------------------------ 1995 1995 1994 1993 1992 1991 --------- ----- ---- ---- ---- ----- Ratio of earnings to combined fixed charges and preferred stock dividends N/A(a)(b) 17.53 7.56 5.29 N/A(c) 7.68
- ------------ (a) For the year ended December 31, 1995, TAP's pro forma earnings were not sufficient to cover pro forma combined fixed charges and preferred stock dividends by $57 million. (b) Included in the historical results of Aetna P&C for the year ended December 31, 1995 are charges of $750 million representing an addition to environmental-related claims reserves in the second quarter and $335 million representing an addition to asbestos reserves in the fourth quarter. If these charges were not included in 1995 results, the pro forma ratio of earnings to combined fixed charges and preferred stock dividends would have been 5.05. (c) For the year ended December 31, 1992, TAP's earnings were not sufficient to cover combined fixed charges and preferred stock dividends by $354 million. ACCOUNTING TREATMENT The financial statements of TAP Capital will be reflected in TAP's consolidated financial statements with the Preferred Securities shown as "TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts." S-15 CAPITALIZATION Set forth below is (i) the historical capitalization of TAP at December 31, 1995; (ii) the pro forma capitalization of TAP at December 31, 1995, after giving effect to the Transactions; (iii) the pro forma capitalization of TAP at December 31, 1995, as adjusted to give effect to the application of the net proceeds from sale of the Class A Common Stock in the Equity Offering to repay a portion of the borrowings under the Credit Agreement; (iv) the pro forma capitalization of TAP at December 31, 1995, as further adjusted to give effect to the application of the net proceeds from the Trust Preferred Securities Offerings (including the Preferred Securities offered hereby) to repay the remaining borrowings under the Credit Agreement and to redeem the Series Z Preferred Stock and (v) the pro forma capitalization of TAP at December 31, 1995, as further adjusted to give effect to the application of the proceeds from the Debt Offerings to repay remaining borrowings under the Credit Agreement. The information presented below should be read in conjunction with the historical consolidated financial statements of TAP and the historical combined financial statements of Aetna P&C and the related notes thereto and the pro forma financial data of the Company, in each case included elsewhere in the accompanying Prospectus.
AT DECEMBER 31, 1995 ------------------------------------------------------------------------------------------- PRO FORMA PRO FORMA FOR THE PRO FORMA ADJUSTMENTS TRANSACTIONS, AS PRO FORMA ADJUSTMENTS PRO FORMA FOR THE ADJUSTED FOR ADJUSTMENTS FOR TAP FOR THE FOR THE EQUITY THE EQUITY THE DEBT HISTORICAL TRANSACTIONS(1) TRANSACTIONS OFFERING(2) OFFERING OFFERINGS(3) ---------- --------------- ------------ ----------- ---------------- ----------------- (Dollars in millions) Long-term debt: Credit Agreement(5)........ $-- $ 2,650 $2,650 $(841) $1,809 $(1,477) Debt Securities(6)(7).... -- -- -- -- -- 1,487 Mortgage indebtedness of Aetna P&C....... -- 35 35 -- 35 -- ----- ------ ----- --- ----- ------ Total long-term debt(6).......... -- 2,685 2,685 (841) 1,844 10 ----- ------ ----- --- ----- ------ Series Z Preferred Stock, $.10 par value; $250,000 liquidation preference(8)(9)... -- 540 540 -- 540 -- TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts(10).......... -- -- -- -- -- -- Stockholders' equity:(9) Preferred Stock, $.10 par value.......... -- -- -- -- -- -- Common Stock, $100 par value.......... 10 (10) -- -- -- -- Class A Common Stock, $.01 par value...... -- 1 1 -- 1 -- Class B Common Stock, $.01 par value...... -- 3 3 -- 3 -- Additional paid-in capital............. 2,889 1,670 4,559 841 5,400 -- Retained earnings.... 422 -- 422 -- 422 -- Unrealized investment gains, net of taxes. 280 -- 280 -- 280 -- ----- ------ ----- --- ----- ------ Total stockholders' equity.......... 3,601 1,664 5,265 841 6,106 -- ----- ------ ----- --- ----- ------ Total capitalization $3,601 $ 4,889 $8,490 $-- $8,490 $ 10 ----- ------ ----- --- ----- ------ ----- ------ ----- --- ----- ------ PRO FORMA FOR THE TRANSACTIONS, AS ADJUSTED FOR THE EQUITY OFFERING, PRO FORMA FOR PRO FORMA THE DEBT THE TRANSACTIONS, ADJUSTMENTS OFFERINGS AS ADJUSTED FOR FOR THE TRUST AND THE TRUST THE EQUITY PREFERRED PREFERRED OFFERING AND THE SECURITIES SECURITIES DEBT OFFERINGS OFFERINGS(4) OFFERINGS ----------------- ------------- ------------------- Long-term debt: Credit Agreement(5)........ $ 332 $(332) $-- Debt Securities(6)(7)...... 1,487 -- 1,487 Mortgage indebtedness of Aetna P&C....... 35 -- 35 ----- --- ----- Total long-term debt(6).......... 1,854 (332) 1,522 ----- --- ----- Series Z Preferred Stock, $.10 par value; $250,000 liquidation preference(8)(9)... 540 (540) -- TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts(10).......... -- 900 900 Stockholders' equity:(9) Preferred Stock, $.10 par value.......... -- -- -- Common Stock, $100 par value.......... -- -- -- Class A Common Stock, $.01 par value..... 1 -- 1 Class B Common Stock, $.01 par value..... 3 -- 3 Additional paid-in capital............ 5,400 (28) 5,372 Retained earnings.... 422 -- 422 Unrealized investment gains, net of taxes 280 -- 280 ----- --- ----- Total stockholders' equity.......... 6,106 (28) 6,078 ----- --- ----- Total capitalization $ 8,500 $-- $ 8,500 ----- --- ----- ----- --- -----
- ------------ (1) Represents the following: Issuance of long-term debt under the Credit Agreement $ 2,650 Historical mortgage indebtedness of Aetna P&C 35 Issuance of Series Z Preferred Stock to Travelers Group 540 Capital contributions by TIGI 1,139 Issuance and sale of Class A Common Stock to the Private Investors 525 ------- $ 4,889 ------- ------- See "Recent History" and "Unaudited Pro Forma Financial Information--Note A of Notes to Unaudited Pro Forma Condensed Combined Balance Sheet" on page 29 in the accompanying Prospectus. (2) Represents the following: Issuance of Class A Common Stock $ 886 Related issuance costs (45) Decrease in long-term debt due to repayment of borrowings under the Credit Agreement (841) ------- $ -- ------- ------- See "Recent History" and "Unaudited Pro Forma Financial Information--Note D of Notes to Unaudited Pro Forma Condensed Combined Balance Sheet" on page 30 in the accompanying Prospectus. (3) Represents the following:
S-16 Issuance of Debt Securities $ 1,487 Decrease in long-term debt due to repayment of borrowings under the Credit Agreement (1,477) ------- $ 10 ------- ------- See "Certain Indebtedness--Recent History" and "Unaudited Pro Forma Financial Information--Note D of Notes to Unaudited Pro Forma Condensed Combined Balance Sheet" on page 30 in the accompanying Prospectus. (4) Represents the following: Issuance of TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts $ 900 Related issuance costs (28) Decrease in long-term debt due to repayment of borrowings under the Credit Agreement (332) Redemption of Series Z Preferred Stock (540) ------- $ -- ------- ------- See "Recent History" and "Unaudited Pro Forma Financial Information--Note D of Notes to Unaudited Pro forma Condensed Combined Balance Sheet" on page 30 in the accompanying Prospectus.
(5) See "Certain Indebtedness--Bank Debt" in the accompanying Prospectus. (6) See "Certain Indebtedness--The Debt Offerings" in the accompanying Prospectus. (7) As of the date of this Prospectus Supplement, the Company had approximately $700 million of commercial paper outstanding, a portion of which the Company may refinance upon the issuance of Debt Securities. (8) The Series Z Preferred Stock is redeemable at the option of the holder. See "Description of Capital Stock" in the accompanying Prospectus. (9) See "Description of Capital Stock" in the accompanying Prospectus for descriptions of the Series Z Preferred Stock, the Preferred Stock, the Class A Common Stock and the Class B Common Stock. (10) The sole asset of each trust will be junior subordinated deferrable interest debentures of TAP. The sole asset of TAP Capital I is $824,743,000 aggregate principal amount of 8.08% junior subordinated deferrable interest debentures of TAP due April 30, 2036. The sole asset of TAP Capital II will be $103,093,000 aggregate principal amount of 8% junior subordinated deferrable interest debentures of TAP due May 15, 2036. S-17 DESCRIPTION OF THE PREFERRED SECURITIES The Preferred Securities will be issued pursuant to the terms of the Declaration. The Declaration has been qualified as an indenture under the Trust Indenture Act. The Institutional Trustee, The Chase Manhattan Bank, N.A., will act as indenture trustee under the Declaration for purposes of compliance with the provisions of the Trust Indenture Act. The terms of the Preferred Securities will include those stated in the Declaration and those made part of the Declaration by the Trust Indenture Act. The following summary of the material terms and provisions of the Preferred Securities does not purport to be complete and is subject to, and qualified in its entirety by reference to, the Declaration (a copy of which is filed as an exhibit to the Registration Statement of which this Prospectus Supplement is a part), the Trust Act and the Trust Indenture Act. GENERAL The Declaration authorizes the Regular Trustees to issue on behalf of TAP Capital the Trust Securities, which represent undivided beneficial interests in the assets of TAP Capital. All of the Common Securities will be owned, directly or indirectly, by TAP. The Common Securities rank pari passu, and payments will be made thereon on a pro rata basis, with the Preferred Securities, except that upon the occurrence and during the continuance of a Declaration Event of Default, the rights of the holders of the Common Securities to receive payment of periodic distributions and payments upon liquidation, redemption and otherwise will be subordinated to the rights of the holders of the Preferred Securities. The Declaration does not permit the issuance by TAP Capital of any securities other than the Trust Securities or the incurrence of any indebtedness by TAP Capital. Pursuant to the Declaration, the Institutional Trustee will hold title to the Junior Subordinated Debt Securities purchased by TAP Capital for the benefit of the holders of the Trust Securities. The payment of distributions out of money held by TAP Capital, and payments upon redemption of the Preferred Securities or liquidation of TAP Capital out of money held by TAP Capital, are guaranteed by TAP to the extent described under "Description of Guarantee." The Guarantee will be held by The Chase Manhattan Bank, N.A., the Guarantee Trustee, for the benefit of the holders of the Preferred Securities. The Guarantee does not cover payment of distributions when TAP Capital does not have sufficient available funds to pay such distributions. In such event, the remedy of a holder of Preferred Securities is to (i) vote to direct the Institutional Trustee to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities or (ii) if the failure of TAP Capital to pay distributions is attributable to the failure of TAP to pay interest or principal on the Junior Subordinated Debt Securities, institute a proceeding directly against TAP for enforcement of payment to such holder of the principal or interest on the Junior Subordinated Debt Securities having a principal amount equal to the aggregate liquidation amount of the Preferred Securities of such holder on or after the respective due date specified in the Junior Subordinated Debt Securities. See "--Voting Rights." DISTRIBUTIONS Distributions on the Preferred Securities will be fixed at a rate per annum of 8% of the stated liquidation amount of $25 per Preferred Security. Distributions in arrears beyond the first date such distributions are payable (or would be payable, if not for any Extension Period or default by TAP on the Junior Subordinated Debt Securities) will bear interest thereon at the rate per annum of 8% thereof compounded quarterly. The term "distribution" as used herein includes any such interest payable unless otherwise stated. The amount of distributions payable for any period will be computed on the basis of a 360-day year of twelve 30-day months. Distributions on the Preferred Securities will be cumulative, will accrue from and including May 15, 1996, and will be payable quarterly in arrears on March 31, June 30, September 30 and December 31 of each year, commencing June 30, 1996. When, as and if available for payment, distributions will be made by the Institutional Trustee, except as otherwise described below. The distribution rate and the distribution payment dates and other payment dates for the Preferred Securities will correspond to the interest rate and interest payment dates and other payment dates on the Junior Subordinated Debt Securities. TAP has the right under the Indenture to defer payments of interest on the Junior Subordinated Debt Securities by extending the interest payment period from time to time on the Junior Subordinated Debt Securities for an Extension Period not exceeding 20 consecutive quarterly interest periods during which no interest shall be due and payable, provided, that no Extension Period may extend beyond the maturity of the Junior Subordinated S-18 Debt Securities. As a consequence of TAP's extension of the interest payment period, quarterly distributions on the Preferred Securities would be deferred (though such distributions would continue to accrue with interest thereon compounded quarterly, since interest would continue to accrue on the Junior Subordinated Debt Securities) during any such extended interest payment period. In the event that TAP exercises its right to extend the interest payment period, then (a) TAP shall not declare or pay any dividend on, make any distributions with respect to, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock or make any guarantee payment with respect thereto (other than (i) repurchases, redemptions or other acquisitions of shares of capital stock of TAP in connection with any employment contract, benefit plan or other similar arrangement with or for the benefit of employees, officers, directors or consultants, (ii) as a result of an exchange or conversion of any class or series of TAP's capital stock for any other class or series of TAP's capital stock, or (iii) the purchase of fractional interests in shares of TAP's capital stock pursuant to the conversion or exchange provisions of such capital stock or the security being converted or exchanged), and (b) TAP shall not make any payment of interest on or principal of (or premium, if any, on), or repay, repurchase or redeem, any debt securities issued by TAP which rank pari passu with or junior to the Junior Subordinated Debt Securities. The foregoing, however, will not apply to any stock dividends paid by TAP where the dividend stock is the same stock as that on which the dividend is being paid. Prior to the termination of any Extension Period, TAP may further extend such Extension Period; provided, that such Extension Period, together with all such previous and further extensions thereof, may not exceed 20 consecutive quarterly interest periods; provided further, that no Extension Period may extend beyond the maturity of the Junior Subordinated Debt Securities. Upon the termination of any Extension Period and the payment of all amounts then due, TAP may commence a new Extension Period, subject to the above requirements. Consequently, there could be up to 80 Extension Periods of varying lengths throughout the term of the Junior Subordinated Debt Securities. See "Description of the Junior Subordinated Debt Securities--Interest" and "--Option to Extend Interest Payment Period." The Regular Trustees shall give the holders of the Preferred Securities notice of any Extension Period upon their receipt of notice thereof from TAP. See "Description of the Junior Subordinated Debt Securities--Option To Extend Interest Payment Period." If distributions are deferred, the deferred distributions and accrued interest thereon shall be paid to holders of record of the Preferred Securities as they appear on the books and records of TAP Capital on the record date next following the termination of such deferral period. Distributions on the Preferred Securities will be made on the dates payable to the extent that TAP Capital has funds available for the payment of such distributions in the Property Account. TAP Capital's funds available for distribution to the holders of the Preferred Securities will be limited to payments received from TAP on the Junior Subordinated Debt Securities. See "Description of the Junior Subordinated Debt Securities." The payment of distributions out of monies held by TAP Capital is guaranteed by TAP to the extent set forth under "Description of Guarantee." Distributions on the Preferred Securities will be payable to the holders thereof as they appear on the books and records of TAP Capital at the close of business on the relevant record dates, which, as long as the Preferred Securities remain in book-entry only form, will be one Business Day prior to the relevant payment dates. Such distributions will be paid through the Institutional Trustee who will hold amounts received in respect of the Junior Subordinated Debt Securities in the Property Account for the benefit of the holders of the Trust Securities. Subject to any applicable laws and regulations and the provisions of the Declaration, each such payment will be made as described under "--Book-Entry Only Issuance--The Depository Trust Company" below. In the event that the Preferred Securities do not continue to remain in book-entry only form, the Regular Trustees shall have the right to select relevant record dates, which shall be at least 14 days but no more than 60 days prior to the relevant payment dates. In the event that any date on which distributions are to be made on the Preferred Securities is not a Business Day, then payment of the distributions payable on such date will be made on the next succeeding day which is a Business Day (and without any interest or other payment in respect of any such delay), except that, if such Business Day is in the next succeeding calendar year, such payment shall be made on the immediately preceding Business Day, in each case with the same force and effect as if made on such record date. A "Business Day" shall mean any day other than Saturday, Sunday or any other day on which banking institutions in New York City (in the State of New York) are permitted or required by any applicable law to close. MANDATORY REDEMPTION OF TRUST SECURITIES The Preferred Securities have no stated maturity date but will be redeemed upon the maturity of the Junior Subordinated Debt Securities or to the extent the Junior Subordinated Debt Securities are redeemed. The Junior Subordinated Debt Securities will mature on May 15, 2036, and may be redeemed, in whole or in part, at any time S-19 on or after May 15, 2001, or at any time, in whole or in part, in certain circumstances upon the occurrence of a Tax Event (as described under "Special Event Redemption or Distribution" below). See "Description of the Junior Subordinated Debt Securities--Optional Redemption." Upon the maturity of the Junior Subordinated Debt Securities, the proceeds of the repayment thereof shall simultaneously be applied to redeem all outstanding Trust Securities at the Redemption Price. Upon the redemption of the Junior Subordinated Debt Securities, whether in whole or in part (either at the option of TAP or pursuant to a Tax Event), the proceeds from such redemption shall simultaneously be applied to redeem Trust Securities having an aggregate liquidation amount equal to the aggregate principal amount of the Junior Subordinated Debt Securities so redeemed at the Redemption Price; provided, that holders of Trust Securities shall be given not less than 30 nor more than 60 days' notice of such redemption. In the event that fewer than all of the outstanding Preferred Securities are to be redeemed, the Preferred Securities will be redeemed pro rata as described under "--Book-Entry Only Issuance--The Depository Trust Company" below. SPECIAL EVENT REDEMPTION OR DISTRIBUTION "Tax Event" means that the Regular Trustees shall have received an opinion of a nationally recognized independent tax counsel experienced in such matters (a "Dissolution Tax Opinion") to the effect that, as a result of (a) any amendment to, or change (including any announced prospective change) in, the laws (or any regulations thereunder) of the United States or any political subdivision or taxing authority thereof or therein or (b) any amendment to or change in an interpretation or application of such laws or regulations by any legislative body, court, governmental agency or regulatory authority (including the enactment of any legislation and the publication of any judicial decision or regulatory determination on or after the date of this Prospectus Supplement), in either case after the date of this Prospectus Supplement, there is more than an insubstantial risk that (i) TAP Capital would be subject to United States federal income tax with respect to income accrued or received on the Junior Subordinated Debt Securities, (ii) interest payable to TAP Capital on the Junior Subordinated Debt Securities would not be deductible, in whole or in part, by TAP for United States federal income tax purposes or (iii) TAP Capital would be subject to more than a de minimis amount of other taxes, duties or other governmental charges. "Investment Company Event" means that the Regular Trustees shall have received an opinion of a nationally recognized independent counsel experienced in practicing under the 1940 Act (as defined herein) to the effect that, as a result of the occurrence of a change in law or regulation or a written change in interpretation or application of law or regulation by any legislative body, court, governmental agency or regulatory authority (a "Change in 1940 Act Law"), there is more than an insubstantial risk that TAP Capital is or will be considered an "investment company" which is required to be registered under the Investment Company Act of 1940, as amended (the "1940 Act"), which Change in 1940 Act Law becomes effective on or after the date of this Prospectus Supplement. If, at any time, a Tax Event or an Investment Company Event (each, as defined above, a "Special Event") shall occur and be continuing, TAP Capital shall, except in the limited circumstances described below, be dissolved with the result that Junior Subordinated Debt Securities with an aggregate principal amount equal to the aggregate stated liquidation amount of, with an interest rate identical to the distribution rate of, and with accrued and unpaid interest equal to accrued and unpaid distributions on, the Trust Securities outstanding at such time would be distributed to the holders of the Trust Securities in liquidation of such holders' interests in TAP Capital on a pro rata basis within 90 days following the occurrence of such Special Event; provided, however, that in the case of the occurrence of a Tax Event, such dissolution and distribution shall be conditioned on the Regular Trustees' receipt of an opinion of nationally recognized independent tax counsel experienced in such matters (a "No Recognition Opinion"), which opinion may rely on published revenue rulings of the Internal Revenue Service, to the effect that the holders of the Trust Securities will not recognize any gain or loss for United States federal income tax purposes as a result of such dissolution and distribution of Junior Subordinated Debt Securities and, provided further, that, if at the time there is available to TAP or TAP Capital the opportunity to eliminate, within such 90 day period, the Special Event by taking some ministerial action, such as filing a form or making an election, or pursuing some other similar reasonable measure, that will have no adverse effect on TAP Capital, TAP or the holders of the Trust Securities, TAP or TAP Capital will pursue such measure in lieu of dissolution. Furthermore, if in the case of the occurrence of a Tax Event, (i) TAP has received an opinion (a "Redemption Tax Opinion") of nationally recognized independent tax counsel experienced in such matters that, as a result of such Tax Event, there is more than an insubstantial risk that TAP would be precluded from deducting the interest on the Junior Subordinated Debt Securities for United States federal income tax purposes, even after the Junior Subordinated Debt Securities were distributed to the holders of Trust Securities in liquidation of such holders' S-20 interests in TAP Capital as described above, or (ii) the Regular Trustees shall have been informed by such tax counsel that it cannot deliver a No Recognition Opinion to the Regular Trustees, TAP shall have the right, upon not less than 30 nor more than 60 days' notice, to redeem the Junior Subordinated Debt Securities, in whole or in part, for cash within 90 days following the occurrence of such Tax Event, and, following such redemption, Trust Securities with an aggregate liquidation amount equal to the aggregate principal amount of the Junior Subordinated Debt Securities so redeemed shall be redeemed by TAP Capital at the Redemption Price on a pro rata basis; provided, however, that if at the time there is available to TAP or TAP Capital the opportunity to eliminate, within such 90-day period, the Tax Event by taking some ministerial action, such as filing a form or making an election or pursuing some other similar reasonable measure that will have no adverse effect on TAP Capital, TAP or the holders of the Trust Securities, TAP or TAP Capital will pursue such measure in lieu of redemption. If the Junior Subordinated Debt Securities are distributed to the holders of the Preferred Securities, TAP will use its best efforts to cause the Junior Subordinated Debt Securities to be listed on the New York Stock Exchange or on such other exchange as the Preferred Securities are then listed. After the date for any distribution of Junior Subordinated Debt Securities upon dissolution of TAP Capital, (i) the Preferred Securities will no longer be deemed to be outstanding, (ii) the securities depositary or its nominee, as the record holder of the Preferred Securities, will receive a registered global certificate or certificates representing the Junior Subordinated Debt Securities to be delivered upon such distribution, and (iii) any certificates representing Preferred Securities not held by the Depositary or its nominee will be deemed to represent Junior Subordinated Debt Securities having an aggregate principal amount equal to the aggregate stated liquidation amount of, with an interest rate identical to the distribution rate of, and with accrued and unpaid interest equal to accrued and unpaid distributions on, such Preferred Securities until such certificates are presented to TAP or its agent for transfer or reissuance. There can be no assurance as to the market prices for either the Preferred Securities or the Junior Subordinated Debt Securities that may be distributed in exchange for the Preferred Securities if a dissolution and liquidation of TAP Capital were to occur. Accordingly, the Preferred Securities that an investor may purchase, whether pursuant to the offer made hereby or in the secondary market, or the Junior Subordinated Debt Securities that an investor may receive if a dissolution and liquidation of TAP Capital were to occur, may trade at a discount to the price that the investor paid to purchase the Preferred Securities offered hereby. REDEMPTION PROCEDURES TAP Capital may not redeem fewer than all of the outstanding Preferred Securities unless all accrued and unpaid distributions have been paid on all Preferred Securities for all quarterly distribution periods terminating on or prior to the date of redemption. If TAP Capital gives a notice of redemption in respect of Preferred Securities (which notice will be irrevocable), then, by 12:00 noon, New York City time, on the redemption date, provided, that if TAP has paid to the Institutional Trustee a sufficient amount of cash in connection with the related redemption or maturity of the Junior Subordinated Debt Securities, the Institutional Trustee will irrevocably deposit with the Depositary (as defined in the accompanying Prospectus) funds sufficient to pay the applicable Redemption Price and will give the Depositary irrevocable instructions and authority to pay the Redemption Price to the holders of the Preferred Securities. See "--Book-Entry Only Issuance--The Depository Trust Company." If notice of redemption shall have been given and funds deposited as required, then, immediately prior to the close of business on the date of such deposit, distributions will cease to accrue and all rights of holders of Preferred Securities so called for redemption will cease, except the right of the holders of such Preferred Securities to receive the Redemption Price but without interest on such Redemption Price. In the event that any date fixed for redemption of Preferred Securities is not a Business Day, then payment of the Redemption Price payable on such date will be made on the next succeeding day that is a Business Day (without any interest or other payment in respect of any such delay), except that, if such Business Day falls in the next calendar year, such payment will be made on the immediately preceding Business Day. In the event that payment of the Redemption Price in respect of Preferred Securities is improperly withheld or refused and not paid either by TAP Capital, or by TAP pursuant to the Guarantee, distributions on such Preferred Securities will continue to accrue at the then applicable rate from the original redemption date to the date of payment, in which case the actual payment date will be considered the date fixed for redemption for purposes of calculating the Redemption Price. S-21 In the event that fewer than all of the outstanding Preferred Securities are to be redeemed, the Preferred Securities will be redeemed in accordance with the Depositary's standard procedures. See "--Book-Entry Only Issuance--The Depository Trust Company." Subject to the foregoing and applicable law (including, without limitation, United States federal securities laws), TAP or its affiliates, including, without limitation, Smith Barney, may at any time, and from time to time, purchase outstanding Preferred Securities by tender, in the open market or by private agreement. LIQUIDATION DISTRIBUTION UPON DISSOLUTION In the event of any voluntary or involuntary liquidation, dissolution, winding-up or termination of TAP Capital (each a "Liquidation"), the holders of the Preferred Securities will be entitled to receive out of the assets of TAP Capital, after satisfaction of liabilities to creditors, distributions in an amount equal to the aggregate of the stated liquidation amount of $25 per Preferred Security plus accrued and unpaid distributions thereon to the date of payment (the "Liquidation Distribution"), unless, in connection with such Liquidation, Junior Subordinated Debt Securities in an aggregate stated principal amount equal to the aggregate stated liquidation amount of, with an interest rate identical to the distribution rate of, and with accrued and unpaid interest equal to accrued and unpaid distributions on, the Preferred Securities outstanding at such time have been distributed on a pro rata basis to the holders of such Preferred Securities. If, upon any such Liquidation, the Liquidation Distribution can be paid only in part because TAP Capital has insufficient assets available to pay in full the aggregate Liquidation Distribution, then the amounts payable directly by TAP Capital on the Preferred Securities shall be paid on a pro rata basis. The holders of the Common Securities will be entitled to receive distributions upon any such Liquidation pro rata with the holders of the Preferred Securities, except that if a Declaration Event of Default has occurred and is continuing the Preferred Securities shall have a preference over the Common Securities with regard to such distributions. Pursuant to the Declaration, TAP Capital shall terminate (i) on May 15, 2051, the expiration of the term of the Trust, (ii) upon the bankruptcy of TAP or the holder of the Common Securities, (iii) upon the filing of a certificate of dissolution or its equivalent with respect to the holder of the Common Securities or TAP, the filing of a certificate of cancellation with respect to TAP Capital, or the revocation of the charter of the holder of the Common Securities or TAP and the expiration of 90 days after the date of revocation without a reinstatement thereof, (iv) upon the distribution of Junior Subordinated Debt Securities upon the occurrence of a Special Event, (v) upon the entry of a decree of a judicial dissolution of the holder of the Common Securities, TAP or TAP Capital, or (vi) upon the redemption of all the Trust Securities. Under the terms of the Indenture, TAP has covenanted that, for so long as the Preferred Securities remain outstanding, it will not voluntarily dissolve, wind-up or terminate TAP Capital except in connection with a distribution of Junior Subordinated Debt Securities upon a Special Event or in connection with certain mergers, consolidations or amalgamations permitted by the Declaration. DECLARATION EVENTS OF DEFAULT An event of default under the Indenture (an "Indenture Event of Default") constitutes an event of default under the Declaration with respect to the Trust Securities (a "Declaration Event of Default"); provided, that pursuant to the Declaration the holder of the Common Securities will be deemed to have waived any Declaration Event of Default with respect to the Common Securities until all Declaration Events of Default with respect to the Preferred Securities have been cured, waived or otherwise eliminated. Until such Declaration Events of Default with respect to the Preferred Securities have been so cured, waived, or otherwise eliminated, the Institutional Trustee will be deemed to be acting solely on behalf of the holders of the Preferred Securities and only the holders of the Preferred Securities will have the right to direct the Institutional Trustee with respect to certain matters under the Declaration, and therefore the Indenture. In the event that any Declaration Event of Default with respect to the Preferred Securities is waived by the holders of the Preferred Securities as provided in the Declaration, the holders of Common Securities pursuant to the Declaration have agreed that such waiver also constitutes a waiver of such Declaration Event of Default with respect to the Common Securities for all purposes under the Declaration without any further act, vote or consent of the holders of Common Securities. See "--Voting Rights." S-22 If the Institutional Trustee fails to enforce its rights under the Junior Subordinated Debt Securities, any holder of Preferred Securities may directly institute a legal proceeding against TAP to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities without first instituting any legal proceeding against the Institutional Trustee or any other person or entity. If a Declaration Event of Default has occurred and is continuing and such event is attributable to the failure of TAP to pay interest or principal on the Junior Subordinated Debt Securities on the date such interest or principal is otherwise payable (or in the case of redemption, the redemption date), then a holder of Preferred Securities may also directly institute a proceeding for enforcement of payment to such holder of the principal of or interest on the Junior Subordinated Debt Securities having a principal amount equal to the aggregate liquidation amount of the Preferred Securities of such holder on or after the respective due date specified in the Junior Subordinated Debt Securities without first (i) directing the Institutional Trustee to enforce the terms of the Junior Subordinated Debt Securities or (ii) instituting a legal proceeding against TAP to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities. In connection with such Direct Action, TAP will be subrogated to the rights of such holder of Preferred Securities under the Declaration to the extent of any payment made by TAP to such holder of Preferred Securities in such Direct Action. Consequently, TAP will be entitled to payment of amounts that a holder of Preferred Securities receives in respect of an unpaid distribution that resulted in the bringing of a Direct Action to the extent that such holder receives or has already received full payment with respect to such unpaid distribution from TAP Capital. The holders of Preferred Securities will not be able to exercise directly any other remedy available to the holders of the Junior Subordinated Debt Securities. Upon the occurrence of an Indenture Event of Default, the Institutional Trustee as the sole holder of the Junior Subordinated Debt Securities will have the right under the Indenture to declare the principal of and interest on the Junior Subordinated Debt Securities to be immediately due and payable. TAP and TAP Capital are each required to file annually with the Institutional Trustee an officers' certificate as to its compliance with all conditions and covenants under the Declaration. VOTING RIGHTS Except as described in this Prospectus Supplement and in the accompanying Prospectus under "Description of Guarantees--Modification of Guarantees; Assignment," and except as provided under the Trust Act, the Trust Indenture Act and as otherwise required by law and the Declaration, the holders of the Preferred Securities will have no voting rights. Subject to the requirement of the Institutional Trustee obtaining a tax opinion in certain circumstances set forth in the last sentence of this paragraph, the holders of a majority in aggregate liquidation amount of the Preferred Securities have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Institutional Trustee, or direct the exercise of any trust or power conferred upon the Institutional Trustee under the Declaration including the right to direct the Institutional Trustee, as holder of the Junior Subordinated Debt Securities, to (i) direct the time, method and place of conducting any proceeding for any remedy available to the Indenture Trustee, or exercising any trust or power conferred on the Indenture Trustee with respect to the Junior Subordinated Debt Securities, (ii) waive any past Indenture Event of Default that is waivable under Section 5.13 of the Indenture, (iii) exercise any right to rescind or annul a declaration that the principal of all the Junior Subordinated Debt Securities shall be due and payable, or (iv) consent to any amendment, modification or termination of the Indenture or the Junior Subordinated Debt Securities where such consent shall be required; provided, however, that, where a consent or action under the Indenture would require the consent or act of holders of more than a majority in principal amount of the Junior Subordinated Debt Securities (a "Super Majority") affected thereby, only the holders of at least such Super Majority in aggregate liquidation amount of the Preferred Securities may direct the Institutional Trustee to give such consent or take such action. If the Institutional Trustee fails to enforce its rights under the Junior Subordinated Debt Securities, any record holder of Preferred Securities may directly institute a legal proceeding against TAP to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities without first instituting any legal proceeding against the Institutional Trustee or any other person or entity. The Institutional Trustee shall notify all holders of the Preferred Securities of any notice of default received from the Indenture Trustee with respect to the Junior Subordinated Debt Securities. Such notice shall state that such Indenture Event of Default also constitutes a Declaration Event of Default. Except with respect to directing the time, method and place of conducting a proceeding for a remedy available to the Institutional Trustee, the Institutional Trustee, as holder of the Junior Subordinated Debentures, shall not take any of the actions described in clauses (i), (ii), (iii) or (iv) above unless S-23 the Institutional Trustee has obtained an opinion of a nationally recognized independent tax counsel experienced in such matters to the effect that, as a result of such action, TAP Capital will not fail to be classified as a grantor trust for United States federal income tax purposes. In the event the consent of the Institutional Trustee, as the holder of the Junior Subordinated Debt Securities, is required under the Indenture with respect to any amendment, modification or termination of the Indenture, the Institutional Trustee shall request the written direction of the holders of the Trust Securities with respect to such amendment, modification or termination and shall vote with respect to such amendment, modification or termination as directed by a majority in liquidation amount of the Trust Securities voting together as a single class; provided, however, that where any amendment, modification or termination under the Indenture would require the consent of a Super Majority, the Institutional Trustee may only give such consent at the direction of the holders of at least the proportion in aggregate liquidation amount of the Trust Securities which the relevant Super Majority represents of the aggregate principal amount of the Junior Subordinated Debt Securities outstanding. The Institutional Trustee shall be under no obligation to take any such action in accordance with the directions of the holders of the Trust Securities unless the Institutional Trustee has obtained an opinion of a nationally recognized independent tax counsel experienced in such matters to the effect that for United States federal income tax purposes TAP Capital will not be classified as other than a grantor trust. A waiver of an Indenture Event of Default by the Institutional Trustee at the direction of the holders of the Preferred Securities will constitute a waiver of the corresponding Declaration Event of Default. Any required approval or direction of holders of Preferred Securities may be given at a separate meeting of holders of Preferred Securities convened for such purpose, at a meeting of all of the holders of Trust Securities or pursuant to written consent. The Regular Trustees will cause a notice of any meeting at which holders of Preferred Securities are entitled to vote, or of any matter upon which action by written consent of such holders is to be taken, to be mailed to each holder of record of Preferred Securities. Each such notice will include a statement setting forth the following information: (i) the date of such meeting or the date by which such action is to be taken; (ii) a description of any resolution proposed for adoption at such meeting on which such holders are entitled to vote or of such matter upon which written consent is sought; and (iii) instructions for the delivery of proxies or consents. No vote or consent of the holders of Preferred Securities will be required for TAP Capital to redeem and cancel Preferred Securities or distribute Junior Subordinated Debt Securities in accordance with the Declaration. Notwithstanding that holders of Preferred Securities are entitled to vote or consent under any of the circumstances described above, any of the Preferred Securities that are owned at such time by TAP or any entity directly or indirectly controlling or controlled by, or under direct or indirect common control with, TAP, shall not be entitled to vote or consent and shall, for purposes of such vote or consent, be treated as if such Preferred Securities were not outstanding. The procedures by which holders of Preferred Securities may exercise their voting rights are described below. See "--Book-Entry Only Issuance--The Depository Trust Company." Holders of the Preferred Securities will have no rights to appoint or remove the TAP Trustees, who may be appointed, removed or replaced solely by TAP as the indirect or direct holder of all of the Common Securities. MODIFICATION OF THE DECLARATION The Declaration may be modified and amended if approved by the Regular Trustees (and in certain circumstances the Institutional Trustee and the Delaware Trustee), provided, that, if any proposed amendment provides for, or the Regular Trustees otherwise propose to effect, (i) any action that would adversely affect the powers, preferences or special rights of the Trust Securities, whether by way of amendment to the Declaration or otherwise or (ii) the dissolution, winding-up or termination of TAP Capital other than pursuant to the terms of the Declaration, then the holders of the Trust Securities voting together as a single class will be entitled to vote on such amendment or proposal and such amendment or proposal shall not be effective except with the approval of holders of at least a majority in liquidation amount of the Trust Securities affected thereby; provided, that, if any amendment or proposal referred to in clause (i) above would adversely affect only the Preferred Securities or the Common Securities, then only holders of the affected class will be entitled to vote on such amendment or proposal and such amendment or proposal shall not be effective except with the approval of holders of a majority in liquidation amount of such class of Trust Securities. S-24 Notwithstanding the foregoing, no amendment or modification may be made to the Declaration if such amendment or modification would (i) cause TAP Capital to be classified for United States federal income tax purposes as other than a grantor trust, (ii) reduce or otherwise adversely affect the powers of the Institutional Trustee or (iii) cause TAP Capital to be deemed an "investment company" which is required to be registered under the 1940 Act. MERGERS, CONSOLIDATIONS OR AMALGAMATIONS TAP Capital may not consolidate, amalgamate, merge with or into, or be replaced by, or convey, transfer or lease its properties and assets substantially as an entirety, to any corporation or other body except as described below. TAP Capital may, with the consent of the Regular Trustees and without the consent of the holders of the Trust Securities, consolidate, amalgamate, merge with or into, or be replaced by a trust organized as such under the laws of any State; provided, that (i) such successor entity either (x) expressly assumes all of the obligations of TAP Capital under the Trust Securities or (y) substitutes for the Preferred Securities other securities having substantially the same terms as the Trust Securities (the "Successor Securities"), so long as the Successor Securities rank the same as the Trust Securities rank with respect to distributions and payments upon liquidation, redemption and otherwise, (ii) TAP expressly acknowledges a trustee of such successor entity possessing the same powers and duties as the Institutional Trustee, in its capacity as the holder of the Junior Subordinated Debt Securities, (iii) the Preferred Securities or any Successor Securities are listed, or any Successor Securities will be listed upon notification of issuance, on any national securities exchange or with another organization on which the Preferred Securities are then listed or quoted, (iv) such merger, consolidation, amalgamation or replacement does not cause the Preferred Securities (including any Successor Securities) to be downgraded by any nationally recognized statistical rating organization, (v) such merger, consolidation, amalgamation or replacement does not adversely affect the rights, preferences and privileges of the holders of the Trust Securities (including any Successor Securities) in any material respect (other than with respect to any dilution of the holders' interest in the new entity), (vi) such successor entity has a purpose identical to that of TAP Capital, (vii) prior to such merger, consolidation, amalgamation or replacement, TAP Capital has received an opinion of a nationally recognized independent counsel to TAP Capital experienced in such matters to the effect that, (A) such merger, consolidation, amalgamation or replacement does not adversely affect the rights, preferences and privileges of the holders of the Trust Securities (including any Successor Securities) in any material respect (other than with respect to any dilution of the holders' interest in the new entity), and (B) following such merger, consolidation, amalgamation or replacement, neither TAP Capital nor such successor entity will be required to register as an "investment company" under the 1940 Act; and (viii) TAP guarantees the obligations of such successor entity under the Successor Securities at least to the extent provided by the Guarantee. Notwithstanding the foregoing, TAP Capital shall not, except with the consent of holders of 100% in liquidation amount of the Trust Securities, consolidate, amalgamate, merge with or into, or be replaced by any other entity or permit any other entity to consolidate, amalgamate, merge with or into, or replace it, if in the opinion of a nationally recognized independent tax counsel experienced in such matters, such consolidation, amalgamation, merger or replacement would cause TAP Capital or the Successor Entity to be classified as other than a grantor trust for United States federal income tax purposes. In addition, so long as any Preferred Securities are outstanding and are not held entirely by TAP, TAP Capital may not voluntarily liquidate, dissolve, wind-up or terminate except as described above under "--Special Event Redemption Distribution." BOOK-ENTRY ONLY ISSUANCE--THE DEPOSITORY TRUST COMPANY The Depository Trust Company ("DTC") will act as securities depositary for the Preferred Securities. The Preferred Securities will be issued only as fully-registered securities registered in the name of Cede & Co. (DTC's nominee). One or more fully-registered global Preferred Securities certificates, representing the total aggregate number of Preferred Securities, will be issued and will be deposited with DTC. The laws of some jurisdictions require that certain purchasers of securities take physical delivery of securities in definitive form. Such laws may impair the ability to transfer beneficial interests in the global Preferred Securities as represented by a global certificate. DTC is a limited-purpose trust company organized under the New York Banking Law, a "banking organization" within the meaning of the New York Banking Law, a member of the Federal Reserve System, a "clearing corporation" within the meaning of the New York Uniform Commercial Code and a "clearing agency" registered S-25 pursuant to the provisions of Section 17A of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). DTC holds securities that its participants ("Participants") deposit with DTC. DTC also facilitates the settlement among Participants of securities transactions, such as transfers and pledges, in deposited securities through electronic computerized book-entry changes in Participants' accounts, thereby eliminating the need for physical movement of securities certificates. Direct Participants include securities brokers and dealers, banks, trust companies, clearing corporations and certain other organizations ("Direct Participants"). DTC is owned by a number of its Direct Participants and by the New York Stock Exchange, the American Stock Exchange, Inc., and the National Association of Securities Dealers, Inc. Access to the DTC system is also available to others, such as securities brokers and dealers, banks and trust companies that clear transactions through or maintain a direct or indirect custodial relationship with a Direct Participant either directly or indirectly ("Indirect Participants"). The rules applicable to DTC and its Participants are on file with the Securities and Exchange Commission. Purchases of Preferred Securities within the DTC system must be made by or through Direct Participants, which will receive a credit for the Preferred Securities on DTC's records. The ownership interest of each actual purchaser of each Preferred Security ("Beneficial Owner") is in turn to be recorded on the Direct and Indirect Participants' records. Beneficial Owners will not receive written confirmation from DTC of their purchases, but Beneficial Owners are expected to receive written confirmations providing details of the transactions, as well as periodic statements of their holdings, from the Direct or Indirect Participants through which the Beneficial Owners purchased Preferred Securities. Transfers of ownership interests in the Preferred Securities are to be accomplished by entries made on the books of Participants acting on behalf of Beneficial Owners. Beneficial Owners will not receive certificates representing their ownership interests in the Preferred Securities, except in the event that use of the book-entry system for the Preferred Securities is discontinued. To facilitate subsequent transfers, all the Preferred Securities deposited by Participants with DTC are registered in the name of DTC's nominee, Cede & Co. The deposit of Preferred Securities with DTC and their registration in the name of Cede & Co. effect no change in beneficial ownership. DTC has no knowledge of the actual Beneficial Owners of the Preferred Securities. DTC's records reflect only the identity of the Direct Participants to whose accounts such Preferred Securities are credited, which may or may not be the Beneficial Owners. The Participants will remain responsible for keeping account of their holdings on behalf of their customers. Conveyance of notices and other communications by DTC to Direct Participants, by Direct Participants to Indirect Participants and by Direct Participants and Indirect Participants to Beneficial Owners will be governed by arrangements among them, subject to any statutory or regulatory requirements that may be in effect from time to time. Redemption notices shall be sent to Cede & Co. If less than all of the Preferred Securities are being redeemed, DTC will reduce the amount of the interest of each Direct Participant in such Preferred Securities in accordance with its procedures. Although voting with respect to the Preferred Securities is limited, in those cases where a vote is required, neither DTC nor Cede & Co. will itself consent or vote with respect to Preferred Securities. Under its usual procedures, DTC would mail an Omnibus Proxy to TAP Capital as soon as possible after the record date. The Omnibus Proxy assigns Cede & Co. consenting or voting rights to those Direct Participants to whose accounts the Preferred Securities are credited on the record date (identified in a listing attached to the Omnibus Proxy). TAP and TAP Capital believe that the arrangements among DTC, Direct and Indirect Participants, and Beneficial Owners will enable the Beneficial Owners to exercise rights equivalent in substance to the rights that can be directly exercised by a holder of a beneficial interest in TAP Capital. Distribution payments on the Preferred Securities will be made to DTC. DTC's practice is to credit Direct Participants' accounts on the relevant payment date in accordance with their respective holdings shown on DTC's records unless DTC has reason to believe that it will not receive payments on such payment date. Payments by Participants to Beneficial Owners will be governed by standing instructions and customary practices, as is the case with securities held for the account of customers in bearer form or registered in "street name," and such payments will be the responsibility of such Participant and not of DTC, TAP Capital or TAP, subject to any statutory or regulatory requirements to the contrary that may be in effect from time to time. Payment of distributions to DTC is the responsibility of TAP Capital, disbursement of such payments to Direct Participants is the responsibility of S-26 DTC, and disbursement of such payments to the Beneficial Owners is the responsibility of Direct and Indirect Participants. Except as provided herein, a Beneficial Owner in a global Preferred Security certificate will not be entitled to receive physical delivery of Preferred Securities. Accordingly, each Beneficial Owner must rely on the procedures of DTC to exercise any rights under the Preferred Securities. DTC may discontinue providing its services as securities depositary with respect to the Preferred Securities at any time by giving reasonable notice to TAP Capital. Under such circumstances, in the event that a successor securities depositary is not obtained, Preferred Securities certificates are required to be printed and delivered. Additionally, the Regular Trustees (with the consent of TAP) may decide to discontinue use of the system of book-entry transfers through DTC (or any successor depositary) with respect to the Preferred Securities. In that event, certificates for the Preferred Securities will be printed and delivered. The information in this section concerning DTC and DTC's book-entry system has been obtained from sources that TAP and TAP Capital believe to be reliable, but neither TAP nor TAP Capital takes responsibility for the accuracy thereof. INFORMATION CONCERNING THE INSTITUTIONAL TRUSTEE The Institutional Trustee, prior to the occurrence of a default with respect to the Trust Securities, undertakes to perform only such duties as are specifically set forth in the Declaration and, after such a default, shall exercise the same degree of care as a prudent individual would exercise in the conduct of his or her own affairs. Subject to such provisions, the Institutional Trustee is under no obligation to exercise any of the powers vested in it by the Declaration at the request of any holder of Preferred Securities, unless offered reasonable indemnity by such holder against the costs, expenses and liabilities which might be incurred thereby. Notwithstanding the foregoing, the holders of Preferred Securities will not be required to offer such indemnity in the event such holders, by exercising their voting rights, direct the Institutional Trustee to take any action following a Declaration Event of Default. PAYING AGENT In the event that the Preferred Securities do not remain in book-entry only form, the following provisions will apply: The Institutional Trustee will act as paying agent and may designate an additional or substitute paying agent at any time. Registration of transfers of Preferred Securities will be effected without charge by or on behalf of TAP Capital, but upon payment (with the giving of such indemnity as TAP Capital or TAP may require) in respect of any tax or other government charges that may be imposed in relation to it. TAP Capital will not be required to register or cause to be registered the transfer of Preferred Securities after such Preferred Securities have been called for redemption. GOVERNING LAW The Declaration and the Preferred Securities will be governed by, and construed in accordance with, the internal laws of the State of Delaware. MISCELLANEOUS The Regular Trustees are authorized and directed to operate TAP Capital in such a way so that TAP Capital will not be required to register as an "investment company" under the 1940 Act or be characterized as other than a grantor trust for United States federal income tax purposes. TAP is authorized and directed to conduct its affairs so that the Junior Subordinated Debt Securities will be treated as indebtedness of TAP for United States federal income tax purposes. In this connection, TAP and the Regular Trustees are authorized to take any action, not inconsistent with applicable law, the certificate of trust of TAP Capital or the certificate of incorporation of TAP, that each of TAP and the Regular Trustees determine in their discretion to be necessary or desirable to achieve such end, as long as such action does not adversely affect the interests of the holders of the Preferred Securities or vary the terms thereof. Holders of the Preferred Securities have no preemptive rights. S-27 DESCRIPTION OF THE JUNIOR SUBORDINATED DEBT SECURITIES Set forth below is a description of the specific terms of the Junior Subordinated Debt Securities in which TAP Capital will invest the proceeds from the issuance and sale of the Trust Securities. This description supplements the description of the general terms and provisions of the Junior Subordinated Debt Securities set forth in the accompanying Prospectus under the caption "Description of Junior Subordinated Debt Securities." The following description does not purport to be complete and is subject to, and is qualified in its entirety by reference to, the description of the Junior Subordinated Debt Securities in the accompanying Prospectus; the Indenture, dated as of April 30, 1996 (the "Indenture"), between TAP and The Chase Manhattan Bank, N.A., as Trustee (the "Indenture Trustee") the form of which is filed as an exhibit to the Registration Statement of which this Prospectus Supplement and the accompanying Prospectus form a part; and the Trust Indenture Act. Certain capitalized terms used herein are defined in the Indenture. Under certain circumstances involving the dissolution of TAP Capital following the occurrence of a Special Event, Junior Subordinated Debt Securities may be distributed to the holders of the Trust Securities in liquidation of TAP Capital. See "Description of the Preferred Securities--Special Event Redemption or Distribution." If the Junior Subordinated Debt Securities are distributed to the holders of the Preferred Securities, TAP will use its best efforts to have the Junior Subordinated Debt Securities listed on the New York Stock Exchange or on such other national securities exchange or similar organization on which the Preferred Securities are then listed or quoted. GENERAL The Junior Subordinated Debt Securities will be issued as unsecured debt under the Indenture. The Junior Subordinated Debt Securities will be limited in aggregate principal amount to approximately $103,093,000, such amount being the sum of the aggregate stated liquidation amount of the Preferred Securities and the capital contributed by TAP to TAP Capital in exchange for the Common Securities (the "TAP Payment"). The Junior Subordinated Debt Securities are not subject to a sinking fund provision. The entire principal amount of the Junior Subordinated Debt Securities will mature and become due and payable, together with any accrued and unpaid interest thereon including Compound Interest (as defined herein) and Additional Interest (as defined herein), if any, on May 15, 2036. If Junior Subordinated Debt Securities are distributed to holders of Preferred Securities in liquidation of such holders' interests in TAP Capital, such Junior Subordinated Debt Securities will initially be issued in the form of one or more Global Securities (as defined under "Book-Entry and Settlement" below). As described herein, under certain limited circumstances, Junior Subordinated Debt Securities may be issued in certificated form in exchange for a Global Security. See "Book-Entry and Settlement" below. In the event that Junior Subordinated Debt Securities are issued in certificated form, such Junior Subordinated Debt Securities will be in denominations of $25 and integral multiples thereof and may be transferred or exchanged at the offices described below. Payments on Junior Subordinated Debt Securities issued as a Global Security will be made to DTC, to a successor depositary or, in the event that no depositary is used, to a Paying Agent for the Junior Subordinated Debt Securities. In the event Junior Subordinated Debt Securities are issued in certificated form, principal and interest will be payable, the transfer of the Junior Subordinated Debt Securities will be registrable and Junior Subordinated Debt Securities will be exchangeable for Junior Subordinated Debt Securities of other denominations of a like aggregate principal amount at the corporate trust office of the Indenture Trustee in New York, New York; provided, that payment of interest may be made at the option of TAP by check mailed to the address of the persons entitled thereto. TAP does not intend to issue and sell the Junior Subordinated Debt Securities to any purchasers other than TAP Capital. There are no covenants or provisions in the Indenture that would afford the holders of the Junior Subordinated Debt Securities protection in the event of a highly leveraged transaction, reorganization, restructuring, merger or similar transaction involving TAP that may adversely affect such holders. SUBORDINATION The Indenture provides that the Junior Subordinated Debt Securities are subordinated and junior in right of payment to all Senior Indebtedness of TAP. No payment of principal (including redemption payments), premium, S-28 if any, or interest on the Junior Subordinated Debt Securities may be made if (i) any Senior Indebtedness of TAP has not been paid when due and any applicable grace period with respect to such default has ended and such default has not been cured or waived or ceased to exist, or (ii) the maturity of any Senior Indebtedness of TAP has been accelerated because of a default. Upon any distribution of assets of TAP to creditors upon any dissolution, winding-up, liquidation or reorganization, whether voluntary or involuntary, or in bankruptcy, insolvency, receivership or other proceedings, all principal, premium, if any, and interest due or to become due on all Senior Indebtedness of TAP must be paid in full before the holders of Junior Subordinated Debt Securities are entitled to receive or retain any payment. Upon satisfaction of all claims related to all Senior Indebtedness of TAP then outstanding, the rights of the holders of the Junior Subordinated Debt Securities will be subrogated to the rights of the holders of Senior Indebtedness of TAP to receive payments or distributions applicable to Senior Indebtedness until all amounts owing on the Junior Subordinated Debt Securities are paid in full. The term "Senior Indebtedness" means, with respect to TAP, (i) the principal, premium, if any, and interest in respect of (A) indebtedness of such obligor for money borrowed and (B) indebtedness evidenced by securities, notes, debentures, bonds or other similar instruments issued by such obligor, (ii) all capital lease obligations of such obligor, (iii) all obligations of such obligor issued or assumed as the deferred purchase price of property, all conditional sale obligations of such obligor and all obligations of such obligor under any conditional sale or title retention agreement (but excluding trade accounts payable arising in the ordinary course of business), (iv) all obligations, contingent or otherwise, of such obligor in respect of any letters of credit, banker's acceptance, security purchase facilities or similar credit transactions, (v) all obligations in respect of interest rate swap, cap or other agreements, interest rate future or option contracts, currency swap agreements, currency future or option contracts and other similar agreements, (vi) all obligations of the type referred to in clauses (i) through (v) above of other persons for the payment of which such obligor is responsible or liable as obligor, guarantor or otherwise and (vii) all obligations of the type referred to in clauses (i) through (vi) above of other persons secured by any lien on any property or asset of such obligor (whether or not such obligation is assumed by such obligor), except for (1) any such indebtedness that is by its terms subordinated to or pari passu with the Junior Subordinated Debt Securities and (2) any indebtedness between or among such obligor or its affiliates, including all other debt securities and guarantees in respect of those debt securities, issued to (a) any other TAP Trust or a trustee of such trust and (b) any other trust, or a trustee of such trust, partnership or other entity affiliated with TAP that is a financing vehicle of TAP (a "financing entity") in connection with the issuance by such financing entity of preferred securities or other securities that rank pari passu with, or junior to, the Preferred Securities. Such Senior Indebtedness shall continue to be Senior Indebtedness and be entitled to the benefits of the subordination provisions irrespective of any amendment, modification or waiver of any term of such Senior Indebtedness. The Indenture does not limit the aggregate amount of Senior Indebtedness that may be issued by TAP. After giving effect to the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings and the application of the proceeds thereof, Senior Indebtedness of TAP would have aggregated approximately $1.496 billion at December 31, 1995. OPTIONAL REDEMPTION TAP shall have the right to redeem the Junior Subordinated Debt Securities, in whole or in part, from time to time, on or after May 15, 2001, or at any time in certain circumstances upon the occurrence of a Tax Event as described under "Description of the Preferred Securities--Special Event Redemption or Distribution," upon not less than 30 nor more than 60 days' notice, at a redemption price equal to 100% of the principal amount to be redeemed plus any accrued and unpaid interest, including Additional Interest (as defined herein), if any, to the redemption date. If a partial redemption of the Preferred Securities resulting from a partial redemption of the Junior Subordinated Debt Securities would result in the delisting of the Preferred Securities, TAP may only redeem the Junior Subordinated Debt Securities in whole. PROPOSED TAX LEGISLATION On March 19, 1996, President Clinton proposed certain tax law changes (the "Proposed Legislation") that would, among other things, generally deny corporate issuers a deduction for interest in respect of certain debt obligations, such as the Junior Subordinated Debt Securities, issued on or after December 7, 1995. On March 29, 1996, Senate Finance Committee Chairman William V. Roth, Jr. and House Ways and Means Committee Chairman Bill Archer issued a joint statement (the "Joint Statement") indicating their intent that the Proposed Legislation, if adopted by either of the tax-writing committees of Congress, would have an effective date that is no S-29 earlier than the date of "appropriate Congressional action." Based upon the Joint Statement, it is expected that if the Proposed Legislation were to be enacted, such legislation would not apply to the Junior Subordinated Debt Securities. There can be no assurances, however, that the effective date guidance contained in the Joint Statement will be incorporated into the Proposed Legislation, if enacted, or that other legislation enacted after the date hereof will not otherwise adversely affect the ability of the Company to deduct the interest payable on the Junior Subordinated Debt Securities. Accordingly, there can be no assurance that a Tax Event will not occur. See "Description of the Preferred Securities--Special Event Redemption or Distribution." INTEREST Each Junior Subordinated Debt Security shall bear interest at the rate of 8% per annum, from and including the original date of issuance, payable quarterly in arrears on March 31, June 30, September 30 and December 31 of each year (each an "Interest Payment Date"), commencing June 30, 1996 to the person in whose name such Junior Subordinated Debt Security is registered, subject to certain exceptions, at the close of business on the Business Day next preceding such Interest Payment Date. In the event the Junior Subordinated Debt Securities shall not continue to remain in book-entry only form, TAP shall have the right to select record dates, which shall be at least 14 days but no more than 60 days prior to the Interest Payment Date. The amount of interest payable for any period will be computed on the basis of a 360-day year of twelve 30-day months. The amount of interest payable for any period shorter than a full quarterly period for which interest is computed will be computed on the basis of the actual number of days elapsed per 30-day month. In the event that any date on which interest is payable on the Junior Subordinated Debt Securities is not a Business Day, then payment of the interest payable on such date will be made on the next succeeding day that is a Business Day (and without any interest or other payment in respect of any such delay), except that, if such Business Day is in the next succeeding calendar year, then such payment shall be made on the immediately preceding Business Day, in each case with the same force and effect as if made on such date. OPTION TO EXTEND INTEREST PAYMENT PERIOD TAP shall have the right at any time, and from time to time, during the term of the Junior Subordinated Debt Securities, to defer payments of interest by extending the interest payment period for a period not exceeding 20 consecutive quarters, provided, that no Extension Period may extend beyond the maturity of the Junior Subordinated Debt Securities, at the end of which Extension Period, TAP shall pay all interest then accrued and unpaid (including any Additional Interest) together with interest thereon compounded quarterly at the rate specified for the Junior Subordinated Debt Securities to the extent permitted by applicable law ("Compound Interest"); provided further, that during any such Extension Period, (a) TAP shall not declare or pay any dividend on, make any distributions with respect to, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock or make any guarantee payment with respect thereto (other than (i) repurchases, redemptions or other acquisitions of shares of capital stock of TAP in connection with any employment contract, benefit plan or other similar arrangement with or for the benefit of employees, officers, directors or consultants, (ii) as a result of an exchange or conversion of any class or series of TAP's capital stock for any other class or series of TAP's capital stock, or (iii) the purchase of fractional interests in shares of TAP's capital stock pursuant to the conversion or exchange provisions of such capital stock or the security being converted or exchanged), and (b) TAP shall not make any payment of interest on or principal of (or premium, if any, on), or repay, repurchase or redeem, any debt securities issued by TAP which rank pari passu with or junior to the Junior Subordinated Debt Securities. The foregoing, however, will not apply to any stock dividends paid by TAP where the dividend stock is the same stock as that on which the dividend is being paid. Prior to the termination of any Extension Period, TAP may further defer payments of interest by extending such Extension Period; provided, however, that such Extension Period, including all such previous and further extensions, may not exceed 20 consecutive quarterly interest periods (including the quarterly interest period in which notice of such Extension Period (as described below) is given); provided further, that no Extension Period may extend beyond the maturity of the Junior Subordinated Debt Securities. Upon the termination of any Extension Period and the payment of all amounts then due, TAP may commence a new Extension Period, subject to the terms set forth in this section. No interest during an Extension Period, except at the end thereof, shall be due and payable. TAP has no present intention of exercising its right to defer payments of interest by extending the interest payment period on the Junior Subordinated Debt Securities. If the Institutional Trustee shall be the sole holder of the Junior Subordinated Debt Securities, TAP shall give the Regular Trustees and the Institutional Trustee notice of its selection of such Extension Period one Business Day prior to the earlier of S-30 (i) the date distributions on the Preferred Securities would be payable, if not for such Extension Period, or (ii) the date the Regular Trustees are required to give notice to the New York Stock Exchange (or other applicable self-regulatory organization) or to holders of the Preferred Securities of the record date or the date such distribution would be payable, if not for such Extension Period, but in any event one Business Day prior to such record date. The Regular Trustees shall give notice of TAP's selection of such Extension Period to the holders of the Preferred Securities. If the Institutional Trustee shall not be the sole holder of the Junior Subordinated Debt Securities, TAP shall give the holders of the Junior Subordinated Debt Securities notice of its selection of such Extension Period ten Business Days prior to the earlier of (i) the next succeeding Interest Payment Date or (ii) the date upon which TAP is required to give notice to the New York Stock Exchange (or other applicable self-regulatory organization) or to holders of the Junior Subordinated Debt Securities of the record or payment date of such related interest payment. ADDITIONAL INTEREST If at any time TAP Capital shall be required to pay any taxes, duties, assessments or governmental charges of whatever nature (other than withholding taxes) imposed by the United States, or any other taxing authority, then, in any such case, TAP will pay as additional interest ("Additional Interest") on the Junior Subordinated Debt Securities such additional amounts as shall be required so that the net amounts received and retained by TAP Capital after paying any such taxes, duties, assessments or other governmental charges will be not less than the amounts TAP Capital would have received had no such taxes, duties, assessments or other governmental charges been imposed. INDENTURE EVENTS OF DEFAULT If any Indenture Event of Default shall occur and be continuing, the Institutional Trustee, as the holder of the Junior Subordinated Debt Securities, will have the right to declare the principal of and the interest on the Junior Subordinated Debt Securities (including any Compound Interest and Additional Interest, if any) and any other amounts payable under the Indenture to be forthwith due and payable and to enforce its other rights as a creditor with respect to the Junior Subordinated Debt Securities. See "Description of Junior Subordinated Debt Securities--Events of Default" in the accompanying Prospectus for a description of the Indenture Events of Default. An Indenture Event of Default also constitutes a Declaration Event of Default. The holders of Preferred Securities in certain circumstances have the right to direct the Institutional Trustee to exercise its rights as the holder of the Junior Subordinated Debt Securities. See "Description of the Preferred Securities--Declaration Events of Default" and "--Voting Rights." Notwithstanding the foregoing, if a Declaration Event of Default has occurred and is continuing and such event is attributable to the failure of TAP to pay interest or principal on the Junior Subordinated Debt Securities on the date such interest or principal is otherwise payable, TAP acknowledges that, in such event, a holder of Preferred Securities may institute a Direct Action for payment on or after the respective due date specified in the Junior Subordinated Debt Securities. TAP may not amend the Indenture to remove the foregoing right to bring a Direct Action without the prior written consent of all of the holders of Preferred Securities of TAP Capital. Notwithstanding any payment made to such holder of Preferred Securities by TAP in connection with a Direct Action, TAP shall remain obligated to pay the principal of or interest on the Junior Subordinated Debt Securities held by TAP Capital or the Institutional Trustee of TAP Capital, and TAP shall be subrogated to the rights of the holder of such Preferred Securities with respect to payments on the Preferred Securities to the extent of any payments made by TAP to such holder in any Direct Action. The holders of Preferred Securities will not be able to exercise directly any other remedy available to the holders of the Junior Subordinated Debt Securities. BOOK-ENTRY AND SETTLEMENT If distributed to holders of Preferred Securities in connection with the involuntary or voluntary dissolution, winding-up or liquidation of TAP Capital as a result of the occurrence of a Special Event, the Junior Subordinated Debt Securities will be issued in the form of one or more global certificates (each a "Global Security") registered in the name of the depositary or its nominee. Except under the limited circumstances described below, Junior Subordinated Debt Securities represented by a Global Security will not be exchangeable for, and will not otherwise be issuable as, Junior Subordinated Debt Securities in definitive form. The Global Securities described above may not be transferred except by the depositary to a nominee of the depositary or by a nominee of the depositary to the depositary or another nominee of the depositary or to a successor depositary or its nominee. S-31 The laws of some jurisdictions require that certain purchasers of securities take physical delivery of such securities in definitive form. Such laws may impair the ability to transfer beneficial interests in such a Global Security. Except as provided below, owners of beneficial interests in such a Global Security will not be entitled to receive physical delivery of Junior Subordinated Debt Securities in definitive form and will not be considered the Holders (as defined in the Indenture) thereof for any purpose under the Indenture, and no Global Security representing Junior Subordinated Debt Securities shall be exchangeable, except for another Global Security of like denomination and tenor to be registered in the name of the depositary or its nominee or to a successor depositary or its nominee. Accordingly, each Beneficial Owner must rely on the procedures of the depositary or if such person is not a Participant, on the procedures of the Participant through which such person owns its interest to exercise any rights of a holder under the Indenture. THE DEPOSITARY If Junior Subordinated Debt Securities are distributed to holders of Preferred Securities in liquidation of such holders' interests in TAP Capital, DTC will act as securities depositary for the Junior Subordinated Debt Securities. For a description of DTC and the specific terms of the depositary arrangements, see "Description of the Preferred Securities--Book-Entry Only Issuance--The Depository Trust Company." As of the date of this Prospectus Supplement, the description therein of DTC's book-entry system and DTC's practices as they relate to purchases, transfers, notices and payments with respect to the Preferred Securities apply in all material respects to any debt obligations represented by one or more Global Securities held by DTC. TAP may appoint a successor to DTC or any successor depositary in the event DTC or such successor depositary is unable or unwilling to continue as a depositary for the Global Securities. None of TAP, TAP Capital, the Indenture Trustee, any paying agent and any other agent of TAP or the Indenture Trustee will have any responsibility or liability for any aspect of the records relating to or payments made on account of beneficial ownership interests in a Global Security for such Junior Subordinated Debt Securities or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests. DISCONTINUANCE OF THE DEPOSITARY'S SERVICES A Global Security shall be exchangeable for Junior Subordinated Debt Securities registered in the names of persons other than the depositary or its nominee only if (i) the depositary notifies TAP that it is unwilling or unable to continue as a depositary for such Global Security and no successor depositary shall have been appointed, (ii) the depositary, at any time, ceases to be a clearing agency registered under the Exchange Act at which time the depositary is required to be so registered to act as such depositary and no successor depositary shall have been appointed, (iii) TAP, in its sole discretion, determines that such Global Security shall be so exchangeable or (iv) there shall have occurred an Indenture Event of Default with respect to such Junior Subordinated Debt Securities. Any Global Security that is exchangeable pursuant to the preceding sentence shall be exchangeable for Junior Subordinated Debt Securities registered in such names as the depositary shall direct. It is expected that such instructions will be based upon directions received by the depositary from its Participants with respect to ownership of beneficial interests in such Global Security. MISCELLANEOUS The Indenture will provide that TAP will pay all fees and expenses related to (i) the offering of the Trust Securities and the Junior Subordinated Debt Securities, (ii) the organization, maintenance and dissolution of TAP Capital, (iii) the retention of the TAP Trustees and (iv) the enforcement by the Institutional Trustee of the rights of the holders of the Preferred Securities. DESCRIPTION OF GUARANTEE Set forth below is a summary of information concerning the Guarantee that will be executed and delivered by TAP for the benefit of the holders of Preferred Securities. The Guarantee has been qualified as an indenture under the Trust Indenture Act. The Chase Manhattan Bank, N.A. will act as indenture trustee under the Guarantee (the "Guarantee Trustee"). The terms of the Guarantee will be those set forth in the Guarantee and those made part of the Guarantee by the Trust Indenture Act. The summary does not purport to be complete and is subject in all S-32 respects to the provisions of, and is qualified in its entirety by reference to, the form of Guarantee, which is filed as an exhibit to the Registration Statement of which this Prospectus Supplement forms a part, and the Trust Indenture Act. The Guarantee will be held by the Guarantee Trustee for the benefit of the holders of the Preferred Securities. GENERAL Pursuant to and to the extent set forth in the Guarantee, TAP will irrevocably and unconditionally agree to pay in full to the holders of the Preferred Securities (except to the extent paid by TAP Capital), as and when due, regardless of any defense, right of set-off or counterclaim which TAP Capital may have or assert, the following payments (the "Guarantee Payments"), without duplication: (i) any accrued and unpaid distributions that are required to be paid on the Preferred Securities, to the extent TAP Capital has funds available therefor, and (ii) the redemption price of $25 per Preferred Security, plus all accrued and unpaid distributions (the "Redemption Price"), to the extent TAP Capital has funds available therefor, with respect to any Preferred Securities called for redemption by TAP Capital, and (iii) upon a voluntary or involuntary dissolution, winding-up or termination of TAP Capital (other than in connection with the distribution of Junior Subordinated Debt Securities to the holders of Preferred Securities or the redemption of all of the Preferred Securities) the lesser of (a) the aggregate of the liquidation amount and all accrued and unpaid distributions on the Preferred Securities to the date of payment or (b) the amount of assets of TAP Capital remaining for distribution to holders of the Preferred Securities in liquidation of TAP Capital. TAP's obligation to make a Guarantee Payment may be satisfied by direct payment of the required amounts by TAP to the holders of Preferred Securities or by causing TAP Capital to pay such amounts to such holders. The Guarantee will be a guarantee on a subordinated basis with respect to the Preferred Securities from the time of issuance of the Preferred Securities but will not apply to any payment of distributions or Redemption Price, or to payments upon the dissolution, winding-up or termination of TAP Capital, except to the extent TAP Capital shall have funds available therefor. If TAP does not make interest payments on the Junior Subordinated Debt Securities, TAP Capital will not pay distributions on the Preferred Securities and will not have funds available therefor. See "Description of Junior Subordinated Debt Securities." The Guarantee, when taken together with TAP's obligations under the Junior Subordinated Debt Securities, the Indenture and the Declaration, including its obligations to pay costs, expenses, debts and liabilities of TAP Capital (other than with respect to Trust Securities), will provide a full and unconditional guarantee on a subordinated basis by TAP of payments due on the Preferred Securities. CERTAIN COVENANTS OF TAP In the Guarantee, TAP will covenant that, so long as any Preferred Securities remain outstanding, if there shall have occurred any event that would constitute an Event of Default under such Guarantee or the Declaration, then (a) TAP shall not declare or pay any dividend on, make any distributions with respect to, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock or make any guarantee payment with respect thereto (other than (i) repurchases, redemptions or other acquisitions of shares of capital stock of TAP in connection with any employment contract, benefit plan or other similar arrangement with or for the benefit of employees, officers, directors or consultants, (ii) as a result of an exchange or conversion of any class or series of TAP's capital stock for any other class or series of TAP's capital stock, or (iii) the purchase of fractional interests in shares of TAP's capital stock pursuant to the conversion or exchange provisions of such capital stock or the security being converted or exchanged) and (b) TAP shall not make any payment of interest on, or principal of (or premium, if any, on), or repay, repurchase or redeem, any debt securities issued by TAP which rank pari passu with or junior to the Junior Subordinated Debt Securities. The Guarantee, however, will except from the foregoing any stock dividends paid by TAP where the dividend stock is the same stock as that on which the dividend is being paid. MODIFICATION OF THE GUARANTEE; ASSIGNMENT Except with respect to any changes that do not adversely affect the rights of holders of Preferred Securities (in which case no vote will be required), the Guarantee may be amended only with the prior approval of the holders of not less than a majority in aggregate liquidation amount of the outstanding Preferred Securities. All guarantees and agreements contained in the Guarantee shall bind the successors, assignees, receivers, trustees and representatives of TAP and shall inure to the benefit of the holders of the Preferred Securities then outstanding. S-33 EVENTS OF DEFAULT An Event of Default under the Guarantee will occur upon the failure of TAP to perform any of its payment or other obligations thereunder. The holders of a majority in aggregate liquidation amount of the Preferred Securities have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Guarantee Trustee in respect of the Guarantee or to direct the exercise of any trust or power conferred upon the Guarantee Trustee under the Guarantee. If the Guarantee Trustee fails to enforce the Guarantee Trustee's rights under the Guarantee, any holder of related Preferred Securities may directly institute a legal proceeding against TAP to enforce the Guarantee Trustee's rights under the Guarantee without first instituting a legal proceeding against TAP Capital, the Guarantee Trustee or any other person or entity. A holder of Preferred Securities may also directly institute a legal proceeding against TAP to enforce such holder's right to receive payment under the Guarantee without first (i) directing the Guarantee Trustee to enforce the terms of the Guarantee or (ii) instituting a legal proceeding against TAP Capital or any other person or entity. TAP will be required to provide annually to the Guarantee Trustee a statement as to the performance by TAP of certain of its obligations under the Guarantee and as to any default in such performance. INFORMATION CONCERNING THE GUARANTEE TRUSTEE The Guarantee Trustee, prior to the occurrence of a default with respect to the Guarantee, undertakes to perform only such duties as are specifically set forth in the Guarantee and, after default with respect to the Guarantee, shall exercise the same degree of care as a prudent individual would exercise in the conduct of his or her own affairs. Subject to such provision, the Guarantee Trustee is under no obligation to exercise any of the powers vested in it by the Guarantee at the request of any holder of Preferred Securities unless it is offered reasonable indemnity against the costs, expenses and liabilities that might be incurred thereby. TERMINATION OF THE GUARANTEE The Guarantee will terminate as to the Preferred Securities upon full payment of the Redemption Price of all Preferred Securities, upon distribution of the Junior Subordinated Debt Securities to the holders of the Preferred Securities or upon full payment of the amounts payable in accordance with the Declaration upon liquidation of TAP Capital. The Guarantee will continue to be effective or will be reinstated, as the case may be, if at any time any holder of Preferred Securities must restore payment of any sums paid under the Preferred Securities or the Guarantee. STATUS OF THE GUARANTEE The Guarantee will constitute an unsecured obligation of TAP and will rank (i) subordinate and junior in right of payment to all other liabilities of TAP, (ii) pari passu with the most senior preferred or preference stock now or hereafter issued by TAP and with any guarantee now or hereafter entered into by TAP in respect of any preferred or preference stock of any affiliate of TAP and (iii) senior to TAP's common stock. The terms of the Preferred Securities provide that each holder of Preferred Securities by acceptance thereof agrees to the subordination provisions and other terms of the Guarantee. The Guarantee will constitute a guarantee of payment and not of collection (that is, the guaranteed party may institute a legal proceeding directly against the guarantor to enforce its rights under the Guarantee without instituting a legal proceeding against any other person or entity). GOVERNING LAW The Guarantee will be governed by, and construed in accordance with, the internal laws of the State of New York. S-34 EFFECT OF OBLIGATIONS UNDER THE JUNIOR SUBORDINATED DEBT SECURITIES AND THE GUARANTEE As set forth in the Declaration, the sole purpose of TAP Capital is to issue the Trust Securities evidencing undivided beneficial interests in the assets of TAP Capital, and to invest the proceeds from such issuance and sale in the Junior Subordinated Debt Securities. As long as payments of interest and other payments are made when due on the Junior Subordinated Debt Securities, such payments will be sufficient to cover distributions and payments due on the Trust Securities because of the following factors: (i) the aggregate principal amount of Junior Subordinated Debt Securities will be equal to the sum of the aggregate stated liquidation amount of the Trust Securities; (ii) the interest rate and the interest and other payment dates on the Junior Subordinated Debt Securities will match the distribution rate and distribution and other payment dates for the Preferred Securities; (iii) pursuant to the Indenture, TAP shall pay, and TAP Capital shall not be obligated to pay, directly or indirectly, all costs, expenses, debt and obligations of TAP Capital other than with respect to the Trust Securities; and (iv) the Declaration further provides that the TAP Trustees shall not cause or permit TAP Capital to, among other things, engage in any activity that is not consistent with the purposes of TAP Capital. Payments of distributions (to the extent funds therefor are available) and other payments due on the Preferred Securities (to the extent funds therefor are available) are guaranteed by TAP as and to the extent set forth under "Description of Guarantees" in the accompanying Prospectus. If TAP does not make interest payments on the Junior Subordinated Debt Securities purchased by TAP Capital, it is expected that TAP Capital will not have sufficient funds to pay distributions on the Preferred Securities. The Guarantee is a guarantee on a subordinated basis with respect to the Preferred Securities from the time of its issuance but does not apply to any payment of distributions unless and until TAP Capital has sufficient funds for the payment of such distributions. The Guarantee covers the payment of distributions and other payments on the Preferred Securities only if and to the extent that TAP has made a payment of interest or principal or other payments on the Junior Subordinated Debt Securities held by TAP Capital as its sole asset. The Guarantee, when taken together with TAP's obligations under the Junior Subordinated Debt Securities and the Indenture and its obligations under the Declaration, including its obligations to pay costs, expenses, debts and liabilities of TAP Capital (other than with respect to the Trust Securities), will provide a full and unconditional guarantee of distributions, redemption payments and liquidation payments on the Preferred Securities. If TAP fails to make interest or other payments on the Junior Subordinated Debt Securities when due (taking account of any Extension Period), the Declaration provides a mechanism whereby the holders of the Preferred Securities, using the procedures described in "Description of the Preferred Securities--Book Entry Only Issuance--The Depository Trust Company" and "--Voting Rights," may direct the Institutional Trustee to enforce its rights under the Junior Subordinated Debt Securities. If the Institutional Trustee fails to enforce its rights under the Junior Subordinated Debt Securities, any holder of Preferred Securities may directly institute a legal proceeding against TAP to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities without first instituting any legal proceeding against the Institutional Trustee or any other person or entity. If a Declaration Event of Default has occurred and is continuing and such event is attributable to the failure of TAP to pay interest or principal on the Junior Subordinated Debt Securities on the date such interest or principal is otherwise payable (or in the case of redemption, on the redemption date), then a holder of Preferred Securities may also institute a Direct Action for payment on or after the respective due date specified in the Junior Subordinated Debt Securities without first (i) directing the Institutional Trustee to enforce the terms of the Junior Subordinated Debt Securities or (ii) instituting a legal proceeding against TAP to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities. In connection with such Direct Action, TAP will be subrogated to the rights of such holder of Preferred Securities under the Declaration to the extent of any payment made by TAP to such holder of Preferred Securities in such Direct Action. Consequently, TAP will be entitled to payment of amounts that a holder of Preferred Securities receives in respect of an unpaid distribution that resulted in the bringing of a Direct Action to the extent that such holder receives or has already received full payment with respect to such unpaid distribution from TAP Capital. TAP, under the Guarantee, acknowledges that the Guarantee Trustee shall enforce the Guarantee on behalf of the holders of the Preferred Securities. If TAP fails to make payments under the Guarantee, the Guarantee provides a mechanism whereby the holders of the Preferred Securities may direct the Guarantee Trustee to enforce its rights thereunder. If the Guarantee Trustee fails to enforce the Guarantee, any holder of Preferred Securities may directly institute a legal proceeding against S-35 TAP to enforce the Guarantee Trustee's rights under the Guarantee without first instituting a legal proceeding against TAP Capital, the Guarantee Trustee, or any other person or entity. A holder of Preferred Securities may also directly institute a legal proceeding against TAP to enforce such holder's right to receive payment under the Guarantee without first (i) directing the Guarantee Trustee to enforce the terms of the Guarantee or (ii) instituting a legal proceeding against TAP Capital or any other person or entity. TAP and TAP Capital believe that the above mechanisms and obligations, taken together, are equivalent to a full and unconditional guarantee by TAP of payments due on the Preferred Securities. See "Description of Guarantee--General." UNITED STATES FEDERAL INCOME TAXATION GENERAL The following is a summary of the material United States federal income tax consequences of the purchase, ownership and disposition of Preferred Securities. Unless otherwise stated, this summary deals only with Preferred Securities held as capital assets by holders who purchase the Preferred Securities upon original issuance ("Initial Holders"). It does not deal with special classes of holders such as banks, thrifts, real estate investment trusts, regulated investment companies, insurance companies, dealers in securities or currencies, tax-exempt investors, persons that have a functional currency other than the U.S. Dollar or persons that will hold the Preferred Securities as a position in a "straddle," as part of a "synthetic security" or "hedge," as part of a "conversion transaction" or other integrated investment, or as other than a capital asset. Further, it does not include any description of any alternative minimum tax consequences or the tax laws of any state or local government or of any foreign government that may be applicable to the Preferred Securities. This summary is based on the Internal Revenue Code of 1986, as amended (the "Code"), Treasury regulations thereunder and administrative and judicial interpretations thereof, as of the date hereof, all of which are subject to change, possibly on a retroactive basis. CLASSIFICATION OF THE JUNIOR SUBORDINATED DEBT SECURITIES In connection with the issuance of the Junior Subordinated Debt Securities, Skadden, Arps, Slate, Meagher & Flom ("Skadden, Arps"), special tax counsel to TAP and TAP Capital, will render its opinion generally to the effect that, under then current law and assuming full compliance with the terms of the Indenture (and certain other documents), and based on certain facts and assumptions contained in such opinion, the Junior Subordinated Debt Securities held by TAP Capital will be classified for United States federal income tax purposes as indebtedness of TAP. CLASSIFICATION OF TAP CAPITAL In connection with the issuance of the Preferred Securities, Skadden, Arps will render its opinion generally to the effect that, under then current law and assuming full compliance with the terms of the Declaration and the Indenture (and certain other documents), and based on certain facts and assumptions contained in such opinion, TAP Capital will be classified for United States federal income tax purposes as a grantor trust and not as an association taxable as a corporation. Accordingly, for United States federal income tax purposes, each holder of Preferred Securities generally will be considered the owner of an undivided interest in the Junior Subordinated Debt Securities, and each holder will be required to include in its gross income any OID accrued with respect to its allocable share of those Junior Subordinated Debt Securities. ORIGINAL ISSUE DISCOUNT Because TAP has the option, under the terms of the Junior Subordinated Debt Securities, to defer payments of interest by extending interest payment periods for up to 20 quarters, all of the stated interest payments on the Junior Subordinated Debt Securities will be treated as "original issue discount." However, if the "issue price" of the Junior Subordinated Debt Securities for federal income tax purposes is higher or lower than their $25 principal amount, the total amount of OID reportable by any holder may differ from the amount of stated interest. Holders of debt instruments issued with OID must include that discount in income on an economic accrual basis before the receipt of cash attributable to the interest, regardless of their method of tax accounting. Generally, all of a holder's taxable interest income with respect to the Junior Subordinated Debt Securities will be accounted for as OID, and actual distributions of stated interest will not be reported as taxable income. The amount of OID that accrues in any month will be approximately equal to the amount of the interest that accrues on the Junior Subordinated Debt S-36 Securities in that month at the stated interest rate unless the "issue price" of the Junior Subordinated Debt Securities for United States federal income tax purposes is higher or lower than $25. In the event that the interest payment period is extended, holders will accrue OID on a current basis in an aggregate amount approximately equal to the amount of the interest payment due at the end of the extended interest payment period (including Compound Interest) on an economic accrual basis over the length of the extended interest period, and any holders who dispose of Preferred Securities prior to the record date for the payment of interest following such extended interest payment period will not receive from TAP Capital any cash related thereto. Because income on the Preferred Securities will constitute interest (in the form of OID), corporate holders of Preferred Securities will not be entitled to a dividends-received deduction with respect to any income recognized with respect to the Preferred Securities. MARKET DISCOUNT AND BOND PREMIUM Holders of Preferred Securities other than Initial Holders may be considered to have acquired their undivided interests in the Junior Subordinated Debt Securities with market discount or acquisition premium as such phrases are defined for United States federal income tax purposes. Such holders are advised to consult their tax advisors as to the income tax consequences of the acquisition, ownership and disposition of the Preferred Securities. RECEIPT OF JUNIOR SUBORDINATED DEBT SECURITIES OR CASH UPON LIQUIDATION OF TAP CAPITAL Under certain circumstances, as described under "Description of the Preferred Securities--Special Event Redemption or Distribution," Junior Subordinated Debt Securities may be distributed to holders in exchange for the Preferred Securities upon the liquidation of TAP Capital. Under current law, such a distribution, for United States federal income tax purposes, would be treated as a non-taxable event to each holder, and each holder would receive an aggregate tax basis in the Junior Subordinated Debt Securities equal to such holder's aggregate tax basis in its Preferred Securities. A holder's holding period in the Junior Subordinated Debt Securities received in liquidation of TAP Capital would include the period during which the Preferred Securities were held by such holder. Under certain circumstances described herein (see "Description of the Preferred Securities"), the Junior Subordinated Debt Securities may be redeemed by TAP for cash and the proceeds of such redemption distributed by TAP Capital to holders in redemption of their Preferred Securities. Under current law, such a redemption would, for United States federal income tax purposes, constitute a taxable disposition of the redeemed Preferred Securities, and a holder could recognize gain or loss as if it sold such redeemed Preferred Securities for cash. See "United States Federal Income Taxation--Sales of Preferred Securities." SALES OF PREFERRED SECURITIES A holder that sells Preferred Securities will be considered to have disposed of all or part of its pro rata share of the Junior Subordinated Debt Securities, and will recognize gain or loss equal to the difference between its adjusted tax basis in the Preferred Securities and the amount realized on the sale of such Preferred Securities. A holder's adjusted tax basis in the Preferred Securities generally will be its initial purchase price increased by OID previously includible in such holder's gross income to the date of disposition and decreased by distributions or other payments received on the Preferred Securities. Such gain or loss generally will be a capital gain or loss (except to the extent of any accrued market discount with respect to such holder's pro rata share of the Junior Subordinated Debt Securities not previously included in income) (see "Market Discount and Bond Premium" above) and generally will be a long-term capital gain or loss if the Preferred Securities have been held for more than one year. The Preferred Securities may trade at a price that does not accurately reflect the value of accrued but unpaid interest with respect to the underlying Junior Subordinated Debt Securities. A holder who disposes of its Preferred Securities between record dates for payments of distributions thereon will be required to include accrued but unpaid interest on the Junior Subordinated Debt Securities to the date of disposition in income as ordinary income, and to add such amount to its adjusted tax basis in its pro rata share of the underlying Junior Subordinated Debt Securities deemed disposed of. To the extent the selling price is less than the holder's adjusted tax basis, such holder will recognize a capital loss. Subject to certain limited exceptions, capital losses cannot be applied to offset ordinary income for United States federal income tax purposes. S-37 PROPOSED TAX LEGISLATION On March 19, 1996, President Clinton proposed certain tax law changes (the "Proposed Legislation") that would, among other things, generally deny corporate issuers a deduction for interest in respect of certain debt obligations, such as the Junior Subordinated Debt Securities, issued on or after December 7, 1995. On March 29, 1996, Senate Finance Committee Chairman William V. Roth, Jr. and House Ways and Means Committee Chairman Bill Archer issued a joint statement (the "Joint Statement") indicating their intent that the Proposed Legislation, if adopted by either of the tax-writing committees of Congress, would have an effective date that is no earlier than the date of "appropriate Congressional action." Based upon the Joint Statement, it is expected that if the Proposed Legislation were to be enacted, such legislation would not apply to the Junior Subordinated Debt Securities. There can be no assurances, however, that the effective date guidance contained in the Joint Statement will be incorporated into the Proposed Legislation, if enacted, or that other legislation enacted after the date hereof will not otherwise adversely affect the ability of the Company to deduct the interest payable on the Junior Subordinated Debt Securities. Accordingly, there can be no assurance that a Tax Event will not occur. See "Description of the Preferred Securities--Special Event Redemption or Distribution." UNITED STATES ALIEN HOLDERS For purposes of this discussion, a "United States Alien Holder" is any corporation, individual, partnership, estate or trust that is, as to the United States, a foreign corporation, a non-resident alien individual, a foreign partnership, or a non-resident fiduciary of a foreign estate or trust. Under present United States federal income tax law: (i) payments by TAP Capital or any of its paying agents to any holder of a Preferred Security who or which is a United States Alien Holder will not be subject to United States federal withholding tax; provided, that, (a) the beneficial owner of the Preferred Security does not actually or constructively own 10% or more of the total combined voting power of all classes of stock of TAP entitled to vote, (b) the beneficial owner of the Preferred Security is not a controlled foreign corporation that is related to TAP through stock ownership, and (c) either (A) the beneficial owner of the Preferred Security certifies to TAP Capital or its agent, under penalties of perjury, that it is not a United States holder and provides its name and address or (B) a securities clearing organization, bank or other financial institution that holds customers' securities in the ordinary course of its trade or business (a "Financial Institution"), and holds the Preferred Security in such capacity, certifies to TAP Capital or its agent, under penalties of perjury, that such statement has been received from the beneficial owner by it or by a Financial Institution holding such security for the beneficial owner and furnishes TAP Capital or its agent with a copy thereof; and (ii) a United States Alien Holder of a Preferred Security will not be subject to United States federal withholding tax on any gain realized upon the sale or other disposition of a Preferred Security. INFORMATION REPORTING TO HOLDERS Generally, income on the Preferred Securities will be reported to holders on Forms 1099, which forms should be mailed to holders of Preferred Securities by January 31 following each calendar year. BACKUP WITHHOLDING Payments made on, and proceeds from the sale of, the Preferred Securities may be subject to a "backup" withholding tax of 31% unless the holder complies with certain identification requirements. Any withheld amounts will be allowed as a credit against the holder's United States federal income tax, provided the required information is provided to the Internal Revenue Service. THE UNITED STATES FEDERAL INCOME TAX DISCUSSION SET FORTH ABOVE IS INCLUDED FOR GENERAL INFORMATION ONLY AND MAY NOT BE APPLICABLE DEPENDING UPON A HOLDER'S PARTICULAR SITUATION. HOLDERS SHOULD CONSULT THEIR TAX ADVISORS WITH RESPECT TO THE TAX CONSEQUENCES TO THEM OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE PREFERRED SECURITIES, INCLUDING THE TAX CONSEQUENCES UNDER STATE, LOCAL, FOREIGN AND OTHER TAX LAWS AND THE POSSIBLE EFFECTS OF CHANGES IN UNITED STATES FEDERAL OR OTHER TAX LAWS. S-38 UNDERWRITING Under the terms and subject to the conditions of the Underwriting Agreement dated May 10, 1996 (the "Underwriting Agreement"), Smith Barney Inc. (the "Underwriter") has agreed to purchase from TAP Capital, and TAP Capital has agreed to sell to the Underwriter, all the Preferred Securities offered hereby. The Underwriter is obligated to take and pay for the total number of Preferred Securities offered hereby if any such Preferred Securities are purchased. The Underwriting Agreement provides that TAP Capital and TAP will indemnify the Underwriter against certain liabilities, including liabilities under the Securities Act of 1933, as amended, and to make certain contributions in respect thereof. TAP Capital and TAP have agreed, during the period beginning on the date of the Underwriting Agreement and continuing to and including the date that is 60 days after the closing date for the purchase of the Preferred Securities, not to offer, sell, contract to sell or otherwise dispose of any preferred securities, any preferred stock or any other securities (including any backup undertakings of such preferred stock or other securities) of TAP or of TAP Capital, in each case that are substantially similar to the Preferred Securities, or any securities convertible into or exchangeable for the Preferred Securities or such substantially similar securities of either TAP Capital or TAP, except preferred securities offered pursuant to the accompanying Prospectus, without the prior written consent of the Underwriter. In view of the fact that the proceeds of the sale of the Preferred Securities will ultimately be used to purchase the Junior Subordinated Debt Securities of TAP, the Underwriting Agreement provides that TAP will pay as compensation to the Underwriter $.7875 per Preferred Security for the account of the Underwriter; provided that such compensation for sales of 10,000 or more Preferred Securities to a single purchaser will be $.50 per Preferred Security. Therefore, to the extent of such sales, the actual amount of Underwriter's Compensation will be less than the aggregate amount specified in the preceding sentence. The Underwriter has informed the Company that it does not intend to confirm sales to accounts over which it exercises discretionary authority. The Underwriter proposes to offer the Preferred Securities, in part, directly to the public at the initial public offering price set forth on the cover page of this Prospectus Supplement, and to certain dealers at a price that represents a concession not in excess of .500, provided that such concession for sales of 10,000 or more Preferred Securities to a single person will not be in excess of .300 per Preferred Security. The Underwriter may allow, and such dealers may reallow, a concession not in excess of .300 per Preferred Security to certain brokers and dealers. After the Preferred Securities are released for sale to the public, the offering price and other selling terms may from time to time be varied by the Underwriter. The Preferred Securities have been approved for listing on the New York Stock Exchange, subject to official notice of issuance. Trading of the Preferred Securities on the New York Stock Exchange is expected to commence within a 30-day period after the date of this Prospectus Supplement. Smith Barney is an indirect wholly owned subsidiary of Travelers Group and an affiliate of TAP and TAP Capital. The offering of Preferred Securities will comply with the requirements of Schedule E of the By-laws of the National Association of Securities Dealers, Inc. ("NASD") regarding a NASD member firm's underwriting securities of an affiliate. James Dimon, a director of TAP, is Chairman of the Board, Chief Executive Officer and a member of the executive committee of Smith Barney and is also a Director, Chief Executive Officer and Chairman of the Board of Smith Barney Holdings Inc., the immediate parent company of Smith Barney. Smith Barney acted as financial advisor to TIGI in connection with the Acquisition. This Prospectus Supplement together with an applicable Prospectus may also be used by Smith Barney in connection with offers and sales of the Preferred Securities (subject to obtaining any necessary approval of the New York Stock Exchange for any such offers and sales) in market-making transactions at negotiated prices related to prevailing market prices at the time of sale. Smith Barney may act as principal or agent in such transactions. Smith Barney has no obligation to make a market in any of the Preferred Securities and may discontinue any market-making activities at any time without notice, at its sole discretion. S-39 LEGAL MATTERS The validity of the Preferred Securities, the Junior Subordinated Debt Securities, the Guarantee and certain matters relating thereto and certain United States federal income tax matters will be passed upon for TAP and TAP Capital by Skadden, Arps, New York, New York. Certain legal matters will be passed upon for the Underwriter by Shearman & Sterling, New York, New York. Kenneth J. Bialkin, a partner of Skadden, Arps, is a director of Travelers Group and is a director of TAP and he and other attorneys in such firm beneficially own an aggregate of less than one percent of the common stock of Travelers Group. S-40 PROSPECTUS Travelers/Aetna Property Casualty Corp. A Member of TravelersGroup[LOGO] JUNIOR SUBORDINATED DEBT SECURITIES ------------------- TRAVELERS P&C CAPITAL I TRAVELERS P&C CAPITAL II TRAVELERS P&C CAPITAL III TRUST PREFERRED SECURITIES GUARANTEED TO THE EXTENT SET FORTH HEREIN BY TRAVELERS/AETNA PROPERTY CASUALTY CORP. ------------------- Travelers/Aetna Property Casualty Corp. ("TAP"), a Delaware corporation and an indirect majority owned subsidiary of Travelers Group Inc. ("Travelers Group"), may offer, from time to time, its unsecured junior subordinated debt securities (the "Junior Subordinated Debt Securities"), consisting of debentures, notes or other evidences of indebtedness, in one or more series and in amounts, at prices and on terms to be determined at or prior to the time of any such offering. TAP's obligations under the Junior Subordinated Debt Securities will be subordinate and junior in right of payment to certain other indebtedness of TAP as described herein or as may be described in an accompanying Prospectus Supplement (the "Prospectus Supplement"). Travelers P&C Capital I, Travelers P&C Capital II and Travelers P&C Capital III (each, a "TAP Trust" and, together, the "TAP Trusts"), each a statutory business trust formed under the laws of the State of Delaware, may offer, from time to time, trust preferred securities, representing undivided beneficial interests in the assets of the respective TAP Trust ("Preferred Securities") with the payment of periodic cash distributions ("distributions") and payments on liquidation, redemption or otherwise of such Preferred Securities guaranteed (each, a "Guarantee") on a subordinated basis by TAP to the extent described herein. See "Description of Guarantees." TAP's obligations under the Guarantees will rank pari passu with the most senior preferred or preference stock now or hereafter issued by TAP. See "Description of Guarantees--Status of Guarantees." Junior Subordinated Debt Securities may be issued and sold from time to time in one or more series by TAP to a TAP Trust, or a trustee of such trust, in connection with the investment of the proceeds from the offering of Preferred Securities and Common Securities (as defined herein) of such TAP Trust, but TAP does not intend to issue and sell the Junior Subordinated Debt Securities directly to other purchasers, including the general public. The Junior Subordinated Debt Securities purchased by a TAP Trust may be subsequently distributed pro rata to holders of Preferred Securities and Common Securities in connection with the dissolution of such TAP Trust upon the occurrence of certain events as may be described in an accompanying Prospectus Supplement. The Guarantee, when taken together with TAP's obligations under the Junior Subordinated Debt Securities, the Indenture and the Declaration, including its obligations to pay costs, expenses, debts and liabilities of such TAP Trust (other than with respect to the Preferred Securities and the Common Securities), will provide a full and unconditional guarantee on a subordinated basis by TAP of payments due on Preferred Securities. (Continued on next page) THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. THIS PROSPECTUS MAY NOT BE USED TO CONSUMMATE SALES OF SECURITIES UNLESS ACCOMPANIED BY A PROSPECTUS SUPPLEMENT. ------------------- SMITH BARNEY INC. April 24, 1996 (continued from previous page) Specific terms of the Junior Subordinated Debt Securities of any series or the Preferred Securities of any TAP Trust in respect of which this Prospectus is being delivered (the "Offered Securities") will be set forth in a Prospectus Supplement with respect to such Offered Securities, which will describe, without limitation and where applicable, the following: (i) in the case of Junior Subordinated Debt Securities, the specific designation, aggregate principal amount, denomination, maturity, premium, if any, redemption or sinking fund provisions, if any, interest rate (which may be fixed or variable), if any, the time and method of calculating interest payments, if any, dates on which premium, if any, and interest, if any, will be payable, the right of TAP, if any, to defer payment of interest on the Junior Subordinated Debt Securities and the maximum length of such deferral period, the initial public offering price, subordination terms, and any listing on a securities exchange and other specific terms of the offering of Junior Subordinated Debt Securities, and (ii) in the case of Preferred Securities, the designation, number of securities, liquidation preference per security, initial public offering price, any listing on a securities exchange, distribution rate (or method of calculation thereof), dates on which distributions shall be payable and dates from which distributions shall accrue, any voting rights, any redemption or sinking fund provisions, any other rights, preferences, privileges, limitations or restrictions relating to the Preferred Securities and the terms upon which the proceeds of the sale of the Preferred Securities shall be used to purchase a specific series of Junior Subordinated Debt Securities. If so specified in the applicable Prospectus Supplement, Offered Securities may be issued in whole or in part in the form of one or more temporary or permanent global securities. If as set forth in the applicable Prospectus Supplement, TAP has the right to defer payments of interest on a series of Junior Subordinated Debt Securities by extending the interest payment period of such series of Junior Subordinated Debt Securities (each, an "Extension Period"), distributions on the corresponding series of Preferred Securities will also be deferred. There could be up to 80 Extension Periods of varying lengths throughout the term of any series of Junior Subordinated Debt Securities. The Offered Securities may be offered in amounts, at prices and on terms to be determined at the time of offering; provided, however, that the aggregate initial public offering price of all Offered Securities shall not exceed $900 million. Any Prospectus Supplement relating to any series of Offered Securities will contain information concerning certain United States federal income tax considerations, if applicable, to the Offered Securities. TAP or any of the TAP Trusts may sell the Offered Securities directly, through agents designated from time to time or through underwriters or dealers. See "Plan of Distribution." If any agents of TAP, any of the TAP Trusts or any underwriters or dealers are involved in the sale of the Offered Securities, the names of such agents, underwriters or dealers and any applicable commissions and discounts will be set forth in any related Prospectus Supplement. This Prospectus, together with an appropriate Prospectus Supplement, may be used by Smith Barney Inc. ("Smith Barney"), a subsidiary of Travelers Group and an affiliate of TAP and the TAP Trusts, in connection with offers and sales of the Offered Securities (subject to obtaining any necessary approval of the New York Stock Exchange for any such offers and sales) in market-making transactions at negotiated prices related to prevailing market prices at the time of sale. Smith Barney may act as principal or agent in such transactions. 2 NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS OR ANY ACCOMPANYING PROSPECTUS SUPPLEMENT AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY TAP OR ANY OF THE TAP TRUSTS, OR ANY UNDERWRITER, AGENT OR DEALER. NEITHER THE DELIVERY OF THIS PROSPECTUS AND ANY PROSPECTUS SUPPLEMENT NOR ANY SALE MADE THEREUNDER SHALL, UNDER ANY CIRCUMSTANCE, CREATE AN IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF TAP OR ANY OF THE TAP TRUSTS SINCE THE DATE HEREOF OR THEREOF. THIS PROSPECTUS AND ANY RELATED PROSPECTUS SUPPLEMENT DO NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY IN ANY JURISDICTION TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION IN SUCH JURISDICTION. ------------------- FOR NORTH CAROLINA INVESTORS: THE COMMISSIONER OF INSURANCE OF THE STATE OF NORTH CAROLINA HAS NOT APPROVED OR DISAPPROVED THIS OFFERING NOR HAS SUCH COMMISSIONER RULED UPON THE ACCURACY OR THE ADEQUACY OF THIS PROSPECTUS. IN CONNECTION WITH THE OFFERING OF CERTAIN OF THE OFFERED SECURITIES, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICES OF SUCH OFFERED SECURITIES OR OTHER SECURITIES OF TAP AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. AVAILABLE INFORMATION This Prospectus constitutes a part of a registration statement on Form S-3 (together with all amendments and exhibits thereto, the "Registration Statement") filed by TAP and each of the TAP Trusts with the Securities and Exchange Commission (the "Commission") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the Offered Securities. This Prospectus does not contain all of the information set forth in such Registration Statement, certain parts of which are omitted in accordance with the rules and regulations of the Commission. Reference is made to such Registration Statement and to the exhibits relating thereto for further information with respect to TAP, the TAP Trusts and the Offered Securities. Any statements contained herein concerning the provisions of any document filed as an exhibit to the Registration Statement or otherwise filed with the Commission or incorporated by reference herein are not necessarily complete, and, in each instance, reference is made to the copy of such document so filed for a more complete description of the matter involved. Each such statement is qualified in its entirety by such reference. TAP is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith is required to file reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information concerning TAP can be inspected and copied at prescribed rates at the public reference facilities maintained by the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549, and at the following Regional Offices of the Commission: 7 World Trade Center, New York, New York 10048; and Citicorp Center, 500 W. Madison St., Chicago, Illinois 60661-2511. Copies of such material can be obtained from the Public Reference Section of the Commission, at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. Such reports, proxy statements and other information can also be inspected at the office of the New York Stock Exchange, Inc., on which TAP common stock will be traded, at 20 Broad Street, New York, New York 10005. No separate financial statements of the TAP Trusts have been included or incorporated by reference herein. TAP does not consider that such financial statements would be material to holders of the Preferred Securities because (i) all of the voting securities of the TAP Trusts will be owned, directly or indirectly, by TAP, a reporting company under the Exchange Act, (ii) the TAP Trusts have no independent operations but exist for the sole purpose of issuing securities representing undivided beneficial interests in their respective assets and investing the proceeds thereof in Junior Subordinated Debt Securities issued by TAP, and (iii) the obligations of the TAP Trusts under the Preferred Securities are fully and unconditionally guaranteed by TAP to the extent that the respective TAP Trust has funds available to meet such obligations. See "Description of Junior Subordinated Debt Securities" and "Description of Guarantees." 3 INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The Registration Statement on Form 8-A, dated April 11, 1996 filed by TAP (File No. 1-14328) with the Commission pursuant to the Exchange Act is incorporated by reference herein and made a part hereof. All documents filed by TAP pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the date of this Prospectus and prior to the later of (i) the termination of the offering of Offered Securities hereby and (ii) the date on which Smith Barney ceases offering and selling Offered Securities pursuant to this Prospectus shall be deemed to be incorporated by reference in this Prospectus and to be a part hereof from the date of filing of such documents. Any statement contained in a document incorporated or deemed to be incorporated by reference herein shall be deemed to be modified or superseded for purposes of this Prospectus to the extent that a statement contained herein, in an accompanying Prospectus Supplement or in any other subsequently filed document which also is or is deemed to be incorporated by reference herein modifies or supersedes such statement. Any such statement so modified or superseded shall not be deemed to constitute a part of this Prospectus except as so modified or superseded. TAP will provide without charge to each person to whom this Prospectus is delivered, on the written or oral request of any such person, a copy of any or all of the documents incorporated by reference in the Registration Statement of which this Prospectus forms a part other than exhibits to such documents unless such exhibits are specifically incorporated by reference into such documents. Requests should be directed to Travelers/Aetna Property Casualty Corp., One Tower Square, Hartford, Connecticut 06183; Attention: Treasurer; telephone (860) 277-0111. 4 PROSPECTUS SUMMARY The following information is qualified in its entirety by the more detailed information and financial statements, including the notes thereto, appearing elsewhere in this Prospectus. Travelers/Aetna Property Casualty Corp., a Delaware corporation ("TAP"), was formed in January 1996 to hold the property and casualty insurance subsidiaries of The Travelers Insurance Group Inc. ("TIGI"). The information contained in this Prospectus gives effect to the April 2, 1996 acquisition (the "Acquisition") by TAP of the domestic property and casualty insurance subsidiaries of Aetna Life and Casualty Company ("Aetna") and to the other Transactions described under "Recent History." TAP is a holding company and has no direct operations. TAP's principal asset is the capital stock of its insurance subsidiaries. The Acquisition and the other Transactions will be consummated before the closing of any offering of Preferred Securities, and therefore, except where otherwise stated, all information in this Prospectus Supplement assumes that the Acquisition and the other Transactions will be consummated around the end of the first quarter of 1996. The closing of the Acquisition is subject to certain conditions, including regulatory approval. As used in this Prospectus, unless the context otherwise requires, "Travelers P&C" refers to The Travelers Indemnity Company ("Travelers Indemnity") and its subsidiaries; "Aetna P&C" refers to The Aetna Casualty and Surety Company ("Aetna Casualty") and The Standard Fire Insurance Company ("Standard Fire") and their subsidiaries; and the "Company" means, subsequent to the Acquisition, TAP together with its consolidated subsidiaries (comprised of Travelers P&C and Aetna P&C), and, prior to the Acquisition, the combined business of Travelers P&C and Aetna P&C operating as wholly owned subsidiaries of TIGI and Aetna, respectively. Consolidated financial statements presented in this Prospectus for TAP for periods prior to the Acquisition consist of financial statements for Travelers Indemnity and its subsidiaries. Statistical data provided herein for the "Company" for all periods prior to the Acquisition is based on combined data for Travelers P&C and Aetna P&C. See "Glossary of Selected Insurance Terms" for the definitions of certain insurance-related terms. Unless otherwise indicated, all data in this Prospectus assumes that the U.S. Underwriters' over-allotment option granted in connection with the Equity Offering (as defined) is not exercised, and all share data in this Prospectus has been adjusted to reflect the Transactions. See "Recent History." Unless otherwise indicated, financial information and operating statistics applicable to the Company set forth in this Prospectus are based on United States generally accepted accounting principles ("GAAP") and not statutory accounting practices. In conformity with industry practice, data derived from A.M. Best Company, Inc. ("A.M. Best") and the National Association of Insurance Commissioners ("NAIC") sources, generally used herein for industry comparisons, are based on statutory accounting practices. THE COMPANY OVERVIEW The Company is the fourth largest property and casualty insurance company in the United States, based on 1994 direct written premiums published by A.M. Best, after giving effect to the acquisition of Aetna P&C and recent industry consolidation. The Company provides a wide range of commercial and personal property and casualty insurance products and services to businesses, government units, associations and individuals. Commercial coverages and personal coverages accounted for 76% and 24%, respectively, of the Company's combined net written premiums and premium in 1995 of $10.5 billion (including premium equivalents for Travelers P&C). After giving pro forma effect to the Transactions, the Equity Offering, the Preferred Trust Securities Offerings (as defined) and the Debt Offerings (as defined), at December 31, 1995 the Company had total assets and stockholders' equity of $49.5 billion and $6.1 billion, respectively. On April 2, 1996, TAP completed the Acquisition. The Company believes that the businesses of Aetna P&C and Travelers P&C provide complementary product offerings and distribution systems. The Company believes that it can effectively integrate these businesses, which will enable it to capitalize on the strengths of Travelers P&C and Aetna P&C and to create a stronger leadership position in the property and casualty insurance industry. The Company further believes that it has the following competitive advantages: (i) brand names that are among the most broadly recognized in the industry; (ii) a management team selected from the most qualified professionals, primarily at Travelers P&C and Aetna P&C, including certain senior managers who have worked together for several years at Travelers P&C and have achieved significant increases in profitability at Travelers P&C through 5 cost reductions, effective underwriting and pricing practices and catastrophe exposure management policies; (iii) nationally leading market shares in several important commercial and personal product lines; and (iv) a strong financial position. COMMERCIAL LINES. The Company is the third largest writer of commercial lines insurance in the United States based on 1994 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. The Company's commercial lines ("Commercial Lines") offers a broad array of property and casualty insurance and insurance-related services. Commercial Lines are organized into four marketing groups that are designed to focus on a particular client base or industry segment to provide products and services that specifically address customers' needs: National accounts ("National Accounts"), primarily serving large national corporations; Commercial accounts ("Commercial Accounts"), serving mid-size businesses; Select accounts ("Select Accounts"), serving small businesses; and Specialty accounts ("Specialty Accounts"), providing a variety of specialty coverages. The Company also has a dedicated group within Commercial Accounts that serves the construction industry ("Construction"). The Company distributes its commercial products through approximately 6,000 brokers and independent agencies located throughout the United States. See "Business--Commercial Lines." The commercial coverages marketed by the Company include workers' compensation, general liability (including product liability), multiple peril, commercial automobile, property (including fire and allied lines), fidelity and surety and several other miscellaneous coverages. The Company underwrites specialty coverages including general liability for selected product liability risks, medical malpractice, umbrella and excess liability coverage, directors and officers liability insurance, errors and omissions insurance, fidelity and surety and fiduciary liability insurance and other professional liability insurance. In addition, the Company offers various risk management services, generally including claims settlement, loss control and engineering services, to businesses that choose to self-insure certain exposures, to states and insurance carriers that participate in state involuntary workers' compensation pools and to employers seeking to manage workers' compensation medical and disability costs. In 1995, Commercial Lines generated combined net written premiums of approximately $5.1 billion and, for Travelers P&C, premium equivalents of $2.8 billion. PERSONAL LINES. The Company is the largest writer of personal lines insurance through independent agents and the sixth largest writer of personal lines insurance overall in the United States based on 1994 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. The Company's personal lines ("Personal Lines") primarily offers personal automobile and homeowners insurance. The Company distributes its Personal Lines products through approximately 5,500 independent agents located throughout the United States. The Company is pursuing a number of initiatives to broaden its distribution of Personal Lines products, including developing special products for affinity groups, employee groups and other sponsoring organizations and establishing co-marketing arrangements with other insurers. Travelers P&C has recently begun marketing personal automobile and homeowners insurance through the independent agents of Primerica Financial Services ("PFS"), an affiliate of the Company. This program was established in 14 states as of December 31, 1995, and is expected to reach approximately 75% of all states by the end of 1996. PFS agents are currently selling approximately 1,500 new automobile and homeowners policies each month. In 1995, Personal Lines generated combined net written premiums of approximately $2.5 billion. THE STRATEGIC PLAN The Company's strategic objectives are to enhance its position as a consistently profitable market leader and to become a low-cost provider of property and casualty insurance in the United States. Since 1993, Travelers P&C's experienced management team has pursued this objective at Travelers P&C by eliminating redundant expenses, reducing overhead and streamlining the corporate infrastructure, realigning its business structure to give more authority to regional and field offices, establishing a performance-based compensation program to promote greater accountability at the operating business level, advancing its leading Commercial Lines presence, improving its underwriting approach and implementing enhanced catastrophe exposure management policies. These initiatives have resulted in substantial productivity and efficiency gains. Since 1993, Travelers P&C has realized annualized expense savings of approximately $180 million and an increase in after-tax operating income (excluding realized gains and losses) to $373 million in 1995 from $248 million in 1993 (before giving effect to a $194 million after-tax charge in 1993 due primarily to an increase in environmental and asbestos reserves). Travelers P&C has also benefited during this period from the financial strength provided by Travelers Group Inc. 6 ("Travelers Group"), which strength contributed to an upgrade in early 1994 in Travelers P&C's A.M. Best rating. The expense savings of approximately $180 million were realized from expenses contained in the general and administrative expense category from 1995 compared to 1993. Offsetting these continuing expense savings in 1995 were approximately $30 million of expenses classified as general and administrative expenses for the first time in 1995 as a result of the consolidation of one subsidiary of Travelers P&C in 1995 which was accounted for on the equity method prior to 1995, and the inclusion in 1995 of approximately $15 million of one-time start up costs for new business ventures. Net of these additions, general and administrative expenses at Travelers P&C continued to decline in 1995. During this period, Aetna P&C experienced losses from continuing operations before income tax benefits and cumulative effect adjustments of $406 million, $91 million and $214 million in 1995, 1994 and 1993, respectively, and had net losses of $243 million and $37 million in 1995 and 1994, respectively (as compared to net income of $239 million in 1993). As one of the first and most integral steps toward reaching its objectives, the Company has selected a management team comprised of the individuals at each of Travelers P&C and Aetna P&C with the broadest complement of skills. Of the top 300 members of the Company's management team, which includes field personnel, approximately 50% represent individuals from Aetna P&C and 50% represent individuals from Travelers P&C. This team also includes two members of senior management from outside Travelers P&C and Aetna P&C to lead the claims and finance functions of the Company. The Company believes that the management strengths of this group, together with stronger financial resources available to the combined Company, will promote the Company's achievement of the goals described below. The Company believes that the acquisition and integration of Aetna P&C present additional opportunities for this experienced management team to continue to improve productivity and efficiency, to further reduce costs and to improve the Company's overall financial strength. Management has established the following key strategic objectives for the Company: BECOME A LOW-COST PROVIDER OF PROPERTY AND CASUALTY INSURANCE. The Company believes that a critical competitive advantage in the property and casualty insurance industry is to be a low-cost provider of insurance products. Beginning in 1993, Travelers P&C made significant changes that reduced costs and enhanced productivity. The Company will implement similar cost reductions and productivity enhancements at Aetna P&C, including reducing overhead expenses, making changes in the corporate infrastructure of Aetna P&C to make it more consistent with the decentralized, streamlined structure at Travelers P&C, and eliminating redundant expenses between the two companies. The Company has identified $300 million in projected annual cost savings to be achieved over the next two years; however, there can be no assurance that such cost savings will be achieved. In addition, the Company has conducted a business-by-business review of each of Aetna P&C and Travelers P&C to select the most effective technology and systems in the marketing, underwriting and claims areas and to identify additional opportunities to reduce costs and to become more responsive to customer needs. These projected annual cost savings include $230 million of salaries and benefits associated with the projected elimination of 3,300 positions, rent expense reductions of $28 million and reduction in other expenses of approximately $42 million. MAINTAIN FINANCIAL STRENGTH AND SEEK TO IMPROVE RATINGS. The Company believes that it is well capitalized and that its financial strength creates a competitive advantage in retaining and attracting business. Travelers P&C and Aetna P&C, the tenth and ninth largest property and casualty insurance companies in the United States, respectively, combined to become the fourth largest property and casualty insurance company in the United States, in each case based on 1994 direct written premiums published by A.M. Best. The Company believes that the combined Company's market share, strong balance sheet and cash flow, together with management's experience in growing companies through acquisitions, create an effective platform for the Company's participation in the continuing consolidation in the property and casualty insurance industry where the Company believes new opportunities will be increasingly available. After giving effect to the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings, at December 31, 1995 the Company had pro forma stockholders' equity of $6.1 billion and a pro forma long-term debt to capitalization ratio of 17.9%. See "Capitalization." The Company plans to maintain its sound financial position through its selective underwriting practices, conservative reserving policies and a high quality investment portfolio. Over time, the Company will seek to improve the claims-paying ratings of its property and casualty insurance operations. 7 CONTINUE TO FOCUS ON CORE PRODUCT LINES USING A DISCIPLINED UNDERWRITING APPROACH. The Company will continue to focus on its core property and casualty insurance product lines and markets in which it has developed expertise in using selective and consistent underwriting policies that are applied across product lines and markets. The Company emphasizes a profit-oriented rather than a premium volume or market share-oriented approach to underwriting. Key elements of this approach include: (i) closely monitoring the quality of the business identified by the Company, its brokers and its agents to assess loss experience and pricing parameters; and (ii) performing periodic reviews and audits of field offices and agents to ensure that the Company's policies and procedures are being consistently and appropriately applied. The Company has also developed an approach to underwriting Commercial Lines business built upon significant underwriting, claims, engineering and actuarial experience that provides specialized knowledge about various industry segments and catastrophe management to analyze risk and account characteristics in determining pricing parameters. The Company believes that this approach enables it to select acceptable risks and to tailor its products and pricing to the specific needs of those Commercial Lines customers who generally require customized insurance products and services. The Company intends to continue to enhance and expand the use of this approach in both Travelers P&C and Aetna P&C businesses. EMPHASIZE CUSTOMER-ORIENTED FOCUS. To continue to provide a broad array of new products and services within the Company's core product lines and markets and to foster simpler, closer relationships with customers, the Company has adopted an industry-specific orientation within its Commercial Lines marketing groups that is based on account characteristics and targeted industry segments. The Company also intends to make changes in the corporate infrastructure of Aetna P&C so that it becomes more consistent with the decentralized, streamlined structure at Travelers P&C, thereby allowing the Company's field personnel to be more responsive to customer needs. The Company will seek to foster point-of-sale transactions by shifting decision-making authority, within defined parameters, to field marketing representatives who interact directly with agents, brokers and insureds. This process is linked with a strong collaborative underwriting review effort both in the Company's regional locations and in the home office. The Company will also seek to enhance customer relations by providing timely, responsive pricing quotes and claims service. EFFECTIVELY MANAGE DISTRIBUTION SYSTEMS AND CAPITALIZE ON CROSS-SELLING OPPORTUNITIES. The Company believes that a critical competitive advantage in the property and casualty insurance industry is a loyal, high quality distribution network which focuses on the insurer's products and services. The Company will seek to maintain strong relationships with its distribution force, including independent agents, selected small to medium-sized brokers having a strong local or regional presence and large national brokerage firms. As a result of the Acquisition, the Company will be able to offer its agents and brokers cross-selling opportunities from a broader product line. In so doing, the Company believes that it will be better positioned to capture a greater percentage of business handled by well established and growing agencies. Examples of cross-selling opportunities that are expected to be made available to the Company's distribution network include the Bond Specialty products and the construction industry market expertise that previously had been available only to agents of Aetna P&C and the workers' compensation expertise in the National Accounts market that is one of the strengths of Travelers P&C. MANAGE CATASTROPHE, ENVIRONMENTAL AND ASBESTOS LOSS EXPOSURE. The Company will continue to manage actively its exposure to catastrophe losses by seeking to control exposure in high-risk areas, by employing sophisticated computer modeling techniques to review significant outstanding coverages to determine where non-renewal is advisable and by implementing price increases where appropriate (in each case, subject to restrictions imposed by insurance regulatory authorities). The Company will continue to manage its environmental liability exposures by aggressively reviewing and settling claims where appropriate. The environmental and asbestos claims of Travelers P&C are managed by a dedicated group of professionals organized as a separate business unit that works closely with members of senior management. The Company believes that this approach gives it consistency in claims handling and policy coverage interpretation. MANAGE CAPITAL RESOURCES. The Company intends to maximize stockholder value by: (i) pursuing premium growth to the extent allowed by market conditions; (ii) making further acquisitions, subject to market conditions; and (iii) increasing return on stockholders' equity. 8 CONTROLLING STOCKHOLDER TAP has two classes of authorized common stock, par value $.01 per share (the "Class A Common Stock" and the "Class B Common Stock" and, collectively, the "Common Stock"). On all matters submitted to a vote of the TAP stockholders, holders of Class A Common Stock are entitled to one vote per share and holders of Class B Common Stock are entitled to ten votes per share. Upon consummation of the Equity Offering, Travelers Group, through TIGI, will own all of the outstanding Class B Common Stock, representing approximately 98.0% of the combined voting power of TAP's Common Stock and approximately 82.7% of the economic interest in TAP (97.9% and 82.0%, respectively, if the Underwriters' over-allotment option granted in connection with the Equity Offering is exercised in full). Travelers Group, which is led by Sanford I. Weill, its Chairman and Chief Executive Officer, has grown substantially through internal growth and a series of acquisitions including Primerica Corporation in 1988, the domestic retail brokerage and asset management businesses of Shearson Lehman Brothers Holdings Inc. in 1993 and The Travelers Corporation in 1993. In 1995, Travelers Group had revenues of $16.6 billion, net income of $1.8 billion and a return on common equity of 18.3%. See "Risk Factors Related to the Company-- Control By and Relationship with Travelers Group; Conflicts of Interest." THE EQUITY OFFERING, THE TRUST PREFERRED SECURITIES OFFERINGS AND THE DEBT OFFERINGS On or about the date hereof, TAP expects to (i) consummate an initial public offering of 35,435,740 shares of its Class A Common Stock (the "Equity Offering"); (ii) offer, subject to market conditions, up to $900 million of Preferred Securities issued by the TAP Trusts pursuant to separate Prospectus Supplements (the "Trust Preferred Securities Offerings"); and (iii) offer, subject to market conditions, up to $1.5 billion principal amount of senior debt securities in one or more series (the "Debt Offerings") pursuant to a separate registration statement. The net proceeds to TAP from the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings are expected to be used to repay certain borrowings incurred in connection with the Acquisition. Any remaining proceeds will be used for general corporate purposes. See "Recent History." ------------------- The Company's executive offices are located at One Tower Square, Hartford, Connecticut 06183 and its telephone number is (860) 277-0111. TAP TRUSTS Each of the TAP Trusts is a statutory business trust formed under Delaware law pursuant to (i) a declaration of trust executed by TAP, as sponsor for such trust (the "Sponsor"), and the trustees of such trust and (ii) the filing of a certificate of trust with the Secretary of State of the State of Delaware on March 15, 1996. Each such declaration will be amended and restated in its entirety (as so amended and restated, each a "Declaration"), and is substantially in the form filed as an exhibit to the Registration Statement of which this Prospectus forms a part. Each of the TAP Trusts exists for the exclusive purposes of (i) issuing the Preferred Securities and common securities representing undivided beneficial interests in the assets of the Trust (the "Common Securities" and, together with the Preferred Securities, the "Trust Securities"), (ii) investing the gross proceeds from the sale of the Trust Securities in the Junior Subordinated Debt Securities and (iii) engaging in only those other activities necessary or incidental thereto. All of the Common Securities will be directly or indirectly owned by TAP. The Common Securities will rank pari passu, and payments will be made thereon pro rata, with the Preferred Securities, except that, upon an event of default under the Declaration, the rights of the holders of the Common Securities to payment in respect of distributions and payments upon liquidation, redemption and otherwise will be subordinated to the rights of the holders of the Preferred Securities. TAP will directly or indirectly acquire Common Securities in an aggregate liquidation amount equal to 3% or more of the total capital of each TAP Trust. Each TAP Trust has a term of approximately 55 years but may terminate earlier, as provided in each Declaration. Each TAP Trust's business and affairs will be conducted by the trustees of each applicable Trust (the "TAP Trustees") appointed by TAP as the direct or indirect holder of all the Common Securities. The holder of the Common Securities will be entitled to appoint, remove or replace any of, or increase or reduce the number of, the TAP Trustees of the TAP Trusts. The duties and obligations of the TAP Trustees shall be governed by the Declaration of such TAP Trust. Each TAP Trust will have two TAP Trustees (the "Regular Trustees") who are employees or officers of or who are affiliated with TAP. One TAP Trustee of each TAP Trust will be a financial 9 institution that is not affiliated with TAP and that has a specified minimum amount of aggregate capital, surplus, and undivided profits of not less than $50,000,000, which shall act as property trustee and as indenture trustee for the purposes of compliance with the provisions of Trust Indenture Act of 1939, as amended (the "Trust Indenture Act"), pursuant to the terms set forth in a Prospectus Supplement (the "Institutional Trustee"). In addition, unless the Institutional Trustee maintains a principal place of business in the State of Delaware and otherwise meets the requirements of applicable law, one TAP Trustee of each TAP Trust will have a principal place of business or reside in the State of Delaware (the "Delaware Trustee"). TAP will pay all fees and expenses related to the TAP Trusts and the offering of the Trust Securities. The office of the Delaware Trustee for each of the TAP Trusts is The Chase Manhattan Bank (USA), 802 Delaware Avenue, Wilmington, Delaware 19801. The address for each TAP Trust is c/o TAP, the Sponsor of the TAP Trusts, at TAP's corporate headquarters located at One Tower Square, Hartford, Connecticut 06183, telephone (860) 277-0111. RISK FACTORS RELATING TO THE COMPANY Prospective investors should consider carefully, in addition to the other information contained in this Prospectus, the matters set forth under the caption "Risk Factors Relating to the Company" before purchasing the Preferred Securities. 10 SUMMARY FINANCIAL INFORMATION SUMMARY CONSOLIDATED HISTORICAL FINANCIAL INFORMATION OF TAP The summary consolidated financial information presented below is derived from the consolidated financial statements of TAP and its subsidiaries. Such financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants, for each of the three years in the period ended December 31, 1995. The consolidated financial statements of TAP and its subsidiaries as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 are included in this Prospectus, and the information set forth below should be read in conjunction with such consolidated financial statements and the notes thereto.
TAP HISTORICAL(1) YEAR ENDED DECEMBER 31, --------------------------------------------------------------- 1995 1994 1993 1992 1991 ------- ------- ------- ----------- --------------- (Dollars in millions) INCOME STATEMENT DATA: (unaudited) Revenues: Premiums.......................................... $ 3,315 $ 3,178 $ 3,378 $ 3,992 $ 4,481 Net investment income............................. 710 573 657 677 724 Fee income........................................ 456 496 470 468 421 Realized investment gains (losses)................ 71 (132) 192 97 5 Other income...................................... 17 53 18 11 19 ------- ------- ------- ----------- ------- Total revenues................................ 4,569 4,168 4,715 5,245 5,650 Benefits and expenses: Claims and claim adjustment expenses.............. 2,817 2,819 3,245 4,033 3,964 Amortization of deferred acquisition costs........ 512 473 475 497 514 General and administrative expenses............... 689 666 825 1,069 905 ------- ------- ------- ----------- ------- Total benefits and expenses................... 4,018 3,958 4,545 5,599 5,383 Income (loss) before federal income taxes and cumulative effects of changes in accounting principles......................................... 551 210 170 (354) 267 Federal income taxes (tax benefits)................ 132 22 3 (168) 12 ------- ------- ------- ----------- ------- Income (loss) before cumulative effects of changes in accounting principles.......................... 419 188 167 (186) 255 Cumulative effects of changes in accounting principles, net of tax............................ -- -- -- (71) -- ------- ------- ------- ----------- ------- Net income (loss).................................. $ 419 $ 188 $ 167 $ (257) $ 255 ------- ------- ------- ----------- ------- ------- ------- ------- ----------- ------- BALANCE SHEET DATA (AT PERIOD END): (unaudited) (unaudited) Total investments.................................. $12,820 $10,325 $10,461 $10,314 $ 9,796 Total assets....................................... 24,621 23,137 21,416 20,842 20,392 Claims and claim adjustment expense reserves....... 15,460 15,299 14,934 14,765 14,709 Total liabilities.................................. 21,020 20,556 18,439 18,242 17,519 Stockholder's equity............................... 3,601 2,581 2,977 2,600 2,873 Stockholder's equity excluding unrealized investment gains and losses, net of taxes......... 3,321 3,024 2,965 2,556 2,852 OTHER DATA (UNAUDITED): Statutory data: Ratio of net premiums written to surplus(2) 1.49x 1.68x 1.62x 1.87x 1.85x Policyholders' surplus........................ $ 2,438 $ 2,133 $ 2,246 $ 2,058 $ 2,374 Loss and LAE ratio(3)......................... 78.2% 90.2% 88.6% 96.1% 83.9% Underwriting expense ratio(3)................. 26.4% 26.2% 29.3% 29.8% 26.8% Combined ratio before policyholder dividends.......................................... 104.6% 116.4% 117.9% 125.9% 110.7% Combined ratio(3)............................. 105.4% 115.3% 118.8% 126.1% 111.2% Statutory industry data: Combined ratio for property and casualty insurers(4)........................................ 107.2% 108.5% 106.9% 115.8% 108.8%
- ------------ (1) GAAP financial data related to the balance sheet data as of December 31, 1993 and subsequent, and income statement data related to periods ended after December 31, 1993 are presented on a purchase accounting basis. (2) Represents statutory net premiums written for the year over statutory policyholders' surplus at the end of such year. (3) The loss and LAE ratio represents the ratio of incurred losses and loss adjustment expenses to net premiums earned. The underwriting expense ratio represents the ratio of underwriting expenses incurred to net premiums written. The combined ratio represents the sum of the loss and LAE ratio and the underwriting expense ratio after policyholder dividends. (4) Source: A.M. Best. Information for 1995 is an estimate. For certain information concerning the operating results for the first quarter of 1996, see "Recent Operating Results." 11 SUMMARY UNAUDITED PRO FORMA FINANCIAL INFORMATION The following summary unaudited pro forma condensed combined statement of income of TAP for the year ended December 31, 1995 presents results for the Company as if the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings had occurred as of January 1, 1995. The accompanying summary unaudited pro forma condensed combined balance sheet as of December 31, 1995 gives effect to the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings as if they had occurred as of December 31, 1995. The summary unaudited pro forma information does not purport to represent what the Company's financial position or results of operations actually would have been had the Transactions and such offerings in fact occurred on the dates indicated, or to project the Company's financial position or results of operations for any future date or period. The pro forma adjustments are based on available information and certain assumptions that the Company currently believes are reasonable in the circumstances. The summary unaudited pro forma combined financial information should be read in conjunction with "Unaudited Pro Forma Financial Information" and the notes thereto, the historical Consolidated Financial Statements of TAP as of and for the year ended December 31, 1995 and the historical Combined Financial Statements of Aetna P&C as of and for the year ended December 31, 1995, in each case contained in this Prospectus. The pro forma adjustments and pro forma combined amounts are provided for informational purposes only. The Company's financial statements will reflect the effects of the Transactions, Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings only from the dates such events occur. The pro forma adjustments are applied to the historical financial statements to, among other things, account for the Acquisition as a purchase. Under purchase accounting, the total purchase cost for the Acquisition will be allocated to the Aetna P&C assets and liabilities based on their fair values. Allocations are subject to valuations as of the date of the Acquisition based on appraisals and other studies, which are not yet completed. Accordingly, the final allocations will be different from the amounts reflected herein. Although the final allocations will differ, the summary unaudited pro forma financial information reflects management's best estimate based on currently available information as of the date of this Prospectus. Included in the historical results of Aetna P&C for the year ended December 31, 1995 are charges of $750 million ($488 million after tax) representing an addition to environmental-related claims reserves in the second quarter of 1995 and $335 million ($218 million after tax) representing an addition to asbestos reserves in the fourth quarter of 1995. As the Aetna P&C operations are integrated with the existing property and casualty insurance operations of the Company, management of the Company expects to realize, over a two-year period, $300 million ($195 million after tax) in annual cost savings from reduction of overhead expenses, changes in the corporate infrastructure of Aetna P&C and the elimination of redundant expenses. There can be no assurance that the Company will achieve its projected cost savings. See "Business--The Strategic Plan." These expected future cost savings are not reflected in the Summary Unaudited Pro Forma Financial Information. 12 SUMMARY UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET AS OF DECEMBER 31, 1995
PRO FORMA ADJUSTMENTS --------------------------------- FOR THE EQUITY OFFERING, THE DEBT OFFERINGS AND THE TRUST AETNA PREFERRED TAP P&C FOR THE SECURITIES PRO FORMA HISTORICAL HISTORICAL TRANSACTIONS OFFERINGS COMBINED ---------- ---------- ------------ -------------- --------- (Dollars in millions) ASSETS Investments............................. $ 12,820 $ 13,853 $ 450 $27,123 Cost of acquired businesses in excess of net assets.............................. 419 848 1,267 Other assets............................ 11,382 9,546 143 $ 10 21,081 ---------- ---------- ------------ ------- --------- Total assets...................... $ 24,621 $ 23,399 $ 1,441 $ 10 $49,471 ---------- ---------- ------------ ------- --------- ---------- ---------- ------------ ------- --------- LIABILITIES AND STOCKHOLDERS' EQUITY Claims and claim adjustment expense reserves................................ $ 15,460 $ 16,559 $32,019 Long-term debt.......................... 35 $ 2,650 $ (1,164) 1,521 Other liabilities....................... 5,560 2,924 468 8,952 ---------- ---------- ------------ ------- --------- Total liabilities................. 21,020 19,518 3,118 (1,164) 42,492 ---------- ---------- ------------ ------- --------- Series Z Preferred Stock................ 540 (540) TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts.................................. 900 900 Stockholders' equity.................... 3,601 3,881 (2,217) 814 6,079 ---------- ---------- ------------ ------- --------- Total liabilities and stockholders' equity............ $ 24,621 $ 23,399 $ 1,441 $ 10 $49,471 ---------- ---------- ------------ ------- --------- ---------- ---------- ------------ ------- ---------
See "Unaudited Pro Forma Financial Information--Notes to Unaudited Pro Forma Condensed Combined Balance Sheet" on pages 29 and 30. 13 SUMMARY UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1995
PRO FORMA ADJUSTMENTS ----------------------------------- FOR THE EQUITY OFFERING, THE TRUST PREFERRED SECURITIES TAP AETNA P&C FOR THE OFFERINGS AND THE PRO FORMA HISTORICAL HISTORICAL TRANSACTIONS DEBT OFFERINGS COMBINED ---------- --------- ------------ -------------------- --------- (Dollars in millions, except per share amounts) Revenues: Premiums....................................... $3,315 $ 4,118 $ 7,433 Net investment income.......................... 710 902 $ (35) 1,577 Fee income..................................... 456 82 538 Realized investment gains...................... 71 199 270 Other income................................... 17 17 ---------- --------- ------ ----- --------- Total revenues............................. 4,569 5,301 (35) -- 9,835 ---------- --------- ------ ----- --------- Benefits and expenses: Claims and claim adjustment expenses........... 2,817 4,232 7,049 Amortization of deferred acquisition costs..... 512 623 1,135 General and administrative expenses............ 689 852 (10) $ 24 1,708 153 ---------- --------- ------ ----- --------- Total benefits and expenses................ 4,018 5,707 143 24 9,892 ---------- --------- ------ ----- --------- Income (loss) before federal income taxes...... 551 (406) (178) (24) (57) Federal income taxes (tax benefits)............ 132 (163) (55) (8) (94) ---------- --------- ------ ----- --------- Net income (loss).............................. $ 419 $ (243) $ (123) $(16) $ 37 ---------- --------- ------ ----- --------- ---------- --------- ------ ----- --------- Net income per share of Common Stock........... $ 0.09 --------- --------- Weighted average number of shares of Common Stock outstanding (in millions)................ 396.5 --------- ---------
See "Unaudited Pro Forma Financial Information--Notes to Unaudited Pro Forma Condensed Combined Statement of Income" on page 32 herein. Included in the historical results of Aetna P&C for the year ended December 31, 1995 are charges of $750 million ($488 million after tax) representing an addition to environmental-related claims reserves in the second quarter of 1995 and $335 million ($218 million after tax) representing an addition to asbestos reserves in the fourth quarter of 1995. As the Aetna P&C operations are integrated with the existing property and casualty insurance operations of the Company, management of the Company expects to realize, over a two-year period, $300 million ($195 million after tax) in annual cost savings from reduction of overhead expenses, changes in the corporate infrastructure of Aetna P&C and elimination of redundant expenses. There can be no assurance that the Company will achieve its projected cost savings. See "Business--The Strategic Plan." These expected future cost savings are not reflected in the Summary Unaudited Pro Forma Financial Information. The allocation of the purchase price to the assets and liabilities of Aetna P&C is subject to valuations as of the date of the Acquisition based on appraisals and other studies, which are not yet completed. Accordingly, the final allocations will differ from the amounts reflected herein. Adjustments of claims and claims adjustment expense reserves and certain other insurance accounts resulting from the valuation of these accounts will be recorded in operations in the period or periods determined. The Company is continuing to review the insurance reserves of Aetna P&C, including the effect of applying the Company's strategies, policies and practices in determining such reserves and in settling claims. Based on the reviews at this stage, it is possible that additional reserves of up to approximately $750 million in the aggregate may be recorded upon completion of these reviews, which would result in after-tax charges to income of up to approximately $488 million in the aggregate, primarily relating to reserves for cumulative injury claims, insurance products involving financial guarantees based on the fair value of underlying collateral and certain insurance receivables. Stockholders' equity would be correspondingly reduced by an equivalent amount as a result of these charges. The Company believes that its reviews are likely to be completed in 1996, although there can be no assurance as to the ultimate timing thereof. 14 RISK FACTORS RELATING TO THE COMPANY Prospective investors should consider carefully, in addition to the other information contained in this Prospectus and in an accompanying Prospectus Supplement, the following risk factors relating to the Company before purchasing Preferred Securities. FLUCTUATION AND UNCERTAINTY OF PROPERTY AND CASUALTY INSURANCE INDUSTRY RESULTS The results of companies in the property and casualty insurance industry historically have been subject to significant fluctuations and uncertainties. The industry's profitability can be affected significantly by volatile and unpredictable developments (including catastrophes); changes in reserves resulting from the general claims and legal environments as different types of claims arise and judicial interpretations relating to the scope of insurers' liability develop; fluctuations in interest rates and other changes in the investment environment, which affect returns on invested capital; and inflationary pressures that affect the size of losses. The demand for property and casualty insurance can also vary significantly, generally rising as the overall level of economic activity increases and falling as such activity decreases. The property and casualty insurance industry historically has been cyclical, and the industry as a whole has been in a soft market since the late 1980s primarily due to premium rate competition, which has resulted in lower underwriting profitability. The Company's results of operations may be adversely affected by these fluctuations. See "Business." CATASTROPHE LOSSES Property and casualty insurers are subject to claims arising out of catastrophes, which may have a significant effect on their results of operations and financial condition. The Company has experienced, and can be expected in the future to experience, catastrophe losses which may have a material adverse effect on the Company's results of operations and financial condition. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosions, severe winter weather and fires, and the incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. Although catastrophes can cause losses in a variety of the Company's property and casualty lines, most of the Company's catastrophe-related claims in the past have related to homeowners and commercial property coverages. See "Business--Reinsurance." The Company generally seeks to reduce its exposure to catastrophe losses through its selective underwriting practices and the purchase of catastrophe reinsurance. There can be no assurance that the reinsurance purchased by the Company will be adequate to protect the Company against material catastrophe losses or that such reinsurance will continue to be available to the Company in the future at commercially reasonable rates. States have from time to time passed legislation that has the effect of limiting the ability of insurers to manage risk, such as legislation prohibiting an insurer from withdrawing from catastrophe-prone areas. While the Company attempts to limit its exposure to acceptable levels, subject to restrictions imposed by insurance regulatory authorities, it is possible that a catastrophic event or multiple catastrophic events could have a material adverse effect on the Company. The Company also participates in the Florida Hurricane Catastrophe Fund ("FHCF"), which is a state-mandated catastrophe reinsurance fund. See "--Reinsurance Considerations" and "Business--Reinsurance." For a discussion of the Company's exposure in different states, see "Business--Commercial Lines--Geographic Distribution" and "Business--Personal Lines--Geographic Distribution." Losses incurred by Travelers P&C from catastrophes, net of reinsurance and after taxes, were $19 million, $56 million, $34 million, $353 million and $37 million in 1995, 1994, 1993, 1992 and 1991, respectively. Effective April 1, 1995, the threshold of losses incurred to qualify a specific event as a catastrophe was increased. Losses incurred by Aetna P&C from catastrophes, net of reinsurance and after taxes, were $65 million, $190 million, $85 million, $118 million and $60 million in 1995, 1994, 1993, 1992 and 1991, respectively. There can be no assurance that the Company will not experience losses of this magnitude or greater from catastrophes in future periods. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." 15 UNCERTAINTY REGARDING ADEQUACY OF PROPERTY AND CASUALTY LOSS RESERVES The Company maintains property and casualty loss reserves to cover its estimated ultimate liability for losses and loss adjustment expenses ("LAE") with respect to reported and unreported claims incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability, but instead represent estimates, generally involving actuarial projections at a given time, of what the Company expects the ultimate settlement and administration of claims will cost based on its assessment of facts and circumstances then known, estimates of future trends in claims severity, frequency, judicial theories of liability and other factors. These variables are affected by both internal and external events, such as changes in claims handling procedures, economic inflation, judicial trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant reporting lags between the occurrence of the insured event and the time it is actually reported to the insurer. Reserve estimates are continually refined in a regular ongoing process as experience develops and further claims are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such estimates are changed. Because establishment of reserves is an inherently uncertain process involving estimates of future losses, there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. See "Business--Reserves." The inherent uncertainties of estimating insurance reserves are generally greater for casualty coverages (particularly reserves for asbestos losses), than for property coverages, due primarily to the longer period of time that typically elapses before a definitive determination of ultimate loss can be made, changing theories of legal liability involving certain types of claims and changing political climates. Certain of the Company's loss reserves are for environmental and asbestos claims. There is a high degree of uncertainty with respect to future exposure from environmental and asbestos claims. See "--Uncertainty Regarding Adequacy of Environmental and Asbestos Loss Reserves." UNCERTAINTY REGARDING ADEQUACY OF ENVIRONMENTAL AND ASBESTOS LOSS RESERVES There is a high degree of uncertainty with respect to future exposure from environmental and asbestos claims. The environmental reserves of Travelers P&C, net of reinsurance, were $404 million, $441 million and $459 million at December 31, 1995, 1994 and 1993, respectively. The asbestos reserves of Travelers P&C, net of reinsurance, were $402 million, $336 million and $347 million at December 31, 1995, 1994 and 1993, respectively. The environmental reserves of Aetna P&C, net of reinsurance, were $977 million, $378 million and $230 million at December 31, 1995, 1994 and 1993, respectively. The asbestos reserves of Aetna P&C, net of reinsurance, were $687 million, $257 million and $225 million at December 31, 1995, 1994 and 1993, respectively. See Note 7 of Notes to the Consolidated Financial Statements of TAP and Note 12 of Notes to the Combined Financial Statements of Aetna P&C, included elsewhere herein. There is a high degree of uncertainty with respect to future exposure from environmental claims. Significant issues exist primarily as to whether there is coverage for claims, the liability of the insureds and diverging legal interpretations and judgments state by state relating to, among other things: when the loss occurred and which policies provide coverage; which claims are covered; whether there is an insured obligation to defend; how policy limits are determined; how policy exclusions are applied and interpreted; whether clean up costs represent insured property damage; and other issues. As a result of various state and federal regulatory efforts aimed at environmental remediation (particularly "Superfund"), the insurance industry has been, and continues to be, involved in extensive litigation involving policy coverage and liability issues. In addition to regulatory pressures, the Company believes that certain court decisions have expanded insurance coverage beyond the original intent of the insurers and insureds. The results of court decisions affecting the industry's coverage positions continue to be inconsistent. Accordingly, the ultimate responsibility and liability for environmental remediation costs remain uncertain. See "--Regulation" and "Business--Environmental and Asbestos Claims." Similarly, there is a high degree of uncertainty with respect to future exposure from asbestos claims because of significant issues surrounding the liabilities of the insureds, diverging legal interpretations and judgments state by state relating to, among other things, when the loss occurred and what policies provide coverage; what claims are covered; whether there is an insured obligation to defend; how policy limits are determined; how policy exclusions are applied and interpreted; whether clean-up costs represent insured property damage; and other matters. In addition, new groups of plaintiffs, whose exposure to asbestos was less direct and whose injuries were often speculative, have been filing lawsuits in increasing numbers. See "Business--Environmental and Asbestos Claims." 16 Given the inconsistencies of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties, it is not presently possible to quantify the ultimate exposure or range of exposure represented by environmental and asbestos claims to the Company's financial condition, results of operations or liquidity. The Company believes that it is reasonably possible that the outcome of the uncertainties regarding environmental and asbestos claims could result in a liability exceeding the reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. See "Business--Environmental and Asbestos Claims." REINSURANCE CONSIDERATIONS The Company uses reinsurance to help manage its exposure to property and casualty risks. The availability and cost of reinsurance are subject to prevailing market conditions, both in terms of price and available capacity, which can affect the Company's business volume and profitability. Although the reinsurer is liable to the Company to the extent of the reinsurance ceded, the Company remains primarily liable as the direct insurer on all risks reinsured. As a result, reinsurance ceded arrangements do not eliminate the Company's obligation to pay all claims regardless of whether they have been ceded to reinsurers. The Company is subject to credit risk with respect to its ability to recover amounts due from reinsurers. The Company believes, based upon its review of its reinsurers' financial statements and reputations in the reinsurance marketplace, that the financial condition of its reinsurers is generally sound. However, there can be no assurance that reinsurance will be adequate to protect the Company against losses or that reinsurance will continue to be available to the Company in the future at commercially reasonable rates. The Company also participates in the Florida Hurricane Catastrophe Fund, which is a state-mandated catastrophe reinsurance fund. FHCF is partially funded by premiums from the insurance companies that write residential property business in Florida and assessments on insurance companies that write other property and casualty insurance in Florida, excluding workers' compensation. FHCF's resources are limited to these contributions and to its borrowing capacity at the time of a significant catastrophe. There can be no assurance that these resources will be sufficient to meet the obligations of the FHCF. The Company's recovery of less than contracted amounts could have a material adverse effect on the Company's results of operations in the event of a significant catastrophe in Florida. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Reinsurance." Lloyd's of London ("Lloyd's"), the Company's largest reinsurer, is currently undergoing a restructuring to solidify its capital base and to segregate claims for years before 1993. As of December 31, 1995, Travelers P&C and Aetna P&C had ceded insurance losses, loss adjustment expenses and unearned premiums to Lloyd's of $289 million and $193 million, respectively. Travelers P&C is in arbitration with underwriters at Lloyd's in New York State to enforce reinsurance contracts with respect to recoveries for certain asbestos claims. The dispute involves the ability of Travelers P&C to aggregate asbestos claims under a market agreement between Lloyd's and Travelers P&C or under the applicable reinsurance treaties. See "Business--Legal Proceedings." The outcomes of the restructuring of Lloyd's and the arbitration referred to above are uncertain and the impact, if any, on collectibility of amounts recoverable by the Company from Lloyd's cannot be quantified at this time. The Company believes that it is possible that an unfavorable resolution of these matters could have a material adverse effect on the Company's operating results in a future period. However, the Company believes that it is not likely that the outcome of these matters could have a material adverse effect on the Company's financial condition or liquidity. In connection with the 1992 sale of American Re Corporation ("Am Re") by Aetna, Am Re and Aetna Casualty entered into a reinsurance agreement which provides that to the extent Am Re incurred losses in 1991 and prior years that were still outstanding at January 1, 1992 in excess of $2.7 billion, Aetna Casualty has an 80% participation in payments on those losses up to a maximum payment by Aetna Casualty of $500 million. In 1995, Am Re increased reserves for asbestos, environmental and other latent liabilities. As a result of this increase, losses of approximately $228 million ($120 million after discount), which were largely workers' compensation life table indemnity claims, were ceded to Aetna Casualty. There was no material effect on Aetna P&C's 1995 earnings since Aetna Casualty had previously established related reserves. It is reasonably possible that additional undiscounted losses of up to approximately $270 million (pre-tax) could be ceded to the Company in the future. See Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and 17 Capital Resources" and Note 14 of Notes to the Combined Financial Statements of Aetna P&C included elsewhere herein. INTEGRATION OF TRAVELERS P&C AND AETNA P&C; ACHIEVEMENT OF EXPENSE SAVINGS TAP was formed in January 1996. TIGI contributed to TAP all of the outstanding shares of common stock of Travelers Indemnity on April 1, 1996 and TAP acquired Aetna P&C on April 2, 1996. The pro forma combined results of operations of Travelers P&C and Aetna P&C are not necessarily indicative of the future results of the Company. Since Travelers P&C and Aetna P&C are both engaged in the property and casualty insurance business and write many of the same lines of insurance throughout the United States, the Company may experience a loss of customers and agents on a combined basis as a result of the Acquisition. The Company's management is reorganizing and consolidating the operations of Travelers P&C and Aetna P&C, and is seeking to achieve significant expense savings by eliminating redundant costs (through workforce reductions and other steps) and by improving overall efficiency. The Company has identified approximately $300 million in projected annual cost savings to be achieved over the next two years. There can be no assurance that the Company will achieve its projected cost savings. See "Business--The Strategic Plan." DISCONTINUANCE OF USE OF "AETNA" AND "TRAVELERS" NAMES Pursuant to an agreement with Aetna, TAP is required to discontinue the use of "Aetna" in its corporate name as of December 31, 1997. As a result, TAP will be required to change its name as of January 1, 1998. In addition, Aetna P&C has entered into an agreement with Aetna pursuant to which Aetna P&C would be required to discontinue its use of the "Aetna" name and other related service marks in all of its operations as of December 31, 1998. As a result, certain of the Aetna P&C companies will be required to change their names and to eliminate the use of the Aetna name in connection with their products as of December 31, 1998. See "Certain Transactions--The Acquisition." Pursuant to the Intercompany Agreement (as defined herein), Travelers Group has granted to TAP and certain of its subsidiaries, a non-exclusive, revocable license to use the "Travelers" name and certain trademarks solely in connection with TAP's property and casualty insurance business and activities related to such business. The Intercompany Agreement provides, among other things, that subject to Travelers Group's ability to revoke the license in certain circumstances and to regulatory approval: (i) within a limited time from the date on which Travelers Group and its subsidiaries (excluding TAP and its subsidiaries) cease to control more than 20% of the combined voting power of the outstanding Common Stock, if TAP's name or any of its subsidiaries' names at such time include the "Travelers" name, TAP and such subsidiaries are required to change their names and will be required to discontinue the use of certain related marks and (ii) after such date, TAP and its subsidiaries will continue to have the right to use the "Travelers" name in connection with the identification of property and casualty products for an initial five-year period with an option to renew for an additional five years. See "--Control By and Relationship with Travelers Group; Conflicts of Interest" and "Certain Transactions--Relationships with TIGI and Travelers Group." Such name changes or the revocation or expiration of such licenses could have a material adverse effect on the Company's ability to conduct its business. HOLDING COMPANY STRUCTURE; DIVIDEND RESTRICTIONS TAP is a holding company and has no direct operations. TAP's principal asset is the capital stock of its insurance subsidiaries. TAP relies primarily on dividends from its subsidiaries to meet its obligations for payment of interest and principal on outstanding debt obligations, dividends to stockholders and corporate expenses. The ability of the insurance subsidiaries to pay dividends to TAP in the future will depend on their statutory surplus, on earnings and on regulatory restrictions. TAP's principal insurance subsidiaries are domiciled in the State of Connecticut. Connecticut law governing the payment of dividends by domestic insurance companies provides that an insurer domiciled in Connecticut must obtain the prior approval of the state insurance commissioner for the declaration or payment of any dividend that together with other distributions made within the preceding twelve months exceeds the greater of (i) 10% of the insurer's surplus or (ii) the insurer's net income for the twelve-month period ending the preceding December 31st, in each case determined in accordance with statutory accounting practices. Such declaration or payment is further limited by adjusted unassigned funds (surplus), as determined in accordance with statutory accounting practices. The insurance holding company laws of other states in which the 18 Company's subsidiaries are domiciled generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends. Aetna Casualty and Standard Fire are not expected to pay dividends in 1996. Travelers Indemnity has statutory surplus of $299 million available in 1996 for payment of dividends to its parent, TAP, without prior approval of the Connecticut Insurance Department. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and "Business--Regulation." The inability of Travelers Indemnity, Aetna Casualty and Standard Fire to pay dividends to TAP in an amount sufficient to meet debt service and preferred stock dividend obligations would have a material adverse effect on TAP. The ability of TAP to pay dividends on the Common Stock is also subject to restrictions contained in the Credit Agreement, the Indenture (as defined herein), each Guarantee and each Declaration, to the prior declaration and payment of dividends on the Series Z Preferred Stock and, subject to minimum ownership requirements, to the prior approval of Travelers Group. See "--Control By and Relationship with Travelers Group; Conflicts of Interest," "Certain Transactions," "Description of Capital Stock" and "Certain Indebtedness." CONTROL BY AND RELATIONSHIP WITH TRAVELERS GROUP; CONFLICTS OF INTEREST TAP's voting stock has been divided into two classes with different voting rights that enable TIGI (the holder of all of the outstanding Class B Common Stock) to control the Company. On all matters submitted to a vote of stockholders, holders of Class A Common Stock are entitled to one vote per share and holders of Class B Common Stock are entitled to ten votes per share. Both classes vote together as a single class on all matters, subject to certain exceptions described under "Description of Capital Stock." Upon any transfer of shares of Class B Common Stock to a person other than Travelers Group or its subsidiaries (other than TAP or its subsidiaries), such shares will automatically convert into shares of Class A Common Stock, except if shares of Class B Common Stock representing more than a 50% economic interest in TAP are so transferred and except in certain other limited circumstances. See "Description of Capital Stock." Upon completion of the Equity Offering, TIGI will own all of the outstanding shares of Class B Common Stock, representing approximately 98.0% of the combined voting power of the outstanding Common Stock and approximately 82.7% of the outstanding shares of Common Stock (97.9% and 82.0%, respectively, if the Underwriters' over-allotment option granted in connection with the Equity Offering is exercised in full). For so long as Travelers Group and its subsidiaries (excluding TAP and its subsidiaries) continue beneficially to own shares of Common Stock representing more than 50% of the combined voting power of the Common Stock, Travelers Group, through TIGI, will control TAP and, subject to certain rights of the Private Investors (as defined herein) pursuant to the Shareholders Agreement (as hereinafter described), will continue to be able to elect all of TAP's directors and to determine the outcome of corporate actions requiring stockholder approval, including, among other things, approving or preventing a change of control of TAP, a business combination involving the Company, the incurrence of certain indebtedness, the issuance of additional Common Stock or other equity securities, subject to certain limited exceptions, and the payment of dividends with respect to the Common Stock, except as otherwise described herein. As of the date hereof, 50% of the combined voting power of the Common Stock represents 9.1% of the outstanding shares of Common Stock. Pursuant to an Intercompany Agreement between TAP and Travelers Group (the "Intercompany Agreement"), the prior written consent of Travelers Group is required in connection with these and other corporate actions by TAP until such time as Travelers Group and its subsidiaries (except TAP and its subsidiaries) no longer control at least 20% of the combined voting power of the outstanding Common Stock or cease beneficially to own at least 20% of the outstanding shares of Common Stock. See "Certain Transactions--Relationships with TIGI and Travelers Group." The Company has engaged in certain transactions, and is party to arrangements, with Travelers Group and its affiliates, certain of which will continue after the consummation of the Equity Offerings, including the Intercompany Agreement which governs certain relationships and transactions between or among the Company, on the one hand, and Travelers Group and its subsidiaries (other than TAP and its subsidiaries), on the other hand. Certain of these arrangements require the approval of the Connecticut Insurance Department. Pursuant to the Intercompany Agreement, among other things, Travelers Group has granted to TAP and certain of its subsidiaries a non- exclusive revocable license to use the "Travelers" name and certain trademarks. See "--Discontinuance of Use of 'Aetna' and 'Travelers' Names" and "Certain Transactions--Relationships with TIGI and Travelers Group." The Company may enter into other agreements with Travelers Group and its other affiliates, which will not be the result of arms'-length negotiations between independent parties. Future arrangements and agreements with Travelers Group and its affiliates to which Travelers P&C and Aetna P&C may become party may be subject to 19 the approval of the Connecticut Insurance Department or other regulatory bodies and may, under certain circumstances, require the approval of the Private Investors pursuant to the Shareholders Agreement. Conflicts of interest could arise in the future with respect to material transactions involving Travelers Group or its affiliates (other than the Company), on the one hand, and the Company, on the other hand. Seven of the nine persons who will be members of TAP's Board of Directors also serve as directors of Travelers Group and certain members of the Company's management who are full-time employees of the Company will continue to hold certain offices at Travelers Group and its other affiliates after the Equity Offering, the Debt Offerings and the Trust Preferred Securities Offerings. Ownership interests of directors or officers of the Company in common stock of Travelers Group or service as a director or officer of both the Company and Travelers Group could create or appear to create potential conflicts of interest when directors and officers are faced with decisions that could have different implications for the Company and Travelers Group. See "Management." TAP's Restated Certificate of Incorporation (the "Charter") provides that Travelers Group shall have no duty to refrain from (i) engaging in the same or similar business activities or lines of business as TAP, (ii) doing business with any client or customer of TAP, subject to any contractual provision to the contrary, or (iii) employing or otherwise engaging any officer or employee of TAP. Accordingly, neither Travelers Group nor any officer or director of Travelers Group (except as provided in the Charter) will be liable to TAP or to its stockholders for breach of any fiduciary duty by reason of any such activities. See "Description of Capital Stock--Charter Provisions Relating to Corporate Opportunities and Interested Directors." Pursuant to the Shareholders Agreement, TIGI has agreed with the Private Investors that, for a limited period of time, TAP will be the primary vehicle through which Travelers Group engages in the property and casualty insurance industry in the United States. See "--Competition." The failure of Travelers Group and its affiliates to maintain beneficial ownership of more than 50% of the combined voting power of TAP's outstanding voting stock would be an event of default under the Credit Agreement. See "Certain Indebtedness." By virtue of its ownership of 98.0% of the combined voting power of the outstanding Common Stock and 82.7% of the outstanding shares of Common Stock, Travelers Group includes TAP in its consolidated tax return for federal income tax purposes. Under applicable law, each member of the Travelers Group consolidated group, which includes Travelers Group, the Company and certain of Travelers Group's other subsidiaries, is jointly and severally liable for the federal income tax liability of each other member of the group and is also jointly and severally liable for pension and benefit funding and termination liabilities of other group members, as well as certain benefit plan taxes. If the Company were no longer to be included in Travelers Group's consolidated group for federal tax purposes, there is no assurance that the Company's tax position would be as favorable as it is at present. In addition, by virtue of its controlling beneficial ownership of TAP and the terms of a tax sharing agreement among the Company, TIGI and Travelers Group (the "Tax Sharing Agreement"), Travelers Group will effectively control all of the Company's tax decisions. Under the Tax Sharing Agreement, Travelers Group will have sole authority to respond to and conduct all tax proceedings (including tax audits) relating to the Company, to file all returns on behalf of the Company and to determine the amount of the Company's liability to (or entitlement to payment from) TIGI under the Tax Sharing Agreement. This arrangement may result in conflicts of interests between the Company and Travelers Group. For example, under the Tax Sharing Agreement, Travelers Group may choose to contest, compromise or settle any adjustment or deficiency proposed by the relevant taxing authority in a manner that may be beneficial to Travelers Group and detrimental to the Company. In connection therewith, however, Travelers Group is obligated under the Tax Sharing Agreement to act in good faith with regard to all members included in the applicable returns. See "Certain Transactions--Relationship with TIGI and Travelers Group--Tax Sharing Agreement." PRIVATE INVESTORS; CONFLICTS OF INTEREST Pursuant to a shareholders agreement (the "Shareholders Agreement"), dated as of April 2, 1996, among TAP, TIGI, J.P. Morgan Capital Corporation ("J.P. Morgan"), The Trident Partnership, L.P. ("Trident"), Fund American Enterprises Holdings, Inc. ("Fund American") and Aetna Life and Casualty Company ("Aetna" and, together with J.P. Morgan, Trident and Fund American, the "Private Investors"), Trident has, subject to certain ownership requirements of all of the Private Investors, the right to nominate one director to the Board of Directors of TAP. Trident has nominated Mr. Roberto G. Mendoza, who was appointed to the Board of Directors of TAP 20 effective April 2, 1996. Pursuant to the Shareholders Agreement, for a period of 18 months from the date of the Shareholders Agreement (subject to early termination), so long as the Private Investors continue to own, in the aggregate, at least 50% of the shares of Class A Common Stock initially purchased by them pursuant to the Private Investors Stock Purchase Agreements, the Private Investors have certain approval rights in connection with the taking of certain fundamental corporate actions by TAP including, among other things, the liquidation, dissolution or winding up of TAP, a sale or other disposition of all or substantially all of the assets of or the merger or consolidation of TAP, and the entry by TAP into any material transaction with an Affiliate (as defined therein) of TAP which does not satisfy certain conditions contained therein. See "Certain Transactions--Private Investors." J.P. Morgan, Trident and Fund American each make investments in or provide financial advisory and other services to insurance enterprises and ventures or other entities that may compete with the Company. As a result, there may currently exist, or may develop in the future, perceived or actual conflicts of interest between the Private Investors or their affiliates, on the one hand, and the Company, on the other hand. REGULATION The Company is subject to extensive regulation and supervision in the jurisdictions in which it does business. Such regulation is generally designed to protect the interests of policyholders, as opposed to stockholders and other investors. Such regulation relates to authorized lines of business, capital and surplus requirements, investment parameters, underwriting limitations, transactions with affiliates, dividend limitations, changes in control, premium rates and a variety of other financial and nonfinancial components of an insurance company's business. The capacity for an insurance company's growth in premiums is in part a function of its statutory surplus. Maintaining appropriate levels of statutory surplus, as measured by statutory accounting practices and procedures, is considered important by state insurance regulatory authorities and the private agencies that rate insurers' claims-paying abilities and financial strength. Failure to maintain certain levels of statutory surplus could result in increased regulatory scrutiny, action by state regulatory authorities or a downgrade by rating agencies. See "Business--Regulation." The NAIC has adopted a system of assessing minimum capital adequacy, which system is applicable to the Company's insurance subsidiaries. This system, known as risk-based capital ("RBC"), is used to identify companies that merit further regulatory action by comparing adjusted surplus to the required surplus, which reflects the risk profile of the insurer. Implementation of these requirements became necessary for regulatory filings made in 1995 covering fiscal year 1994. Insurers having less statutory surplus than that required by the RBC model formula are subject to varying degrees of regulatory action depending on the level of capital inadequacy. At December 31, 1995, the RBC ratios of the Company's insurance subsidiaries were in excess of levels that would require regulatory action. In recent years the state insurance regulatory framework has come under increased federal scrutiny, and certain state legislatures have considered or enacted laws that altered and, in many cases, increased state authority to regulate insurance companies and insurance holding companies. Further, the NAIC and state insurance regulators are reexamining existing laws and regulations, specifically focusing on investment laws for insurers, modifications to holding company regulations, codification of statutory accounting practices, RBC guidelines, interpretations of existing laws and the development of new laws. In addition, Congress and certain federal agencies are investigating the current condition of the insurance industry in the United States to determine whether to impose federal regulation. The Company cannot predict with certainty the effect any proposed or future legislation or NAIC initiatives may have on the conduct of the Company's business or the financial condition or results of operations of the Company. See "Business--Regulation." Congress has considered and continues to consider several proposals to revise the Comprehensive Environmental Response, Compensation, and Liability Act ("CERCLA" or "Superfund"). It is not possible to predict whether such proposed legislation will be enacted, what form such legislation might take, or the potential effects such legislation may have on the Company and its competitors. STATE GUARANTY FUNDS, SHARED MARKETS MECHANISMS AND POOLING ARRANGEMENTS All fifty states of the United States have insurance guaranty fund laws requiring all property and casualty insurance companies doing business within the state to participate in guaranty funds or associations, which are organized to pay contractual obligations under insurance policies issued by impaired or insolvent insurance 21 companies. These associations levy assessments (up to prescribed limits) on all member insurers in a particular state on the basis of the proportionate share of the premiums written by member insurers in the lines of business in which the impaired or insolvent insurer is engaged. Mandatory assessments by state guaranty funds are used to cover losses to policyholders of insolvent or rehabilitated companies and in many states can be partially recovered through future policy surcharges and reductions in premium taxes. These assessments may increase in the future depending upon the rate of insolvencies of insurance companies. Although the Company is not able reasonably to estimate the potential effect on it of any such future assessments, the Company believes, based upon a review of the current significant insolvency proceedings of insurers in the states in which the Company's insurance subsidiaries engage in business, that assessments with respect to any pending insurance company impairments and insolvencies will not be material. See "Business--Regulation." In addition, as a condition to the ability to conduct business in various states, the Company's insurance subsidiaries are required to participate in mandatory property and casualty shared market mechanisms or pooling arrangements, which provide various types of insurance coverage to individuals or other entities that otherwise are unable to purchase such coverage voluntarily from private insurers. The underwriting results of these pools traditionally have been unprofitable. See "Business--Regulation." COMPETITION The property and casualty insurance business is highly competitive and the Company believes that it will remain highly competitive with little prospect for periods of dramatically improved pricing in the foreseeable future. The residual effects of the recession in the early 1990s, coupled with a demand for low-cost, high quality service, have created difficult conditions in the domestic property and casualty market, as is evidenced by a leveling or reduction in premium rates in certain lines of business in which the Company competes. The Company competes with domestic and foreign insurers, some of which have greater financial resources than the Company. Competition is based on many factors, including the perceived overall financial strength of the insurer, pricing and other terms and conditions of products offered, levels of customer service (including the speed with which claims are paid) and experience in the business. The Company competes with insurance companies that use captive agents or salaried employees to sell their products. Because these companies generally do not pay commissions, they may be able to obtain business at a lower cost than the Company, which sells its products primarily through independent agents and brokers. See "Business--Competition." Several property and casualty insurers writing commercial lines of business, including the Company, now offer products for alternative forms of risk protection in addition to traditional insurance products. These products, including large deductible programs and various forms of self-insurance that utilize captive insurance companies and risk retention groups, have been instituted in reaction to the escalating cost of insurance caused in part by increased jury awards in third-party liability and workers' compensation cases. It is not possible to predict how continued growth in alternative forms of risk protection will affect the Company's future operations. Aetna has agreed that, for a period of five years from the closing of the Acquisition, it will not engage in any business in the United States, Canada or the United Kingdom that competes with any of the Aetna P&C businesses as conducted in such countries as of the closing, with certain limited exceptions. See "Certain Transactions--The Acquisition." Pursuant to the Shareholders Agreement with the Private Investors and TIGI, TIGI has agreed that until the earlier to occur of (i) the date the Private Investors no longer beneficially own at least 50% of the shares of Class A Common Stock originally purchased by them; (ii) Travelers Group and its affiliates (excluding TAP and its subsidiaries), in the aggregate, no longer beneficially own at least 50% of the outstanding Common Stock; and (iii) 30 days following the fifth anniversary of the date of the closing of the Acquisition, the Company will be the primary vehicle through which Travelers Group or any of its affiliates (other than the Company) engages in the property and casualty insurance business in the United States, with certain limited exceptions. See "Certain Transactions--Private Investors." RATINGS Claims-paying and financial strength ratings have become an increasingly important factor in establishing the competitive position of insurance companies. See "Business--Ratings" for a discussion of the ratings of the Company's insurance pools and their recent ratings history. Each of the rating agencies reviews its ratings periodically, and there can be no assurance that current ratings will be maintained in the future. A significant downgrade in such ratings could have a material adverse effect on the results of operations and financial condition 22 of the Company. In November 1995, following the announcement of the Acquisition, Standard & Poor's Ratings Group ("Standard & Poor's") placed the claims-paying ability rating of the Travelers Indemnity intercompany pool on creditwatch with negative implications. In April 1996, Standard & Poor's downgraded the Travelers Indemnity intercompany pool's rating from AA- (the fourth highest of eighteen rating categories) to A+ (the fifth highest of eighteen rating categories). In July 1995, the Aetna Insurance pool's rating was downgraded from A+ (the fifth highest of eighteen rating categories) to A (the sixth highest of eighteen rating categories) by Standard & Poor's and from AA- (the fourth highest of eighteen rating categories) to A+ (the fifth highest of eighteen rating categories) by Duff & Phelps Corp. ("Duff & Phelps"). In April 1996, the Aetna Insurance pool's rating was upgraded from A (the sixth highest of eighteen rating categories) to A+ (the fifth highest of eighteen rating categories) by Standard & Poor's. The ratings are not in any way a measure of protection offered to investors in the Preferred Securities and should not be relied upon with respect to making an investment in the Preferred Securities. See "Business--Ratings." 23 RECENT HISTORY On or before April 2, 1996, the following transactions took place (all of the transactions described herein under "Recent History" are collectively referred to as the "Transactions"): . TIGI contributed all the outstanding shares of common stock of Travelers Indemnity to TAP. . TAP filed a restated certificate of incorporation and effected a recapitalization as a result of which TIGI's shares of TAP common stock were converted into shares of Class B Common Stock and the authorized capital of TAP was changed as is described under "Description of Capital Stock." . TAP acquired all of the outstanding shares of common stock of Aetna Casualty and Standard Fire for a purchase price of approximately $4.16 billion in cash. As a result, TAP owns directly 100% of the common stock of Aetna Casualty and Standard Fire. Obligations under insurance policies in effect at the time of the consummation of the Transactions were not affected as a result of the Transactions. . TIGI contributed approximately $1.1 billion to TAP. The $4.16 billion purchase price for the Acquisition, including transaction costs and capital contributions totalling $710 million to Aetna P&C, were funded as follows: . $1.14 billion from the purchase of Class B Common Stock by TIGI. . $540 million from the purchase of Series Z Preferred Stock by Travelers Group. . $525 million from the purchase of 33,000,515 shares of Class A Common Stock by the Private Investors. . $2.65 billion from borrowings by TAP under the Credit Agreement (as defined herein). . $18 million from the settlement of receivables from Aetna. Travelers Indemnity expects to pay in the second quarter of 1996, subject to receipt of any necessary regulatory approval, approximately $300 million to TAP, which amount will then be contributed to Aetna P&C. See "Certain Transactions," "Description of Capital Stock" and "Certain Indebtedness" for a more detailed description of certain of the financing transactions described above. USE OF PROCEEDS All of the net proceeds from the sale of any Preferred Securities offered hereby will be invested by the TAP Trust in Junior Subordinated Debt Securities. TAP will use the proceeds from the sale of the Junior Subordinated Debt Securities to TAP Capital for general corporate purposes, which may include capital contributions to subsidiaries of TAP and/or the reduction or refinancing of borrowings of TAP or its subsidiaries (including borrowings used to fund TAP's purchase of the domestic property and casualty insurance subsidiaries of Aetna Life and Casualty Company). See "Recent History." 24 CAPITALIZATION Set forth below is (i) the historical capitalization of TAP at December 31, 1995; (ii) the pro forma capitalization of TAP at December 31, 1995, after giving effect to the Transactions; (iii) the pro forma capitalization of TAP at December 31, 1995, as adjusted to give effect to the application of the net proceeds from sale of the Class A Common Stock in the Equity Offering to repay a portion of the borrowings under the Credit Agreement; (iv) the pro forma capitalization of TAP at December 31, 1995, as further adjusted to give effect to the application of the net proceeds from the Trust Preferred Securities Offerings (including the Preferred Securities offered hereby) to repay the remaining borrowings under the Credit Agreement and to redeem the Series Z Preferred Stock and (v) the pro forma capitalization of TAP at December 31, 1995, as further adjusted to give effect to the application of the proceeds from the Debt Offerings to repay remaining borrowings under the Credit Agreement. The consummation of the Equity Offering is not conditioned upon completion of the Trust Preferred Securities Offerings or the Debt Offerings, and there can be no assurance that these offerings will be consummated. The information presented below should be read in conjunction with the historical consolidated financial statements of TAP and the historical combined financial statements of Aetna P&C and the related notes thereto and the pro forma financial data of the Company, in each case included elsewhere in this Prospectus.
AT DECEMBER 31, 1995 ------------------------------------------------------------------------------------------- PRO FORMA PRO FORMA FOR THE PRO FORMA ADJUSTMENTS TRANSACTIONS, AS PRO FORMA ADJUSTMENTS PRO FORMA FOR THE ADJUSTED FOR ADJUSTMENTS FOR TAP FOR THE FOR THE EQUITY THE EQUITY THE DEBT HISTORICAL TRANSACTIONS(1) TRANSACTIONS OFFERING(2) OFFERING OFFERINGS(3) ---------- --------------- ------------ ----------- ---------------- ----------------- (Dollars in millions) Long-term debt: Credit Agreement(5).......... $-- $ 2,650 $2,650 $(841) $1,809 $(1,477) Debt Securities(6)(7)...... -- -- -- -- -- 1,487 Mortgage indebtedness of Aetna P&C....... -- 35 35 -- 35 -- ----- ------ ----- --- ----- ------ Total long-term debt(6)............... -- 2,685 2,685 (841) 1,844 10 ----- ------ ----- --- ----- ------ Series Z Preferred Stock, $.10 par value; $250,000 liquidation preference(8)(9)...... -- 540 540 -- 540 -- ]TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts(10)............ -- -- -- -- -- -- Stockholders' equity:(9) Preferred Stock, $.10 par value.......... -- -- -- -- -- -- Common Stock, $100 par value.......... 10 (10) -- -- -- -- Class A Common Stock, $.01 par value........ -- 1 1 -- 1 -- Class B Common Stock, $.01 par value........ -- 3 3 -- 3 -- Additional paid-in capital............... 2,889 1,670 4,559 841 5,400 -- Retained earnings.... 422 -- 422 -- 422 -- Unrealized investment gains, net of taxes... 280 -- 280 -- 280 -- ----- ------ ----- --- ----- ------ Total stockholders' equity................ 3,601 1,664 5,265 841 6,106 -- ----- ------ ----- --- ----- ------ Total capitalization........ $3,601 $ 4,889 $8,490 $-- $8,490 $ 10 ----- ------ ----- --- ----- ------ ----- ------ ----- --- ----- ------ PRO FORMA FOR THE TRANSACTIONS, AS ADJUSTED FOR THE PRO FORMA FOR PRO FORMA EQUITY OFFERING, THE TRANSACTIONS, ADJUSTMENTS THE DEBT AS ADJUSTED FOR FOR THE TRUST OFFERINGS AND THE THE EQUITY PREFERRED TRUST PREFERRED OFFERING AND THE SECURITIES SECURITIES DEBT OFFERINGS OFFERINGS(4) OFFERINGS ----------------- ------------- ------------------- Long-term debt: Credit Agreement(5).......... $ 332 $(332) -$- Debt Securities(6)(7)...... 1,487 -- 1,487 Mortgage indebtedness of Aetna P&C....... 35 -- 35 ----- --- ----- Total long-term debt(6)............... 1,854 (332) 1,522 ----- --- ----- Series Z Preferred Stock, $.10 par value; $250,000 liquidation preference(8)(9)...... 540 (540) -- ]TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts(10)............ -- 900 900 Stockholders' equity:(9) Preferred Stock, $.10 par value.......... -- -- -- Common Stock, $100 par value.......... -- -- -- Class A Common Stock, $.01 par value........ 1 -- 1 Class B Common Stock, $.01 par value........ 3 -- 3 Additional paid-in capital............... 5,400 (28) 5,372 Retained earnings.... 422 -- 422 Unrealized investment gains, net of taxes... 280 -- 280 ----- --- ----- Total stockholders' equity................ 6,106 (28) 6,078 ----- --- ----- Total capitalization........ $ 8,500 $-- $ 8,500 ----- --- ----- ----- --- -----
- ------------ (1) Represents the following: Issuance of long-term debt under the Credit Agreement $ 2,650 Historical mortgage indebtedness of Aetna P&C 35 Issuance of Series Z Preferred Stock to Travelers Group 540 Capital contributions by TIGI 1,139 Issuance and sale of Class A Common Stock to the Private Investors 525 ------- $ 4,889 ------- ------- See "Recent History" and "Unaudited Pro Forma Financial Information--Note A of Notes to Unaudited Pro Forma Condensed Combined Balance Sheet" on page 29. (2) Represents the following: Issuance of Class A Common Stock $ 886 Related issuance costs (45) Decrease in long-term debt due to repayment of borrowings under the Credit Agreement (841) ------- $ -- ------- -------
25 See "Recent History" and "Unaudited Pro Forma Financial Information--Note D of Notes to Unaudited Pro Forma Condensed Combined Balance Sheet" on page 30. (3) Represents the following: Issuance of Debt Securities $ 1,487 Decrease in long-term debt due to repayment of borrowings under the Credit Agreement (1,477) ------- $ 10 ------- ------- See "Certain Indebtedness--Recent History" and "Unaudited Pro Forma Financial Information--Note D of Notes to Unaudited Pro Forma Condensed Combined Balance Sheet" on page 30. (4) Represents the following: Issuance of TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts $ 900 Related issuance costs (28) Decrease in long-term debt due to repayment of borrowings under the Credit Agreement (332) Redemption of Series Z Preferred Stock (540) ------- $ -- ------- ------- See "Recent History" and "Unaudited Pro Forma Financial Information--Note D of Notes to Unaudited Pro forma Condensed Combined Balance Sheet" on page 30.
(5) See "Certain Indebtedness--Bank Debt". (6) See "Certain Indebtedness--The Debt Offering". (7) The Company may, subject to market conditions and other factors, issue commercial paper or other short-term instruments in lieu of up to $600 of the Debt Securities. (8) The Series Z Preferred Stock is redeemable at the option of the holder. See "Description of Capital Stock." (9) See "Description of Capital Stock" for descriptions of the Series Z Preferred Stock, the Preferred Stock, the Class A Common Stock and the Class B Common Stock. (10) The sole asset of each trust will be junior subordinated deferrable interest debentures of TAP. 26 UNAUDITED PRO FORMA FINANCIAL INFORMATION The following unaudited pro forma condensed combined statement of income of TAP for the year ended December 31, 1995 presents results for the Company as if the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings had occurred as of January 1, 1995. The accompanying unaudited pro forma condensed combined balance sheet as of December 31, 1995 gives effect to the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings as if they had occurred as of December 31, 1995. The unaudited pro forma information does not purport to represent what the Company's financial position or results of operations actually would have been had the Transactions and such offerings in fact occurred on the dates indicated, or to project the Company's financial position or results of operations for any future date or period. The pro forma adjustments are based on available information and certain assumptions that the Company currently believes are reasonable in the circumstances. The unaudited pro forma combined financial information should be read in conjunction with the accompanying notes thereto, the historical Consolidated Financial Statements of TAP as of and for the year ended December 31, 1995 and the historical Combined Financial Statements of Aetna P&C as of and for the year ended December 31, 1995, in each case contained elsewhere herein. The pro forma adjustments and pro forma combined amounts are provided for informational purposes only. The Company's financial statements will reflect the effects of the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings only from the dates such events occur. The pro forma adjustments are applied to the historical financial statements to, among other things, account for the Acquisition as a purchase. Under purchase accounting, the total purchase cost for the Acquisition will be allocated to the Aetna P&C assets and liabilities based on their fair values. Allocations are subject to valuations as of the date of the Acquisition based on appraisals and other studies, which are not yet completed. Accordingly, the final allocations will be different from the amounts reflected herein. Although the final allocations will differ, the unaudited pro forma financial information reflects management's best estimate based on currently available information as of the date of this Prospectus. Included in the historical results of Aetna P&C for the year ended December 31, 1995 are charges of $750 million ($488 million after tax) representing an addition to environmental-related claims reserves in the second quarter of 1995 and $335 million ($218 million after tax) representing an addition to asbestos reserves in the fourth quarter of 1995. As the Aetna P&C operations are integrated with the existing property and casualty insurance operations of the Company, management of the Company expects to realize, over a two-year period, $300 million ($195 million after tax) in annual cost savings from reduction of overhead expenses, changes in the corporate infrastructure of Aetna P&C and the elimination of redundant expenses. There can be no assurance that the Company will achieve its projected cost savings. See "Business--The Strategic Plan." These expected future cost savings are not reflected in the Unaudited Pro Forma Financial Information. 27 UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET AS OF DECEMBER 31, 1995
PRO FORMA ADJUSTMENTS --------------------------- AETNA TAP P&C HISTORICAL HISTORICAL FOR THE TRANSACTIONS ---------- ---------- --------------------------- (Dollars in millions) ASSETS Fixed maturities available for sale, at market...................................... $ 10,908 $ 11,598 $ 710(A) Equity securities, at market................ 603 500 (27)(B) Mortgage loans.............................. 213 1,062 (166)(B) Real estate held for sale................... 23 265 (67)(B) Short-term securities....................... 786 137 Other investments........................... 287 291 ---------- ---------- ------ Total investments...................... 12,820 13,853 450 ---------- ---------- ------ Cash and cash equivalents................... 51 1,137 Investment income accrued................... 165 185 Premium balances receivable................. 2,213 1,002 Reinsurance recoverables.................... 5,407 5,277 Deferred acquisition costs.................. 202 306 (101)(B) Cost of acquired businesses in excess of net assets...................................... 419 848(B) Deferred federal income taxes............... 650 634 306(B) Contractholder receivables.................. 1,713 Other assets................................ 981 1,005 1(A) (18)(A) (45)(B) ---------- ---------- ------ Total assets........................... $ 24,621 $ 23,399 $ 1,441 ---------- ---------- ------ ---------- ---------- ------ LIABILITIES Claims and claim adjustment expense reserves.................................... $ 15,460 $ 16,559 Unearned premium reserves................... 1,695 1,398 Long-term debt.............................. 35 $ 2,650(A) Contractholder payables..................... 1,713 Other liabilities........................... 2,152 1,526 468(B) ---------- ---------- ------ Total liabilities...................... 21,020 19,518 3,118 ---------- ---------- ------ Series Z Preferred Stock.................... 540(A) TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts...................................... ---------- ---------- ------ STOCKHOLDERS' EQUITY Common stock................................ 10 30 (6)(A) (30)(C) Additional paid-in capital.................. 2,889 1,477 1,145(A) 525(A) (1,477)(C) Retained earnings........................... 422 2,061 (2,061)(C) Unrealized investment gains (losses), net of taxes....................................... 280 313 (313)(C) ---------- ---------- ------ Total stockholders' equity............. 3,601 3,881 (2,217) ---------- ---------- ------ Total liabilities and stockholders' equity...................................... $ 24,621 $ 23,399 $ 1,441 ---------- ---------- ------ ---------- ---------- ------ FOR THE EQUITY OFFERINGS AND THE DEBT OFFERINGS AND THE TRUST PRO FORMA PREFERRED SECURITIES OFFERINGS COMBINED --------------- --------- ASSETS Fixed maturities available for sale, at market...................................... $23,189 Equity securities, at market................ 1,103 Mortgage loans.............................. 1,109 Real estate held for sale................... 221 Short-term securities....................... 923 Other investments........................... 578 --------- Total investments...................... 27,123 --------- Cash and cash equivalents................... 1,188 Investment income accrued................... 350 Premium balances receivable................. 3,215 Reinsurance recoverables.................... 10,684 Deferred acquisition costs.................. 407 Cost of acquired businesses in excess of net assets...................................... 1,267 Deferred federal income taxes............... 1,590 Contractholder receivables.................. 1,713 Other assets................................ $ 10(D) 1,934 ------ --------- Total assets........................... $ 10 $49,471 ------ --------- ------ --------- LIABILITIES Claims and claim adjustment expense reserves.................................... $32,019 Unearned premium reserves................... 3,093 Long-term debt.............................. $ (2,650)(D) 1,521 1,486(D) Contractholder payables..................... 1,713 Other liabilities........................... 4,146 ------ --------- Total liabilities...................... (1,164) 42,492 ------ --------- Series Z Preferred Stock.................... (540)(D) -- TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts...................................... 900(D) 900 ------ --------- STOCKHOLDERS' EQUITY Common stock................................ 4 Additional paid-in capital.................. 886(D) 5,373 (44)(D) (28)(D) Retained earnings........................... 422 Unrealized investment gains (losses), net of taxes....................................... 280 ------ --------- Total stockholders' equity............. 814 6,079 ------ --------- Total liabilities and stockholders' equity...................................... $ 10 $49,471 ------ --------- ------ ---------
See accompanying Notes to Unaudited Pro Forma Condensed Combined Balance Sheet. 28 NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET (Dollars in millions) A. The following pro forma adjustments reflect the funding of the Acquisition, contributions to TAP's capital by TIGI and the issuance of Series Z Preferred Stock to Travelers Group:
Capital contribution by TIGI................................................ $ 429 Issuance of Series Z Preferred Stock to Travelers Group..................... 540 Incurrence of long-term debt under the Credit Agreement..................... 2,650 Fees and expenses relating to Credit Agreement borrowings................... (1) Proceeds from issuance and sale of TAP's Class A Common Stock to the Private Investors................................................................... 525 Settlement of receivables from Aetna........................................ 18 ------ Total purchase price for the Acquisition................................ 4,161 ------ Additional capital contribution by TIGI (invested in fixed maturities)...... 710 ------ Total funded............................................................ $4,871 ------ ------
See Note D of Notes to Unaudited Pro Forma Condensed Combined Balance Sheet for information concerning the Equity Offering, the Debt Offerings and Trust Preferred Securities Offerings. B. The following pro forma adjustments result from allocation of the purchase price for the Acquisition based on the fair value of the underlying net assets acquired. The amounts and assumptions related to the primary adjustments are as follows:
DEBIT (CREDIT) -------------- ASSETS Discount allocated to investments in fixed maturities based on the fair value of the investments.............................................. $ (27) Adjustment of carrying amount of investments in mortgage loans based on the fair value of underlying collateral reflecting the Company's sales strategy................................................................ $ (166) Adjustment of carrying amount of real estate to fair value reflecting the Company's sales strategy.......................................... $ (67) Adjustment to deferred acquisition costs to reflect the Company's policy of deferring only commissions and premium taxes on sale of property and casualty insurance policies....................................... $ (101) Excess of purchase price for the Acquisition over the fair value of net assets acquired....................................................... $ 848 Adjustment to reflect the net deferred tax benefit of purchase accounting adjustments................................................ $ 306 Adjustments to other assets............................................. $ (45) LIABILITIES Adjustments to other liabilities: Amounts allocated to restructuring costs.............................. Severance and benefit payments for employees to be terminated....... $ (120) Rent expense for excess or unused office space...................... (65) Lease payments for unused office and data processing equipment and software................................................................ (40) Cost of relocating employees and other related costs................ (25) Adjustment to the liability for loss based assessments for second injury funds........................................................ (124) Other................................................................. (94) ------- Total adjustments................................................... $ (468) ------- -------
29 NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED BALANCE SHEET (Dollars in millions) (Continued) C. Adjustment to eliminate the Aetna P&C stockholders' equity. D. The following pro forma adjustments reflect the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings:
Issuance of Debt Securities(1).............................................. $1,486 Related issuance costs.................................................... (10) Issuance of TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts........................................................... 900 Related issuance costs.................................................... (28) Issuance of Class A Common Stock............................................ 886 Related issuance costs.................................................... (44) ------ $3,190 ------ ------ Decrease in long-term debt due to repayment of borrowings under the Credit Agreement................................................................... $2,650 Redemption of Series Z Preferred Stock issued to Travelers Group............ 540 ------ $3,190 ------ ------
- ------------ (1) The Company may, subject to market conditions and other factors, issue commercial paper or other short-term instruments in lieu of up to $600 of the Debt Securities. 30 UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME FOR THE YEAR ENDED DECEMBER 31, 1995
PRO FORMA ADJUSTMENTS ---------------------------- FOR THE EQUITY OFFERING, DEBT OFFERINGS AND THE TRUST PREFERRED TAP AETNA P&C FOR THE SECURITIES PRO FORMA HISTORICAL HISTORICAL TRANSACTIONS OFFERINGS COMBINED ---------- --------- ------------ ----------- --------- (Dollars in millions, except per share amounts) Revenues: Premiums........................................... $3,315 $ 4,118 $ 7,433 Net investment income.............................. 710 902 $ (35)(a)(b) 1,577 Fee income......................................... 456 82 538 Realized investment gains.......................... 71 199 270 Other income....................................... 17 17 ---------- --------- ------ ----- --------- Total revenues................................. 4,569 5,301 (35) -- 9,835 ---------- --------- ------ ----- --------- Benefits and expenses: Claims and claim adjustment expenses............... 2,817 4,232 7,049 Amortization of deferred acquisition costs......... 512 623 1,135 General and administrative expenses................ 689 852 (10)(a) $ 24(d) 1,708 153(c) ---------- --------- ------ ----- --------- Total benefits and expenses.................... 4,018 5,707 143 24 9,892 ---------- --------- ------ ----- --------- Income (loss) before federal income taxes.......... 551 (406) (178) (24) (57) Federal income taxes (tax benefits)................ 132 (163) (55)(e) (8)(e) (94) ---------- --------- ------ ----- --------- Net income (loss).................................. $ 419 $ (243) $ (123) $ (16) $ 37 ---------- --------- ------ ----- --------- ---------- --------- ------ ----- --------- Net income per share of Common Stock............... $ 0.09 --------- --------- Weighted average number of shares of Common Stock outstanding (in millions).......................... 396.5 --------- ---------
See accompanying Notes to Unaudited Pro Forma Condensed Combined Statement of Income. 31 NOTES TO UNAUDITED PRO FORMA CONDENSED COMBINED STATEMENT OF INCOME (Dollars in millions) (a) The primary adjustments resulting from the allocation of the purchase price for the Acquisition based on the fair value of the underlying net assets are as follows:
INCREASE (DECREASE) IN INCOME BEFORE FEDERAL INCOME TAXES ----------------------------- Net investment income: Amortization of premium allocated to investments on a level yield basis over the life of the investments.......................... $ (35) --- --- General and administrative expenses: Amortization of liability for loss based assessments for second injury funds..................................................... $ 26 Amortization of excess of purchase price over the fair value of net assets acquired, over 40 years.............................. (21) Other............................................................ 5 --- $ 10 --- ---
See Note B of Notes to Unaudited Pro Forma Condensed Combined Balance Sheet for additional information. (b) No pro forma adjustment has been made to net investment income to reflect the net investment income resulting from the capital contribution of $710 by TIGI. If these proceeds were assumed to be invested in fixed maturities at a rate of 6.5%, net investment income would increase by $46 ($30 after tax). A 1/8% change in the assumed investment rate would change this amount by approximately $1 ($1 after tax). (c) Pro forma adjustment to reflect financing costs relating to the Acquisition as follows:
Interest expense at 5.75% on borrowings under the Credit Agreement, including amortization of issuance costs (a 1/8% change in the assumed interest rate for these borrowings would change interest expense by approximately $3 ($2 after tax))..... $ 153 --- ---
(d) Pro forma adjustments to reflect the change in financing costs resulting from the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings as follows:
Interest expense at 7% on Debt Securities, including amortization of issuance costs (a 1/8% change in the assumed interest rate for the Debt Securities would change interest expense by approximately $2 ($1 after tax))(1).............................. $ 105 Dividends at 8% on TAP-Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts (a 1/8% change in the assumed dividend rate would change preferred dividends by approximately $1 ($1 after tax))............................................... 72 Reduction of interest expense at 5.75% for repayment of borrowings under the Credit Agreement........................... (153) ------ $ 24 ------ ------
------------ (1) The Company may, subject to market conditions and other factors, issue commercial paper or other short-term instruments in lieu of up to $600 of the Debt Securities. At an assumed interest rate of 5.6%, pro forma net income would be increased by $1 for each $100 of Debt Securities replaced by commercial paper.
(e) Adjustment to reflect the federal income tax effects of (a), (b), (c) and (d) above.
The pro forma information is not necessarily indicative of future consolidated results of operations. Included in the historical results of Aetna P&C for the year ended December 31, 1995 are charges of $750 ($488 after tax) representing an addition to environmental-related claims reserves in the second quarter of 1995 and $335 ($218 after tax) representing an addition to asbestos reserves in the fourth quarter of 1995. As the Aetna P&C operations are integrated with the existing property and casualty insurance operations of the Company, management of the Company expects to realize, over a two-year period, $300 ($195 after tax) in annual cost savings from reduction of overhead expenses, changes in the corporate infrastructure of Aetna P&C and elimination of redundant expenses. There can be no assurance that the Company will achieve its projected cost savings. See "Business--The Strategic Plan." These expected future cost savings are not reflected in the accompanying pro forma presentation. The allocation of the purchase price to the assets and liabilities of Aetna P&C is subject to valuations as of the date of the Acquisition based on appraisals and other studies, which are not yet completed. Accordingly, the final allocations will differ from the amounts reflected herein. Adjustments of claims and claims adjustment expense reserves and certain other insurance accounts resulting from the valuation of these accounts will be recorded in operations in the period or periods determined. The Company is continuing to review the insurance reserves of Aetna P&C, including the effect of applying the Company's strategies, policies and practices in determining such reserves and in settling claims. Based on the reviews at this stage, it is possible that additional reserves of up to approximately $750 in the aggregate may be recorded upon completion of these reviews, which would result in after-tax charges to income of up to approximately $488 in the aggregate, primarily relating to reserves for cumulative injury claims, insurance products involving financial guarantees based on the fair value of underlying collateral and certain insurance receivables. Stockholders' equity would be correspondingly reduced by an equivalent amount as a result of these charges. The Company believes that its reviews are likely to be completed in 1996, although there can be no assurance as to the ultimate timing thereof. 32 SELECTED HISTORICAL FINANCIAL INFORMATION The selected consolidated financial information presented below is derived from the consolidated financial statements of TAP and its subsidiaries. Such financial statements have been audited by KPMG Peat Marwick LLP, independent certified public accountants, for each of the three years in the period ended December 31, 1995. The consolidated financial statements of TAP as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 are included in this Prospectus, and the information set forth below should be read in conjunction with such consolidated financial statements and the notes thereto.
TAP HISTORICAL(1) YEAR ENDED DECEMBER 31, ----------------------------------------------------------- 1995 1994 1993 1992 1991 ------- ------- ------- ----------- ----------- (Dollars in millions) INCOME STATEMENT DATA: (unaudited) Revenues: Premiums............................................. $ 3,315 $ 3,178 $ 3,378 $ 3,992 $ 4,481 Net investment income................................ 710 573 657 677 724 Fee income........................................... 456 496 470 468 421 Realized investment gains (losses)................... 71 (132) 192 97 5 Other income......................................... 17 53 18 11 19 ------- ------- ------- ----------- ----------- Total revenues................................... 4,569 4,168 4,715 5,245 5,650 Benefits and expenses: Claims and claim adjustment expenses................. 2,817 2,819 3,245 4,033 3,964 Amortization of deferred acquisition costs........... 512 473 475 497 514 General and administrative expenses.................. 689 666 825 1,069 905 ------- ------- ------- ----------- ----------- Total benefits and expenses...................... 4,018 3,958 4,545 5,599 5,383 Income (loss) before federal income taxes and cumulative effects of changes in accounting principles............................................ 551 210 170 (354) 267 Federal income taxes (tax benefits) Current.............................................. 160 (6) 15 (39) 83 Deferred............................................. (28) 28 (12) (129) (71) ------- ------- ------- ----------- ----------- 132 22 3 (168) 12 Income (loss) before cumulative effects of changes in accounting principles................................ 419 188 167 (186) 255 Cumulative effect of change in accounting for postretirement benefits other than pensions net of tax................................................... -- -- -- (130) -- Cumulative effect of change in accounting for income taxes................................................. -- -- -- 59 -- ------- ------- ------- ----------- ----------- Net income (loss)..................................... $ 419 $ 188 $ 167 $ (257) $ 255 ------- ------- ------- ----------- ----------- ------- ------- ------- ----------- ----------- BALANCE SHEET DATA (AT PERIOD END): (unaudited) (unaudited) Total investments..................................... $12,820 $10,325 $10,461 $10,314 $ 9,796 Total assets.......................................... 24,621 23,137 21,416 20,842 20,392 Claims and claim adjustment expense reserves.......... 15,460 15,299 14,934 14,765 14,709 Total liabilities..................................... 21,020 20,556 18,439 18,242 17,519 Stockholder's equity.................................. 3,601 2,581 2,977 2,600 2,873 Stockholder's equity, excluding unrealized investment gains and losses, net of taxes....................... 3,321 3,024 2,965 2,556 2,852 OTHER DATA (UNAUDITED): Statutory data: Ratio of net premiums written to surplus(2)...... 1.49x 1.68x 1.62x 1.87x 1.85x Policyholders' surplus........................... $ 2,438 $ 2,133 $ 2,246 $ 2,058 $ 2,374 Loss and LAE ratio(3)............................ 78.2% 90.2% 88.6% 96.1% 83.9% Underwriting expense ratio(3).................... 26.4% 26.2% 29.3% 29.8% 26.8% Combined ratio before policyholder dividends..... 104.6% 116.4% 117.9% 125.9% 110.7% Combined ratio(3)................................ 105.4% 115.3% 118.8% 126.1% 111.2% Statutory industry data: Combined ratio(4)................................ 107.2% 108.5% 106.9% 115.8% 108.8%
- ------------ (1) GAAP financial data related to balance sheet data as of December 31, 1993 and subsequent, and income statement data related to periods ended after December 31, 1993, are presented on a purchase accounting basis. (2) Represents statutory net premiums written for the year over statutory policyholders' surplus at the end of such year. (3) The loss and LAE ratio represents the ratio of incurred losses and loss adjustment expenses to net premiums earned. The underwriting expense ratio represents the ratio of underwriting expenses incurred to net premiums written. The combined ratio represents the sum of the loss and LAE ratio and the underwriting expense ratio after policyholder dividends. (4) Source: A.M. Best. Information for 1995 is an estimate. 33 RECENT OPERATING RESULTS RECENT OPERATING RESULTS OF TRAVELERS P&C First Quarter Results For the quarter ended March 31, 1996, Travelers P&C net income increased to $98 million compared to $75 million in the first quarter of 1995. Excluding net realized investment gains, earnings were $81 million, up from $79 million. Higher net investment income and favorable loss experience in personal auto lines offset higher catastrophe losses resulting from winter storm-related claims during the quarter and a $13 million after tax charge relating to the settlement of a stop loss insurance arrangement with TIGI. Catastrophe losses, after taxes and reinsurance, totaled $24 million for the three months ended March 31, 1996 compared to $2 million for the three months ended March 31, 1995. Revenues for the quarter ended March 31, 1996 totaled $1.152 billion compared to $1.162 billion for the first quarter of 1995. Net earned premiums of $826 million were down $40 million from a year ago and fee income of $99 million decreased $25 million, largely offset by higher net investment income and realized investment gains. Net written premiums and equivalents in the National Accounts market were $948 million in the first quarter of 1996 compared with $1.039 billion in 1995, reflecting continued decline in the workers' compensation pool service business as involuntary pools continued to depopulate. Net written premiums and equivalents in the Commercial Accounts market were down slightly from a year ago. Travelers P&C has continued to be selective in renewal activity in this highly competitive market. However, specific industry programs have demonstrated continued growth. Select Accounts and Specialty Accounts both experienced modest premium growth in the quarter. Personal Lines net written premiums for the quarter ended March 31, 1996 totaled $342 million. Excluding the effect of a 1995 change in reinsurance coverage, net written premiums improved slightly over 1995, reflecting growth in target markets. RECENT OPERATING RESULTS OF AETNA P&C Aetna has not yet released its results of operations for the three months ended March 31, 1996, and accordingly the results of operations of Aetna P&C for that period are not yet available. The Company believes that losses similar to those experienced by Travelers P&C during the first quarter of 1996, caused by the severe winter storms, have also been experienced by Aetna P&C. Such losses are likely to have had an adverse effect on the results of operations of Aetna P&C for that period and will likely have an adverse effect on the pro forma combined results of operations of the Company. 34 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Results of Operations presented in the first part of this section reflect the consolidated results of operations of Travelers Indemnity and its subsidiaries ("Travelers P&C") for the periods presented. The Results of Operations presented in the second part of this section reflect the combined results of operations of Aetna Casualty and Standard Fire and their subsidiaries ("Aetna P&C"). The "Outlook" and "Liquidity and Capital Resources" sections discuss the financial position of TAP on a consolidated basis, after giving effect to the Acquisition. This "Management's Discussion and Analysis of Financial Condition and Result of Operations" should be read in conjunction with the Consolidated Financial Statements of TAP and the notes thereto and the Combined Financial Statements of Aetna P&C and the notes thereto included elsewhere in this Prospectus. TRAVELERS P&C OVERVIEW Travelers P&C provides a wide range of commercial and personal property and casualty insurance products and services to businesses, government units, associations and individuals throughout the United States. Prior to the Acquisition, Travelers P&C was a wholly owned subsidiary of TIGI, which is an indirect wholly owned subsidiary of Travelers Group. In December 1992, Travelers Group, then known as Primerica Corporation, acquired approximately 27% of the common stock of TIGI's then parent, The Travelers Corporation (the "27% Acquisition"). In connection with the 27% Acquisition, Travelers Group transferred 50% of Gulf Insurance Company ("Gulf") to The Travelers Corporation, which contributed it to Travelers Indemnity. The 50% interest was valued at $150 million. Effective December 31, 1993, Travelers Group acquired the approximately 73% of The Travelers Corporation common stock that it did not already own, and The Travelers Corporation was merged into Travelers Group (the "Merger"). The 27% Acquisition and the Merger were accounted for as a "step acquisition," and the purchase accounting adjustments were "pushed down" as of December 31, 1993 to the subsidiaries of TIGI, including Travelers Indemnity. Evaluation and appraisal of assets and liabilities were completed during 1994. The excess of the purchase price of The Travelers Corporation common stock over the fair value of the 73% of net assets acquired at December 31, 1993, which was allocated to Travelers Indemnity through "pushdown" accounting, was approximately $443 million and is being amortized over 40 years on a straight-line basis. No goodwill was allocated to Travelers Indemnity in connection with the 27% Acquisition. On December 31, 1994, Travelers Indemnity acquired the remaining 50% of Gulf that it did not already own for approximately $150 million. The effects of this transaction were not material. CONSOLIDATED RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1995
YEAR ENDED DECEMBER 31, -------------------------------------------------------------- 1995 1994 1993 ------------------ ------------------ ------------------ NET NET NET REVENUES INCOME REVENUES INCOME REVENUES INCOME -------- ------ -------- ------ -------- ------ (Dollars in millions) Commercial Lines..................................... $3,070 $329 $2,626 $ 93 $2,988 $ 42 Personal Lines....................................... 1,481 107 1,519 97 1,614 121 Corporate and Other.................................. 18 (17) 23 (2) 113 4 -------- ------ -------- ------ -------- ------ Total................................................ $4,569 $419 $4,168 $188 $4,715 $167 -------- ------ -------- ------ -------- ------
Revenues of $4.569 billion in 1995 increased $401 million from 1994 and revenues declined $547 million from 1993 to 1994. The increase in 1995 compared to 1994 was primarily attributable to an increase in realized investment gains of $203 million, an increase in net investment income of $137 million and an increase in earned premiums of $137 million. The decline in 1994 compared to 1993 was due to a decrease in realized investment gains of $324 million and a decrease in earned premiums of $200 million, which reflected selective renewal activity 35 by Travelers P&C in Commercial Lines because of the competitive pricing environment as well as continued success in lowering workers' compensation losses of customers, which reduces earned premiums. The shift to fee-based service products from insurance products within Commercial Lines continued throughout 1994 and 1995. Net investment income was $710 million in 1995, an increase of $137 million from 1994. Net investment income decreased $84 million from 1993 to 1994. The increase in 1995 compared to 1994 was primarily due to increased investable funds and a higher return on investments. The decline in 1994 compared to 1993 was attributable to lower interest rates on new investments, and a shift from taxable to tax-exempt securities. Fee income is significantly impacted by National Accounts within Commercial Lines because the recorded revenue from premium equivalents is primarily reflected in fees. Fee income decreased in 1995 to $456 million, a $40 million decrease from 1994. Fee income of $496 million in 1994 increased $26 million over 1993. The 1995 decrease in fee income compared to 1994 was due to the depopulation of involuntary pools as the loss experience of workers' compensation improved and insureds moved to voluntary markets, Travelers P&C's selective renewal activity to address the competitive pricing environment and its continued success in lowering workers' compensation losses of customers. The 1994 increase in fee income compared to 1993 reflected the shift to fee-based service products from insurance products. Benefits and expenses of $4.018 billion in 1995 increased $60 million from 1994, and benefits and expenses decreased $587 million from 1993 to 1994. In 1995, the effect of the consolidation of Gulf more than offset the decrease in benefits and expenses due to expense reduction initiatives and improved loss trends in the workers' compensation business. The 1994 decrease was primarily attributable to the $299 million addition to environmental and asbestos reserves by Commercial Lines in 1993, expense reduction initiatives and favorable reserve development on prior years' personal automobile business. Travelers P&C's effective tax rate was 24%, 10% and 2% for 1995, 1994 and 1993, respectively. These rates differed from the statutory tax rate in those years primarily due to municipal bond interest not taxed for federal income tax purposes. The 1995 effective rate was higher than 1994 due to the same level of tax-exempt income and higher pre-tax income. In addition, 1993 reflected the effect of the increase in the corporate tax rate from 34% to 35% resulting in an increase in the deferred tax asset. Also, 1993 was the final year of the "fresh start" benefit attributable to the accrual of salvage and subrogation. Net income in 1995 of $419 million increased $231 million over 1994, and 1994 net income of $188 million increased $21 million compared to 1993. The 1995 increase compared to 1994 was the result of the previously mentioned increases in realized investment gains and net investment income, as well as improved loss trends in the workers' compensation line of business and expense reduction initiatives. The 1994 increase compared to 1993 was primarily attributable to the Commercial Lines addition in 1993 of $299 million to its reserves ($194 million on an after-tax basis), predominantly for asbestos and environmental liabilities, and the after-tax gain of $19 million from the 1994 sale of Bankers and Shippers Insurance Company ("Bankers and Shippers"). The increase was largely offset by the fluctuation in realized investment gains (losses) from an after-tax gain of $113 million in 1993 to an after-tax loss of $97 million in 1994. Excluding realized investment gains and losses in all years, the 1994 gain on the sale of Bankers and Shippers and the 1993 reserve addition described above, Travelers P&C's earnings were $373 million, $266 million and $248 million in 1995, 1994 and 1993, respectively. RESULTS OF OPERATIONS BY SEGMENT Commercial Lines Commercial Lines net written premiums for 1995 totaled $2.309 billion, up $197 million compared to $2.112 billion in 1994, which was an increase of $34 million compared to $2.078 billion in 1993. Premium equivalents for 1995 totaled $2.821 billion, down $169 million compared to $2.990 billion in 1994, which was up $79 million compared to $2.911 billion in 1993. Premium equivalents, which are associated largely with National Accounts, represent estimates of premiums that customers would have been charged under a fully insured arrangement and do not represent actual premium revenues. A significant component of Commercial Lines is National Accounts, which works with national brokers and regional agents providing insurance coverages and services, primarily workers' compensation, mainly to large corporations. National Accounts net written premiums of $703 million in 1995 declined $132 million from 1994. 36 Net written premiums for 1994 decreased $66 million from 1993. National Accounts premium equivalents of $2.780 billion for 1995 were $179 million below 1994, which was $50 million above 1993. The 1995 decline reflects Travelers P&C's selective renewal activity in response to the competitive pricing environment as well as continued success in lowering workers' compensation losses of customers (which reduces premiums and premium equivalents). The decrease in premium equivalents in 1995 compared to 1994 also reflected a depopulation of involuntary pools as the loss experience of workers' compensation improved and insureds moved to voluntary markets. For 1995, new business, including both premiums and premium equivalents, was $444 million compared to $325 million in 1994 and $407 million in 1993. Retention ratios dropped to 84% in 1995 from 88% in 1994 and 95% in 1993. This decline reflected Travelers P&C's selective renewal activity in response to the competitive pricing environment. Commercial Accounts serves mid-sized businesses through a network of independent agencies and brokers. Commercial Accounts net written premiums of $730 million for 1995 were $59 million above 1994 premium levels, which were $67 million above 1993 premium levels. These increases in net written premiums reflected the continued growth in Commercial Accounts' industry-specific programs and in retrospectively rated policies and other loss-responsive products, partly offset by continued softness in guaranteed cost products sold by Commercial Accounts. Commercial Accounts premium equivalents grew to $41 million in 1995, $10 million above the 1994 level, which was $29 million above the 1993 level. These increases reflected a shift from guaranteed cost products to fee-for-service business. For 1995, new premium and premium equivalent business in Commercial Accounts was $470 million compared to $381 million in 1994, which was $80 million higher than 1993. The Commercial Accounts business retention ratio was 73% in 1995 and 79% in both 1994 and 1993. Commercial Accounts continues to focus on the retention of existing business while maintaining its product pricing standards and its selective underwriting policy. Select Accounts serves small businesses through a network of independent agencies. Select Accounts net written premiums of $542 million for 1995 were $76 million above 1994 premium levels, due primarily to an increase in new business. 1994 net written premiums decreased $24 million from 1993 due to lower retention levels, partially offset by an increase in new business. New business in Select Accounts was $131 million, $112 million and $94 million in 1995, 1994 and 1993, respectively. The Select Accounts business retention ratio was 75%, 73% and 75% in 1995, 1994 and 1993, respectively. Specialty Accounts net written premiums of $334 million for 1995 were $194 million higher than 1994, which was $57 million above 1993. The 1995 increase compared to 1994 primarily reflected consolidation of Gulf following the acquisition of the 50% of Gulf that Travelers Indemnity did not already own. Gulf's net written premiums for 1995 were $176 million. The 1994 increase compared to 1993 was attributable to an increase in property, liability and specialty auto writings, and assumed reinsurance. Benefits and expenses of $2.646 billion in 1995 increased $103 million from 1994, and decreased $439 million from 1993 to 1994. Excluding the effects of consolidating Gulf in 1995 and the environmental and asbestos reserve addition in 1993, benefits and expenses decreased $20 million from 1994 to 1995 and decreased $140 million from 1993 to 1994. These decreases were primarily attributable to favorable current year loss development in certain workers' compensation lines and residual markets in 1995, and to expense reduction initiatives in 1994. Catastrophe losses, net of tax and reinsurance, were $7 million, $30 million and $21 million in 1995, 1994 and 1993, respectively. The increase in catastrophe losses in 1994 was due to winter storms in the first quarter of 1994. Effective April 1, 1995, the threshold of losses incurred to qualify a specific event as a catastrophe was increased. Net income in 1995 of $329 million increased $236 million over 1994, and 1994 net income of $93 million increased $51 million compared to 1993. The 1995 increase compared to 1994 reflected improved loss trends in the workers' compensation line. In addition, the increase was due to a $112 million after-tax increase in realized investment gains, higher net investment income and expense reduction initiatives. The 1994 increase compared to 1993 was attributable to the addition in 1993 of $299 million to reserves ($194 million on an after-tax basis), primarily for asbestos and environmental liabilities, partially offset by a $157 million after-tax decrease in realized investment gains. Excluding realized investment gains and losses in all years and the 1993 reserve addition referenced above, Commercial Lines' earnings were $288 million, $164 million and $150 million in 1995, 1994 and 1993, respectively. 37 Statutory and GAAP combined ratios for Commercial Lines were as follows:
1995 1994 1993 ----- ----- ----- Statutory: Loss and LAE ratio............................................................ 80.6% 104.2% 100.3% Underwriting expense ratio.................................................... 24.4 24.0 27.0 Combined ratio before policyholder dividends.................................. 105.0 128.2 127.3 Combined ratio................................................................ 106.3 126.2 128.7 GAAP: Loss and LAE ratio............................................................ 74.6 82.3 91.9 Underwriting expense ratio.................................................... 28.9 27.4 31.4 Combined ratio before policyholder dividends.................................. 103.5 109.7 123.3 Combined ratio................................................................ 104.6 108.1 124.6
GAAP combined ratios for Commercial Lines differ from statutory combined ratios primarily due to the gross up for GAAP reporting purposes of revenues and expenses related to service business, including servicing of residual market pools and deductible policies. The 1994 statutory combined ratio includes a statutory charge of $225 million for reserve increases for environmental claims and for a reduction of ceded reinsurance balances. Excluding this charge, the statutory combined ratio for 1994 was 114.2%. The 1993 combined ratios included $299 million of reserve strengthening predominantly for asbestos and environmental liabilities. Excluding this charge, the 1993 statutory and GAAP combined ratios were 114.2% and 111.9%, respectively. The improvement in the 1995 combined ratios compared to the adjusted 1994 combined ratios was due to the first quarter 1994 catastrophe losses and favorable loss development in certain workers' compensation lines and residual markets in 1995. Personal Lines Net written premiums for 1995 were $1.298 billion compared to $1.433 billion in 1994 and $1.361 billion in 1993. The 1995 decline of $135 million compared to 1994 was attributable to the sale of Bankers and Shippers in October 1994. Excluding Bankers and Shippers business, net written premiums for 1995 were up approximately 8% from 1994, reflecting reduced insurance ceded and targeted growth in sales through independent agents. The 1994 increase of $72 million compared to 1993 was primarily attributable to reduced insurance ceded in 1994. Benefits and expenses of $1.335 billion in 1995 decreased $49 million from 1994, and decreased $68 million from 1993 to 1994. The decline in both years was primarily attributable to expense reduction initiatives. In addition, 1995 reflected lower expenses due to the October 1994 sale of Bankers and Shippers, and 1994 benefited from the resolution of the New Jersey Market Transition Facility ("MTF") deficit and favorable reserve development on prior years' business. Included in 1995 were after-tax catastrophe losses, net of reinsurance, of $12 million compared to $26 million in 1994 and $13 million in 1993. The increase in catastrophe losses in 1994 was due to the severe winter storms in the Northeast during the first quarter. Effective April 1, 1995, the threshold of losses incurred to qualify a specific event as a catastrophe was increased. Net income in 1995 of $107 million increased $10 million compared to $97 million in 1994, which was down $24 million from 1993. The 1995 increase compared to 1994 was attributable to higher after-tax net investment income of $23 million and higher after-tax realized investment gains of $23 million as well as expense reduction initiatives, largely offset by results in 1994 benefiting from favorable loss reserve development in 1994 on prior years' business in the personal automobile line of business, a one-time contribution of $9 million from the favorable resolution of the MTF deficit and the earnings from Bankers and Shippers (which was sold in October 1994). The decrease in net income in 1994 compared to 1993 reflected a decline of approximately $47 million after tax of realized investment gains in 1994 compared to 1993, partially offset by a $19 million after tax gain on the 1994 sale of the non-standard personal automobile insurance business of Bankers and Shippers for $142 million in cash. 38 Statutory and GAAP combined ratios for Personal Lines were as follows:
1995 1994 1993 ----- ----- ----- Statutory: Loss and LAE ratio............................................................ 74.5% 71.0% 71.2% Underwriting expense ratio.................................................... 29.9 29.4 33.2 Combined ratio................................................................ 104.4 100.4 104.4 GAAP: Loss and LAE ratio............................................................ 74.5 72.2 71.3 Underwriting expense ratio.................................................... 29.1 28.3 34.1 Combined ratio................................................................ 103.6 100.5 105.4
The lower ratios in 1994 compared to 1995 and 1993 were primarily due to the benefit of favorable loss reserve development and the favorable resolution of the MTF deficit. Corporate and Other Travelers P&C's Corporate and Other operations reflect the accident and health business written by certain affiliated companies and reinsured by Travelers P&C. The decline in revenues from 1993 to 1994 was attributable to a reduction in accident and health business. ENVIRONMENTAL CLAIMS Travelers P&C continues to receive claims alleging liability exposures arising out of insureds' alleged disposition of toxic substances. These claims when submitted rarely indicate the monetary amount being sought by the claimant from the insured and Travelers P&C does not keep track of those few claims that indicate a monetary amount being sought. The Travelers P&C review and investigation of such claims includes an assessment of the probable liability, available coverage, judicial interpretations and historical value of similar claims. In addition, the unique facts presented in each claim are evaluated individually and collectively. Due consideration is given to the many variables presented in each claim, such as: the nature of the alleged activities of the insured at each site; the allegations of environmental damage at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of environmental harm and the corresponding remedy at a site; the nature of government enforcement activities at each site; the ownership and general use of each site; the willingness and ability of other potentially responsible parties to contribute to the cost of the required remediation at each site; the overall nature of the insurance relationship between Travelers P&C and the insured; the identification of other insurers; the potential coverage available, if any; the number of years of coverage, if any; the obligation to provide a defense to insureds, if any, and the applicable law in each jurisdiction. Travelers P&C's reserves for environmental claims are not established on a claim-by-claim basis. An aggregate bulk reserve is carried for all of Travelers P&C environmental claims that are in the dispute process. This bulk reserve is established and adjusted based upon the aggregate volume of in process environmental claims and Travelers P&C's experience in resolving such claims. Until the dispute is resolved, the estimated amounts for disputed coverage claims are carried in a bulk reserve. At December 31, 1995, approximately 24% of the net environmental loss reserve (i.e., approximately $95 million) is case reserve for resolved claims. The balance, approximately 76% of the net aggregate reserve (i.e., approximately $309 million), is carried in a bulk reserve together with incurred but not yet reported environmental claims for which Travelers P&C has not received any specific claims. The following table displays activity for environmental losses and loss expenses and reserves for 1995, 1994 and 1993. 39 Environmental Losses
1995 1994 1993 ---- ---- ---- (Dollars in millions) Beginning reserves: Direct......................................................................... $449 $466 $175 Ceded.......................................................................... (8) (7) -- ---- ---- ---- Net.......................................................................... 441 459 175 Incurred losses and loss expenses: Direct......................................................................... 117 45 192 Ceded.......................................................................... (61) (4) (15) Losses paid: Direct......................................................................... 145 65 56 Ceded.......................................................................... (22) (4) (8) Other: Direct......................................................................... 33 3 155 Ceded.......................................................................... (3) (1) -- ---- ---- ---- Ending reserves: Direct......................................................................... 454 449 466 Ceded.......................................................................... (50) (8) (7) ---- ---- ---- Net.......................................................................... $404 $441 $459 ---- ---- ----
The duration of Travelers P&C's investigation and review of such claims and the extent of time necessary to determine an appropriate estimate, if any, of the value of the claim to Travelers P&C, varies significantly and is dependent upon a number of factors. These factors include, but are not limited to, the cooperation of the insured in providing claim information, the pace of underlying litigation or claim processes, the pace of coverage litigation between the insured and Travelers P&C and the willingness of the insured and Travelers P&C to negotiate, if appropriate, a resolution of any dispute between them pertaining to such claims. Since the foregoing factors vary from claim to claim and insured by insured, Travelers P&C cannot provide a meaningful average of the duration of an environmental claim. However, based upon Travelers P&C's experience in resolving such claims, the range may vary from months to several years. The industry does not have a standard method of calculating claim activity for environmental losses. Generally for environmental claims, Travelers P&C establishes a claim file for each insured on a per site, per claimant basis. If there is more than one claimant, e.g., a federal and a state agency, this method will result in two claims being set up for a policyholder at that one site. Travelers P&C adheres to its method of calculating claim activity on all environmental-related claims, whether such claims are tendered on primary, excess or umbrella policies. As of December 31, 1995, Travelers P&C had approximately 10,500 pending environmental-related claims and had resolved over 20,600 such claims since 1986. Approximately 65% of the pending environmental-related claims in inventory at such date represented federal or state EPA-type claims tendered by approximately 700 insureds. The balance represented bodily injury claims alleging injury due to the discharge of insureds' waste or pollutants. To date, Travelers P&C generally has been successful in resolving its coverage litigation and continues to reduce its potential exposure through favorable settlements with certain insureds. These settlement agreements with certain insureds are based on the variables presented in each piece of coverage litigation. Generally the settlement dollars paid in disputed coverage claims are a percentage of the total coverage sought by such insureds. In addition, with respect to settlement of many of the environmental claims, the agreement between Travelers P&C and the insured extinguishes any obligation Travelers P&C may have under any policy issued to the insured for future environmental liability risks. This form of settlement is commonly referred to as a "buy-back" of the policies for future environmental liability risks. Additional provisions of these agreements include the appropriate indemnities and hold harmless provisions to protect Travelers P&C. Travelers P&C's general purpose in executing such agreements is to reduce its potential environmental exposure and eliminate both the risks presented by coverage litigation with the insured and the cost of such litigation. In 1995, Congress considered the "Superfund Reform Act of 1995" and certain other proposals, which seek to effect improvements in remediation of hazardous waste sites listed on the National Priorities List ("NPL") and to achieve certain other reforms of Superfund. It is not possible to predict whether proposed legislation will be 40 enacted, what form such legislation might take when enacted, or the potential effects such legislation may have on Travelers P&C and its competitors. For a discussion of the adequacy of reserves for environmental claims, see "--Outlook" below. In the above table, "Other" represents (i) a purchase accounting adjustment in 1993 reflecting appellate court decisions that resolved issues concerning obligations of insurers for environmental claims under liability policies in certain jurisdictions, (ii) the 1994 acquisition by Travelers P&C of the remaining 50% of Gulf that it did not already own, and (iii) the termination in 1995 of certain agreements with TIGI whereby TIGI had assumed certain reserves from Travelers P&C. ASBESTOS CLAIMS In the area of asbestos claims, Travelers P&C believes that the property and casualty insurance industry has suffered from judicial interpretations that have attempted to maximize insurance availability from both a coverage and liability standpoint far beyond the intent of the contracting parties. These policies generally were issued prior to the 1980s. Travelers P&C continues to receive asbestos claims alleging insureds' liability from claimants' asbestos-related injuries. These claims when submitted rarely indicate the monetary amount being sought by the claimant from the insured and Travelers P&C does not keep track of those few claims that indicate a monetary amount being sought. Originally the cases involved mainly plant workers and traditional asbestos manufacturers and distributors. However, in the mid-1980s, a new group of plaintiffs, whose exposure to asbestos was less direct and whose injuries were often speculative, began to file lawsuits in increasing numbers against the traditional defendants as well as peripheral defendants who had produced products that may have contained small amounts of some form of encapsulated asbestos. These claims continue to arise and on an individual basis generally involve smaller companies with smaller limits of potential coverage. Also, there has emerged a group of non-product claims by plaintiffs, mostly independent labor union workers, mainly against companies, alleging exposure to asbestos while working at these companies' premises. In addition, various insurers, including Travelers P&C, remain defendants in an action brought in Philadelphia regarding potential consolidation and resolution of future asbestos bodily injury claims. The cumulative effect of these claims and judicial actions on Travelers P&C and its insureds currently is uncertain. In addition, various classes of asbestos defendants, such as major product manufacturers, peripheral and regional product defendants as well as premises owners, are tendering asbestos-related claims to the industry. Because each insured presents different liability and coverage issues, Travelers P&C evaluates those issues on an insured-by-insured basis. Travelers P&C's evaluations have not resulted in any meaningful data from which an average asbestos defense or indemnity payment may be determined. The varying defense and indemnity payments made by Travelers P&C on behalf of its insureds have also precluded Travelers P&C from deriving any meaningful data by which it can predict whether its defense and indemnity payments for asbestos claims (on average or in the aggregate) will remain the same or change in the future. Based upon Travelers P&C's experience with asbestos claims, the duration period of an asbestos claim from the date of submission to resolution is approximately two years. 41 The following table displays activity for asbestos losses and loss expenses and reserves for 1995, 1994 and 1993. In general, Travelers P&C posts case reserves for pending but unsettled asbestos claims within approximately 30 business days of receipt of such claims. At December 31, 1995, approximately 18% of the net aggregate reserve (i.e., approximately $73 million) is for pending but unsettled asbestos claims. The balance, approximately 82% (i.e., approximately $329 million) of the net asbestos reserves represents incurred but not yet reported losses for which Travelers P&C has not received any specific claims. Asbestos Losses
1995 1994 1993 ---- ---- ---- (Dollars in millions) Beginning reserves: Direct......................................................................... $614 $683 $360 Ceded.......................................................................... (278) (336) (219) ---- ---- ---- Net.......................................................................... 336 347 141 Incurred losses and loss expenses: Direct......................................................................... 109 52 409 Ceded.......................................................................... (66) (9) (200) Losses paid: Direct......................................................................... 116 121 86 Ceded.......................................................................... (92) (67) (13) Other: Direct......................................................................... 88 -- -- Ceded.......................................................................... (41) -- 70 ---- ---- ---- Ending reserves: Direct......................................................................... 695 614 683 Ceded.......................................................................... (293) (278) (336) ---- ---- ---- Net.......................................................................... $402 $336 $347 ---- ---- ----
The largest reinsurer of Travelers P&C's asbestos risks is Lloyd's of London. Lloyd's is currently undergoing a restructuring to solidify its capital base and to segregate claims for years before 1993. Travelers P&C is in arbitration with underwriters at Lloyd's in New York State to enforce reinsurance contracts with respect to recoveries for certain asbestos claims. The dispute involves the ability of Travelers P&C to aggregate asbestos claims under a market agreement between Lloyd's and Travelers P&C or under the applicable reinsurance treaties. See "Business--Legal Proceedings." The outcomes of the restructuring of Lloyd's and the arbitration referred to above are uncertain and the impact, if any, on collectibility of amounts recoverable by Travelers P&C from Lloyd's cannot be quantified at this time. Travelers P&C believes that it is possible that an unfavorable resolution of these matters could have a material adverse effect on Travelers P&C's operating results in a future period. However, Travelers P&C believes that it is not likely that the outcome of these matters could have a material adverse effect on Travelers P&C's financial condition or liquidity. The Company's ceded losses to Lloyd's arise predominantly from contracts written prior to 1980. Since 1986, Lloyd's has generally limited its business with U.S. carriers to assumption of property and non-traditional liability lines. The restructuring of the Lloyd's market has not had any meaningful impact on the Company's ability to purchase reinsurance to date and, because of the recent growth in reinsurance market capacity which provides a number of alternatives to Lloyd's, the Company does not expect the Lloyd's restructuring will have a meaningful impact on the Company's ability to purchase reinsurance in the future. For a discussion of the adequacy of reserves for asbestos claims, see "--Outlook" below. In the above table, "Other" represents (i) a purchase accounting adjustment in 1993 to reflect the measurement of amounts recoverable for asbestos claims from reinsurers based upon commutation of reinsurers' liabilities at a discount and (ii) the termination in 1995 of certain agreements with TIGI whereby TIGI had assumed certain reserves from Travelers P&C. To date, there have been no material commutations with any of Travelers P&C's reinsurers regarding asbestos claims. The commutation negotiations pertain to certain specific reinsurance treaties purchased many years ago. The negotiations were commenced as a result of a change in strategy to resolve such reinsurance obligations following the new management directive as a result of the merger of The Travelers Corporation into Travelers Group. Based upon negotiations to date, the effect of commuting these treaties will not have a material adverse effect on Travelers P&C's results of operations, financial condition or liquidity. 42 OTHER Commercial Lines ceded losses to reinsurers of $1.174 billion, $580 million and $1.039 billion, respectively, and Personal Lines ceded losses of $71 million, $95 million and $39 million, respectively, in 1995, 1994 and 1993. Included in the Corporate and Other segment were accident and health ceded losses of $49 million in 1994 and negative ceded losses of $66 million in 1993 associated with the termination of an intercompany reinsurance arrangement. The increase in Commercial Lines ceded losses in 1995 primarily reflected prior year reserve strengthening by residual market pools for which Travelers P&C acts as the servicing carrier. The decrease from 1993 to 1994 reflected a decrease in residual market pools resulting from a decline in volume stemming from a depopulation of involuntary pools. Because Travelers P&C is a servicing carrier, these movements did not have an effect on its results of operations or liquidity as there were corresponding movements in direct losses. In addition, the 1995 increase reflects the consolidation of Gulf. INVESTMENT PORTFOLIO The investment portfolio of Travelers P&C totaled $12.8 billion at December 31, 1995, representing 52% of total assets of $24.6 billion. The average yield (excluding realized and unrealized investment gains) was 6.2% in 1995. Because the primary purpose of the investment portfolio is to fund future policyholder benefits and claims payments, Travelers P&C seeks to employ a conservative investment philosophy. Travelers P&C's fixed maturity portfolio at December 31, 1995 totaled $10.9 billion, comprised of $9.7 billion of publicly traded fixed maturities and $1.2 billion of private fixed maturities. The weighted average quality ratings of Travelers P&C's publicly traded fixed maturity portfolio and private fixed maturity portfolio at December 31, 1995 were Aa3 and Baa1, respectively. Included in the fixed maturity portfolio at such date were approximately $402 million of below investment grade securities. The average duration of the fixed maturity portfolio, including short-term investments, was 5.2 years at such date. Travelers P&C makes significant investments in collateralized mortgage obligations ("CMOs"). Such CMOs typically have high credit quality, offer good liquidity, and provide a significant advantage in yield and total return compared to U.S. treasury securities. The investment strategy of Travelers P&C is to purchase CMO tranches that are protected against prepayment risk, primarily planned amortization class ("PAC") tranches. Prepayment protected tranches are preferred because they provide stable cash flows in a variety of scenarios. Travelers P&C does invest in other types of CMO tranches if a careful assessment indicates a favorable risk/return tradeoff; however, it does not purchase residual interests in CMOs. At December 31, 1995, Travelers P&C held CMOs with a market value of $956 million. Approximately 90% of CMO holdings were fully collateralized by GNMA, FNMA or FHLMC securities at such date, and the balance were fully collateralized by portfolios of individual mortgage loans. In addition, Travelers P&C held $618 million of GNMA, FNMA or FHLMC mortgage-backed securities at December 31, 1995. Virtually all of these securities were rated AAA at such date. Travelers P&C uses exchange traded financial futures contracts to manage its exposure to changes in interest rates. Travelers P&C is subject to reinvestment risk from investments that mature, are called or are sold. To hedge against adverse changes in interest rates, Travelers P&C enters long positions in financial futures contracts which offset asset price changes resulting from changes in market interest rates until an investment is purchased. At December 31, 1995, Travelers P&C held financial futures contracts with a notional amount of approximately $220 million. Futures contracts are with organized exchanges as the counterparties. Margin payments are required to enter a futures contract and contract gains or losses are settled daily in cash. The notional amount of futures contracts represents the extent of Travelers P&C's involvement, but not future cash requirements, as open positions are typically closed out prior to the delivery date of the contract. At December 31, 1995, Travelers P&C's futures contracts had no fair value because these contracts are marked to market and settled in cash. Travelers P&C uses derivative financial instruments, including forward contracts and interest rate swaps, as a means of hedging exposure to foreign currency and/or interest rate risk on anticipated investment purchases or existing assets and liabilities. Also, in the normal course of business, Travelers P&C has fixed and variable rate loan commitments and unfunded commitments to partnerships. Travelers P&C does not hold or issue derivative instruments for trading purposes. The off-balance-sheet risks of forward contracts, interest rate swaps, fixed and variable rate loan commitments and unfunded commitments to partnerships were not significant at December 31, 1995 and 1994. 43 AETNA P&C SELECTED HISTORICAL FINANCIAL INFORMATION The selected combined financial information presented below is derived from the combined financial statements of Aetna P&C. The combined financial statements of Aetna P&C as of December 31, 1995 and 1994 and for each of the three years in the period ended December 31, 1995 are included in this Prospectus, and the information set forth below should be read in conjunction with such combined financial statements and the notes thereto.
AETNA P&C ----------------------------- YEAR ENDED DECEMBER 31, ----------------------------- 1995 1994 1993 ------- ------- ------- (Dollars in millions) STATEMENT OF INCOME DATA: Revenue: Premiums............................................................. $ 4,118 $ 4,355 $ 4,609 Net investment income................................................ 902 824 964 Fees and other income................................................ 82 116 154 Net realized capital gains........................................... 199 6 144 ------- ------- ------- Total revenue...................................................... 5,301 5,301 5,871 ------- ------- ------- Claims and Expenses: Claims and claim adjustment expenses................................. 4,232 3,747 4,191 Operating expenses................................................... 852 1,011 1,248(1) Amortization of deferred policy acquisition costs.................... 623 634 646 ------- ------- ------- Total claims and expenses.......................................... 5,707 5,392 6,085 ------- ------- ------- Loss from continuing operations before income tax benefits and cumulative effect adjustments....................................................... (406) (91) (214) Income tax benefits...................................................... (163) (54) (159) ------- ------- ------- Loss from continuing operations before cumulative effect adjustments..... (243) (37) (55) Discontinued operations, net of tax...................................... -- -- 27 ------- ------- ------- Loss before cumulative effect adjustments for continuing operations...... (243) (37) (28) Cumulative effect adjustments for continuing operations, net of tax...... -- -- 267 ------- ------- ------- Net income (loss)........................................................ $ (243) $ (37) $ 239 ------- ------- ------- ------- ------- ------- BALANCE SHEET DATA (AT PERIOD END): Total investments........................................................ $13,853 $12,651 $14,699 Total assets............................................................. 23,399 21,671 21,900 Claims and claim adjustment expense reserves(2).......................... 16,598 16,024 15,446 Total liabilities........................................................ 19,518 18,550 18,041 Shareholder's equity..................................................... 3,881 3,121 3,858 Shareholder's equity, excluding unrealized investment gains and losses, net of taxes........................................................... 3,569 3,509 3,546 OTHER DATA (UNAUDITED): Statutory data: Ratio of net premiums written to surplus(3)............................ 1.46x 1.74x 1.68x Policyholders' surplus................................................. $ 2,793 $ 2,526 $ 2,687 Loss and LAE ratio(4).................................................. 102.8% 87.5% 81.4% Underwriting expense ratio(4).......................................... 33.5% 35.2% 34.4% Combined ratio before policyholder dividends........................... 136.3% 122.7% 115.8% Combined ratio(4)...................................................... 136.7% 123.3% 116.4% Statutory industry data: Combined ratio(5)...................................................... 107.2% 108.5% 106.9%
- ------------ (1) Includes severance and facilities charge of $155. (2) Includes unpaid claims and claim adjustment expenses and policyholders' funds left with the companies. (3) Represents statutory net premiums written for the year over statutory policyholders' surplus at the end of such year. (4) The loss and LAE ratio represents the ratio of incurred losses and loss adjustment expenses to net premiums earned. The underwriting expense ratio represents the ratio of underwriting expenses incurred to net premiums written. The combined ratio represents the sum of the loss and LAE ratio and the underwriting expense ratio after policyholder dividends. (5) Source: A.M. Best. Information for 1995 is an estimate. 44 OVERVIEW Aetna entered into a definitive agreement, dated November 28, 1995 (the "Stock Purchase Agreement"), to sell Aetna Casualty and Standard Fire and their subsidiaries for $4.0 billion in cash, subject to various closing adjustments. The sale was completed on April 2, 1996. See "Certain Transactions--The Acquisition." Aetna P&C provides most types of commercial and personal property-casualty insurance, bonds, and insurance-related services for businesses, government units and associations and individuals. COMBINED RESULTS OF OPERATIONS FOR THE THREE YEARS ENDED DECEMBER 31, 1995
YEAR ENDED DECEMBER 31, ---------------------------------------------------------------------------- 1995 1994 1993 ------------------------- ------------------------- ------------------ NET NET NET REVENUES INCOME (LOSS) REVENUES INCOME (LOSS) REVENUES INCOME -------- ------------- -------- ------------- -------- ------ (Dollars in millions) Commercial Lines.......................... $3,819 $(377) $3,775 $ (74) $4,151 $200 Personal Lines............................ 1,482 134 1,526 37 1,721 39 -------- ------ -------- ----- -------- ------ Total................................. $5,301 $(243) $5,301 $ (37) $5,872 $239
Revenues of $5.301 billion in 1995 were level with 1994, primarily reflecting a decrease of $237 million in premiums offset by an increase in net realized capital gains of $193 million and an increase in net investment income of $78 million. The decline in revenues of $571 million from 1993 to 1994 was primarily attributable to a $255 million decrease in premiums, a decrease in net investment income of $140 million and a decrease in net realized capital gains of $138 million. The decline in premiums in 1995 was due primarily to the transferring of risk through restructured and expanded reinsurance programs, and reductions in residual market business assumed as a result of exiting certain markets. During 1995, Aetna P&C continued to evaluate personal automobile market conditions in each state and attempted to maintain or increase Aetna P&C's presence in those states that offered acceptable returns and reduce their presence in those remaining states where Aetna P&C was unable to earn acceptable returns. In 1994 compared to 1993, reductions in personal automobile and workers' compensation exposures, a decrease in commercial auto exposures, generally stricter underwriting in Commercial Lines and the competitive marketplace contributed to the premium decline. Net investment income was $902 million in 1995, an increase of $78 million from 1994. Net investment income decreased $140 million from 1993 to 1994. The increase in 1995 compared to 1994 was primarily attributable to the reinvestment of proceeds from the sale of equity and U.S. Treasury securities in higher yielding corporate bonds. The decline in 1994 compared to 1993 was attributable to lower investment yields. Net realized after-tax capital gains in 1995 include $156 million resulting from the sale of equity securities in Aetna P&C's investment portfolio primarily due to Aetna P&C's efforts to reduce volatility in its statutory surplus, to increase income, and in connection with Aetna's agreement to reduce Aetna P&C's equity portfolio pursuant to the Stock Purchase Agreement. Net realized after-tax capital gains in 1994 include a $14 million gain resulting from the sale of a portion of an unconsolidated subsidiary. Aetna P&C's 1995 net loss was $243 million compared with a net loss of $37 million in 1994 and net income of $239 million (which includes $267 million of cumulative effect benefit for accounting changes) in 1993. The following significant factors impact these comparisons: . Net realized after-tax capital gains were $129 million, $4 million and $97 million in 1995, 1994 and 1993, respectively. . Net income in 1993 includes an after-tax gain on discontinued operations of $27 million in connection with the 1993 redemption of preferred stock received in the 1992 sale of its subsidiary, Am Re. . The 1995 net loss included an addition to environmental reserves of $488 million after-tax upon completion of Aetna P&C's 1995 environmental study in the second quarter of 1995, an addition to asbestos reserves of $218 million after tax in the fourth quarter of 1995, and an addition to environmental reserves of $150 million after-tax in 1994. . 1993 net income included a severance and facilities charge of $101 million after tax. 45 . Catastrophe losses, net of tax and reinsurance, were $65 million, $190 million and $85 million in 1995, 1994 and 1993, respectively. Catastrophe losses in 1994 included $161 million from the Los Angeles earthquake and the severe winter weather. . 1994 net loss reflected after-tax reductions of $66 million in prior year loss reserves related to the personal auto business. 1993 net income included an increase of $259 million (after tax and after discounting) in workers' compensation reserves for prior accident years. . Net income in 1993 reflected a net tax benefit of $26 million related to revaluing the deferred tax asset as a result of the increase in federal income tax rates. Excluding the unusual items above, earnings in 1995 compared to 1994 reflected a reduction in the level of ongoing operating expenses, primarily due to actions taken by Aetna P&C's management in prior years to lower costs, increased emphasis on underwriting and claims handling, and higher net investment income resulting from the reinvestment of proceeds from the sale of equity and U.S. Treasury securities in higher yielding corporate bonds. Excluding the unusual items above, 1994 earnings compared to 1993 also reflected a reduction in operating expenses, primarily due to management's efforts to lower costs and exiting unprofitable markets. Partially offsetting the improvements in 1994 earnings was lower net investment income primarily due to lower investment yields. Aetna P&C has undertaken a number of actions in the past few years to improve its expense position. The Company will seek to further reduce the costs associated with acquiring, processing and servicing business. Aetna P&C has taken a number of steps intended to moderate the volatility of its earnings, including transferring more risk through restructured and expanded reinsurance programs. Additionally, exposure to catastrophes is being reduced through restricting business writings in certain geographic areas, subject to restrictions imposed by insurance regulatory authorities. These actions somewhat reduce premium levels. RESULTS OF OPERATIONS BY SEGMENT Commercial Lines Commercial Lines revenues of $3.819 billion in 1995 were slightly higher than 1994, reflecting an increase in net realized capital gains of $153 million and an increase in net investment income of $96 million offset by a decrease in premiums of $173 million and a decrease in fees and other income of $32 million. The decline in revenues of $375 million from 1993 to 1994 was primarily attributable to a decrease in realized capital gains of $144 million, a decrease in net investment and other income of $117 million and a decrease in premiums of $114 million. The decline in premiums in 1995 was due primarily to the transferring of risk through restructured and expanded reinsurance programs, and reductions in residual market business assumed as a result of exiting certain markets. In 1994 compared to 1993, reductions in workers' compensation exposures, a decrease in commercial auto exposures, generally stricter underwriting and the competitive marketplace contributed to the premium decline. Net investment income was $757 million in 1995, an increase of $96 million from 1994. Net investment income decreased $78 million from 1993 to 1994. The increase in 1995 compared to 1994 was primarily attributable to the reinvestment of proceeds from the sale of equity and U.S. Treasury securities in higher yielding corporate bonds. The decline in 1994 compared to 1993 was attributable to lower investment yields. Net realized after-tax capital gains in 1995 include $115 million resulting from the sale of equity securities in Aetna P&C's investment portfolio primarily due to Aetna P&C's efforts to reduce volatility in its statutory surplus, to increase income, and in connection with Aetna's agreement to reduce Aetna P&C's equity portfolio pursuant to the Stock Purchase Agreement. Commercial Lines 1995 net loss was $377 million compared with a net loss of $74 million in 1994 and net income of $200 million (which includes $264 million of cumulative effect benefit for accounting changes) in 1993. The following significant factors impact these comparisons: . Net realized after-tax capital gains (losses) were $99 million, $(1) million and $96 million in 1995, 1994 and 1993, respectively. 46 . Net income in 1993 includes an after-tax gain on discontinued operations of $27 million in connection with the 1993 redemption of preferred stock received in the 1992 sale of its subsidiary, AmRe. . The 1995 net loss included an addition to environmental reserves of $488 million after tax upon completion of Aetna P&C's 1995 environmental study in the second quarter of 1995, an addition to asbestos reserves of $218 million after tax in the fourth quarter of 1995, and an addition to environmental reserves of $150 million after tax in 1994. . 1993 net income included a severance and facilities charge of $70 million after tax. . Catastrophic losses, net of tax and reinsurance, were $40 million, $110 million and $37 million in 1995, 1994 and 1993, respectively. Catastrophic losses in 1994 included $98 million from the Los Angeles earthquake and the severe winter weather. . 1993 net income included an increase of $259 million (after tax and after discounting) in workers' compensation reserves for prior accident years. . Net income in 1993 reflected a net tax benefit of $23 million related to revaluing the deferred tax asset as a result of the increase in federal income tax rates. For Commercial Lines, excluding the unusual items above, earnings of $270 million in 1995 compared to $187 million in 1994 reflecting a reduction in the level of ongoing operating expenses, primarily due to actions taken by Aetna P&C's management in prior years to lower costs, increased emphasis on underwriting and claims handling, and higher net investment income resulting from the reinvestment of proceeds from the sale of equity and U.S. Treasury securities in higher yielding corporate bonds. Excluding the unusual items above, 1994 earnings of $187 million compared to 1993 earnings of $156 million also reflected a reduction in operating expenses, primarily due to Aetna P&C management's efforts to lower costs and exiting unprofitable markets. Partially offsetting the improvements in 1994 earnings was lower net investment income primarily due to lower investment yields. Significant actions have been taken to improve basic underwriting and claims-handling fundamentals in order to improve profitability. Continued focus on stricter underwriting programs, geographic-specific strategies, and increased service and value-added business, which address the requirements of customers with more complicated insurance needs, is expected to continue to improve the earnings outlook in Commercial Lines. Existing market conditions, where rate increases have not kept pace with cost trends, except in isolated markets and lines of business, continue to put earnings under pressure. Statutory and GAAP combined ratios for Commercial Lines were as follows:
1995 1994 1993 ----- ----- ----- Statutory: Loss and LAE ratio........................................................... 117.9% 91.1% 83.8% Underwriting expense ratio................................................... 35.0 35.7 34.5 Combined ratio............................................................... 152.9 126.8 118.3 GAAP: Loss and LAE ratio........................................................... 117.5 89.3 82.9 Underwriting expense ratio................................................... 33.6 32.6 32.7 Combined ratio............................................................... 151.1 121.9 115.6
The differences between statutory and GAAP ratios for 1994 primarily reflect the establishment of a reserve for statutory purposes for severance and facilities charges in 1994, which was previously reserved for on a GAAP basis. Excluding an addition to environmental reserves of $750 million in the second quarter of 1995, an addition to asbestos reserves of $335 million in the fourth quarter of 1995, and an addition to environmental reserves of $230 million in 1994, the statutory and GAAP combined ratios would have been 114.6% and 112.2% in 1995 and 119.1% and 114.2% in 1994. The improvement in these adjusted combined ratios from 1994 to 1995 is primarily due to lower catastrophe losses in 1995. 47 Personal Lines Personal Lines revenues of $1.482 billion in 1995 were slightly lower than 1994, primarily reflecting a decrease in premiums of $64 million and a decrease in net investment income of $18 million offset by an increase in net realized capital gains of $40 million. The decline in revenues of $195 million from 1993 to 1994 was primarily attributable to a decrease in premiums of $140 million and a decrease in net investment income of $62 million. The decline in premiums in 1995 was due primarily to the transferring of risk through restructured and expanded reinsurance programs. In 1994 compared to 1993, reductions in personal auto exposures and the competitive marketplace contributed to the premium decline. Net investment income was $145 million in 1995, a decrease of $18 million from 1994. Net investment income decreased $62 million from 1993 to 1994. The decrease in 1995 compared to 1994 was primarily attributable to a smaller investment base due to reduced premium volume, offset in part by the reinvestment of proceeds from the sale of equity and U.S. Treasury securities in higher yielding corporate bonds. The decline in 1994 compared to 1993 was attributable to lower investment yields and a lower invested asset base resulting from reduction in premium volume. Net realized after-tax capital gains in 1995 include $41 million resulting from the sale of equity securities in Aetna P&C's investment portfolio primarily due to Aetna P&C's efforts to reduce volatility in its statutory surplus, to increase income, and in connection with Aetna's agreement to reduce Aetna P&C's equity portfolio pursuant to the Stock Purchase Agreement. Personal Lines 1995 net income was $134 million compared with net income of $37 million in 1994 and net income of $39 million in 1993. The following significant factors impact these comparisons: . Net realized after-tax capital gains were $30 million, $5 million and $1 million in 1995, 1994 and 1993, respectively. . Net income reflected after-tax reductions in prior year loss reserves related to personal auto business of $42 million, $66 million and $12 million in 1995, 1994 and 1993, respectively. . 1993 net income included a severance and facilities charge of $31 million after-tax. . Catastrophe losses, net of tax and reinsurance, were $25 million, $80 million and $49 million in 1995, 1994 and 1993, respectively. Catastrophe losses in 1994 included $64 million from the Los Angeles earthquake and the severe winter weather. . Net income in 1993 reflected a net tax benefit of $3 million related to revaluing the deferred tax asset as a result of the increase in federal income tax rates. For Personal Lines, excluding the unusual items above, earnings of $87 million in 1995 compared to $46 million in 1994 reflected a reduction in the level of ongoing operating expenses, primarily due to actions taken by Aetna P&C's management in prior years to lower costs, increased emphasis on underwriting and claims handling, offset in part by a decrease in net investment income resulting from a lower invested asset base resulting from reduced premium volume. Excluding the unusual items above, 1994 earnings of $46 million compared to 1993 earnings of $103 million reflected a significant decline in net investment income attributable to lower investment yields and a lower invested asset base resulting from reductions in premium volume. Partially offsetting this decline was a reduction in operating expenses, primarily due to Aetna P&C management's efforts to lower costs and exiting unprofitable markets. Aetna P&C management's actions have improved personal auto underwriting profitability. However, increasingly competitive market conditions will put pressure on further improvement. Aetna P&C's management will continue to evaluate personal auto market conditions in each state and maintain or increase Aetna P&C's presence in those states that offer acceptable returns and reduce its presence in those states where Aetna P&C is unable to earn acceptable returns, subject to restrictions imposed by insurance regulatory authorities. 48 Statutory and GAAP combined ratios for Personal Lines were as follows:
1995 1994 1993 ----- ----- ----- Statutory: Loss and LAE ratio........................................................... 69.3% 79.3% 76.5% Underwriting expense ratio................................................... 31.6 36.0 36.2 Combined ratio............................................................... 100.9 115.3 112.7 GAAP: Loss and LAE ratio........................................................... 69.0 75.2 76.3 Underwriting expense ratio................................................... 30.8 33.2 33.4 Combined ratio............................................................... 99.8 108.4 109.7
The difference between the statutory and GAAP combined ratios in 1994 primarily reflects the settlement of Proposition 103 claims for statutory purposes, which had previously been reserved for on a GAAP basis. The improvement in the combined ratio from 1994 to 1995 primarily reflects a lower level of catastrophe losses. ADDITIONS TO RESERVES FOR PRIOR ACCIDENT YEARS The table below shows the changes in loss estimates (net of reinsurance) related to prior accident years, most of which were for losses and related expenses for environmental liability risks, asbestos and other product liability risks, and workers' compensation claims. Additions (reductions) to reserves for prior accident years reduce (increase) net income for the period in which the adjustment is made.
1995(1) 1994 1993(2) ------ ---- ---- (Dollars in millions) Pre-tax........................................................................ $1,137 $263 $51 After-tax...................................................................... 739 171 33
- ------------ (1) Reserve additions in 1995 include the addition to environmental reserves of $750 million ($488 million after tax) upon the completion of Aetna P&C's 1995 environmental study in the second quarter of 1995 and the addition to asbestos reserves of $335 million ($218 million after tax) in the fourth quarter of 1995. (2) Reserve additions in 1993 are net of the cumulative effect of $514 million (pre-tax) related to the implementation of discounting of workers' compensation life table indemnity reserves. ENVIRONMENTAL AND ASBESTOS-RELATED CLAIMS Reserving for environmental and asbestos-related claims is subject to significant uncertainties. See "--Outlook." Reserves for these liabilities are evaluated by management regularly and adjustments are made to such reserves as developing loss patterns, reserving methodologies and other information appear to warrant. As a result of developments that have occurred inside and outside of Aetna P&C (discussed below), reserves for environmental and asbestos-related claims were increased significantly in 1995. Aetna P&C takes reinsurance into account in the reserve calculations for environmental and asbestos-related claims only when it is probable of collection, based on past experience or agreements with reinsurers. Aetna P&C believes that the reinsurance recoveries which have been taken into account in the reserve calculations are probable of recovery; however, there can be no assurances that reinsurance for these types of claims will not become subject to coverage disputes with reinsurers, or that all reinsurers will have the ability to pay such claims. ENVIRONMENTAL-RELATED CLAIMS Aetna P&C has been a major writer of certain Commercial Lines insurance policies which are alleged to cover hazardous waste clean-up costs. Aetna P&C generally disputes that there is insurance coverage for environmental claims, and vigorously litigates coverage and related issues that will ultimately determine, in many cases, whether and to what extent insurance coverage exists for environmental claims. Environmental claims, particularly large coverage disputes, are complex and subject to significant uncertainties in addition to the vagaries of and risks inherent in major litigation generally. These uncertainties include estimation of the underlying liability of a claimant as a potentially responsible party ("PRP") at waste disposal 49 sites and whether insurance policies will be found to cover PRP liabilities. Courts have reached inconsistent conclusions regarding a wide range of insurance coverage issues relating to an insurer's indemnity and defense obligations for environmental-related liabilities. Because of these uncertainties and a lack of historically developed data, such liabilities are not estimable using conventional actuarial reserving techniques. Aetna P&C actively manages its environmental claims through a special environmental claim unit. The number of environmental-related liability claims Aetna P&C had as of December 31, 1995 was 3,771. Of the claims at December 31, 1995, approximately 88% represented environmental pollution-related cleanup cases (including Superfund claims) against policyholders, and the balance represented environmental pollution-related third-party bodily injury and property damage claims against policyholders. Of the claims open at December 31, 1995, approximately 44% were involved in coverage disputes between Aetna P&C and its policyholders that had reached the litigation stage. Claims are calculated separately for each of the categories described above, and are calculated on a "per policyholder, per site" basis. The claims number reflects cases where policyholders have notified Aetna P&C of a claim under primary insurance policies. In addition, policyholders have placed Aetna P&C on notice of possible claims that may potentially involve excess general liability policies. Aetna P&C generally does not consider these notifications open claims (and the claims number above does not include these notifications) because under these policies (i) Aetna P&C does not have a duty to defend the policyholders and (ii) the policyholders must first exhaust their primary insurance coverage for such claims before they can look to Aetna P&C for coverage. Based on these two factors, Aetna P&C does not currently consider that such claims present any material exposure to Aetna P&C. Aetna P&C has continued to gather and analyze legal and factual information on environmental-related claims and to reassess its environmental reserving techniques as developments have occurred over time. During 1994 and 1995, certain of Aetna P&C's environmental claims in litigation matured (providing Aetna P&C with additional information relating to the claim) or settled. The maturing and settling of these claims, coupled with increasing expertise in handling environmental claims, also better enable Aetna P&C to understand the profile of its other environmental claims. Additionally, supplemental data bases and alternative methodologies were being developed by outside firms for possible use in estimating environmental liabilities. In connection with these developments, Aetna P&C conducted a comprehensive environmental reserving review during the first half of 1995, and, upon completion of the review, significantly increased reserves for environmental-related claims. Aetna P&C developed a sophisticated methodology which, when used in conjunction with other methods and information available to it, assisted Aetna P&C in estimating indemnity-related liabilities for all of its known environmental claims. This methodology (the "exposure methodology"), while not a conventional actuarial reserving technique, is a detailed analysis that involves the estimation of indemnity-related liabilities for environmental claims from direct policies on a site-by-site, policyholder-by-policyholder basis. The exposure methodology depends heavily upon management's subjective judgment, in that it requires management to make numerous assumptions as to, among other things, estimated total clean-up costs for each site, allocation of site clean-up costs to particular policyholders under joint and several liability principles, resolution of unsettled coverage questions, and resolution of unsettled questions involving the allocation of losses to specific insurance policies. As all of the information necessary to estimate liability on a particular site frequently is not available, the exposure methodology also simulates data in such cases from available data. In addition to estimating indemnity-related liabilities on known claims, as part of the reserving review Aetna P&C also estimated losses for incurred but not reported environmental claims ("IBNR"), unallocated loss adjustment expenses ("ULAE") associated with environmental claims, and additional costs of expected future coverage litigation. Aetna P&C's estimation of IBNR, ULAE and coverage litigation costs are based on a combination of historical data and various assumptions about the future, including assumptions regarding the number and severity of new environmental claims that will arise, and trends in the volume and cost of future litigation. Upon completing the 1995 reserving review, Aetna P&C added $750 million (pre-tax) ($488 million, after tax) to environmental-related claims reserves. While Aetna P&C expects to recover some of its environmental losses from its reinsurers, due to the uncertainty in estimating amounts to be recovered, no reinsurance benefits were recorded in establishing this reserve addition. 50 The table below reflects activity in the reserve for environmental liability claims (pre-tax and before reinsurance) for the years ended December 31:
1995 1994 1993 ---- ---- ---- (Dollars in millions) Beginning reserve: Direct....................................................................... $ 436 $233 $238 Ceded........................................................................ (58) (3) (8) ------ ---- ---- Net.................................................................... 378 230 230 Incurred losses and loss expenses:(1) Direct....................................................................... 827 290 37 Ceded........................................................................ (49) (59) 3 Losses paid:(2) Direct....................................................................... 257 87 42 Ceded........................................................................ (78) (4) (2) Ending reserves:(3) Direct....................................................................... 1,006 436 233 Ceded........................................................................ (29) (58) (3) ------ ---- ---- Net.................................................................... $ 977 $378 $230 ------ ---- ---- ------ ---- ----
- ------------ (1) In 1995, includes the addition to reserves of $750 million upon the completion of Aetna P&C's 1995 environmental study. (2) Includes legal fees paid of $46 million in 1995, $52 million in 1994 and $31 million in 1993. (3) Net of $32 million of discount on settlements in 1995. The reserves at December 31, 1995 consist of approximately $560 million for indemnity-related environmental liabilities for all of Aetna P&C's known environmental claims, including those where Aetna P&C is in coverage disputes with its policyholders. In addition, $119 million of the $560 million is for resolved claims which have been discounted and will be paid over a number of years, in accordance with a fixed payment schedule. The remainder of the reserve represents IBNR, estimated coverage litigation costs and ULAE. The reserve at December 31, 1994 consists of approximately $299 million for estimated indemnity-related liabilities, and the remainder represents a bulk reserve for legal fees. In 1994, Aetna P&C added $290 million pre-tax and before reinsurance ($231 million pre-tax and after reinsurance) to reserves for environmental liability claims primarily for certain indemnity-related liabilities. In the opinion of Aetna P&C's management, the reserves for environmental-related claims at December 31, 1995 represent Aetna P&C's best estimate of its ultimate environmental-related liability, based on currently known facts, current law (including Superfund), current technology, and assumptions considered reasonable where facts are not known. Due to the significant uncertainties and related management judgment involved in estimating Aetna P&C's environmental liability, no assurances can be given that the environmental reserve represents the amount that will ultimately be paid by Aetna P&C for all environmental-related losses. The amount ultimately paid could differ materially from Aetna P&C's currently recorded reserve as legal and factual issues are clarified, but any difference cannot be reasonably estimated at this time. Congress was scheduled to reauthorize the Superfund law in 1995, but did not do so. There continues to be substantial dissatisfaction among insurance and business groups and others with the current law, particularly with respect to the law's cleanup requirements and liability provisions, and there is general recognition that major reforms are needed. At this time, it is too early to determine whether the law will be reauthorized and reformed in 1996, what the substance of the enacted legislation will be, or what the effect of any such reforms will be on Aetna P&C. ASBESTOS-RELATED CLAIMS Reserving for asbestos-related claims is subject to significant uncertainties and management is currently unable to quantify the ultimate amount of losses or range of losses for all asbestos-related claims and related litigation expenses. Aetna P&C's management has continued to evaluate Aetna P&C's reserves for asbestos liabilities as Aetna P&C continued to gather and analyze new information and reassess its reserving techniques for these claims in order to determine whether Aetna P&C can better estimate its liability. In connection with such evaluation, Aetna P&C added $335 million ($218 million, after tax) to asbestos-related claims reserves in the fourth quarter of 1995. While Aetna P&C expects to recover some of its asbestos losses from its reinsurers, due to the uncertainty in estimating amounts to be recovered, no reinsurance benefits were recorded in establishing this 51 addition to reserves. Further adjustments may be made to such reserves as loss patterns develop and other information is obtained, and the amount ultimately paid for such claims could differ materially from reserves, although any difference cannot be reasonably estimated at this time. Numerous liability claims for bodily injury have been asserted against major producers of asbestos and asbestos products, some of which are insureds of Aetna P&C. In order to control transaction costs and provide efficient claim handling, the Center for Claims Resolution ("CCR") was formed in 1988 to handle asbestos-related bodily injury claims on behalf of its member producers. Aetna P&C participates in CCR by virtue of its insurance contracts with certain CCR members and is assessed a fee by CCR for its claim-handling services. Aetna P&C also provides insurance coverge to producers that are not CCR members. A large number of asbestos bodily injury actions that were pending in pretrial stages in various courts have been consolidated and transferred to single federal or state courts. In January 1993, CCR announced a global proposal involving plaintiffs, attorneys, producers and insurers to settle asbestos bodily injury claims over the next ten years. The proposed settlement is subject to, among other things, court approval and acceptance by a minimum number of plaintiffs, and no assurance can be given that all such claims will be settled, or settled on the terms proposed. To date, the CCR proposed settlement has not received final approval by the courts. Over the last few years, asbestos bodily injury claims also have been filed by plaintiffs against entities that installed asbestos products and others involved in ancillary ways with asbestos products or processes, including insureds of Aetna P&C. Additionally, some policyholders have attempted to recharacterize asbestos bodily injury product liability claims in an effort to avoid applicable policy coverage limits on product liability claims (i.e., non- products asbestos claims). In 1995 Aetna P&C settled a case involving one such major producer that had exhausted applicable policy limits on asbestos products claims and asserted coverage under policy provisions for other types of liability. Aetna P&C obtained a release from the insured for all current and future asbestos bodily injury claims and certain asbestos property damage claims (along with all environmental claims) under existing policies in exchange for fixed, scheduled cash payments, which were recorded on a discounted basis. In connection with this settlement, $120 million of reserves not previously classified as covering asbestos-related claims were transferred to asbestos reserves. No amounts were transferred from environmental reserves, and the environmental-related portion of the settlement was covered by existing environmental reserves. As a result, this settlement did not affect 1995 results of operations. As part of the settlement, Aetna P&C also agreed, among other things, to make insurance coverage available to the insured in the year 2000 (on a one-time basis), for a percentage of all asbestos defense and indemnity claim payments made by the insured in the years 2000 through 2007. Aetna P&C's payment obligations would be subject to annual dollar caps. Given the uncertainty as to whether the insured will elect to purchase this additional insurance, no related premiums or losses have been recorded by Aetna P&C at this time. In addition to bodily injury claims, property damage claims have been brought against Aetna P&C's insureds seeking reimbursement for the expense of replacing insulation material and other building components made of asbestos. It is Aetna P&C's position that in most cases its product liability policies do not cover this replacement expense. Aetna P&C's management cannot predict whether the courts will ultimately support Aetna P&C's position. Recently, however, Aetna P&C has selectively settled claims where it has considered it reasonable and appropriate to do so. 52 The table below reflects activity in the reserve for asbestos claims and claim adjustment expenses (pre-tax) for the years ended December 31:
1995 1994 1993 ---- ---- ---- (Dollars in millions) Beginning reserve: Direct......................................................................... $326 $277 $326 Ceded.......................................................................... (69) (52) (56) ---- ---- ---- Net.......................................................................... 257 225 270 Incurred losses and loss expenses: Direct......................................................................... 437 123 112 Ceded.......................................................................... (37) (85) (23) Transfers........................................................................ 119 0 0 Losses paid:(1) Direct......................................................................... 106 74 161 Ceded.......................................................................... (17) (68) (27) Ending reserves:(2) Direct......................................................................... 776 326 277 Ceded.......................................................................... (89) (69) (52) ---- ---- ---- Net.......................................................................... $687 $257 $225 ---- ---- ---- ---- ---- ----
- ------------ (1) Includes legal fees paid of $29 million in 1995, $30 million in 1994 and $56 million in 1993. (2) Net of $26 million of discount on settlements in 1995. WORKERS' COMPENSATION CLAIMS Aetna P&C added $565 million (pre-tax, before the cumulative effect of implementing discounting) to prior accident year loss reserves in 1993 for workers' compensation claims. Of this addition, approximately $250 million related to reserves for workers' compensation life table indemnity claims. The increase of $565 million resulted from a study of Aetna P&C's workers' compensation reserves and the factors which were contributing to its adverse developments. Concurrent with this addition to workers' compensation reserves, Aetna P&C implemented a change in accounting to discount reserves for workers' compensation life table indemnity claims in order to more accurately reflect the economic value of Aetna P&C's obligations and improve the matching of revenues and expenses. Such discounting was consistent with industry practice. This discounting resulted in a reduction as of December 31, 1993 of $614 million (pre-tax) to loss reserves for workers' compensation claims. See Notes 1 and 12 of Notes to the Combined Financial Statements of Aetna P&C. OTHER Policyholders of Aetna P&C also seek insurance coverage from Aetna P&C for other long-term exposure claims against them, including claims relating to silicone-based personal products, lead paint and other allegedly toxic or harmful substances. Evaluating and reserving for these types of exposures is complex and subject to many uncertainties including those stemming from coverage issues, long latency periods and changing or expanding laws and legal theories of liability. Adjustments will be made to such reserves as claims mature or settle and as new information becomes available to Aetna P&C, and such adjustments may be material. In 1995, Aetna P&C purchased a loss ratio aggregate treaty designed to reinsure unfavorable developments which would impact the 1995 accident year loss ratio. As of December 31, 1995, the treaty has resulted in an after-tax benefit of $6 million to the Commercial Lines business. Aetna P&C Commercial Lines ceded losses to reinsurers of $706 million, $1.151 billion and $908 million, respectively, and Aetna P&C Personal Lines ceded losses of $121 million, $43 million and $143 million, respectively, in 1995, 1994 and 1993. See "--Outlook" for information concerning a reinsurance agreement entered into between Am Re and Aetna Casualty in connection with the 1992 sale of Am Re. 53 INVESTMENTS At December 31, 1995 and 1994 and for the years then ended, Aetna P&C's invested assets, net of impairment reserves, and net investment income were as follows:
1995 1994 ------- ------- (Dollars in millions) Debt securities: Available for sale, at fair value (amortized cost $11,182 and $9,696)........... $11,598 $ 9,097 Held for investment, at amortized cost (fair value $407)(1)..................... -- 413 Equity securities, at fair value (cost $289 and $779)............................. 500 1,018 Short-term investments............................................................ 137 106 Mortgage loans.................................................................... 1,062 1,454 Real estate....................................................................... 265 262 Other............................................................................. 291 301 ------- ------- Total invested assets........................................................... $13,853 $12,651 ------- ------- Net investment income............................................................. 902 $ 824 ------- -------
- ------------ (1) See Note 1 of Notes to the Combined Financial Statements of Aetna P&C for a discussion of transfers of securities from Held for Investment to Available for Sale in 1995. Aetna P&C's investment objective has been to fund policyholder and other liabilities in a manner which enhances shareholder and contractholder value, subject to appropriate risk constraints. Aetna P&C's intention has been that this investment objective be met by a mix of investments which reflects the characteristics of the liabilities they support; diversifies the types of investment risks in Aetna P&C's portfolios by interest rate, liquidity, credit and equity price risk; and achieves asset diversification by investment type, industry, issuer and geographic location. Aetna P&C has periodically projected duration and cash flow characteristics of liabilities and made appropriate adjustments in the asset portfolios. The weighted average quality rating of Aetna P&C's fixed maturity portfolio was AA at December 31, 1995 and 1994. Included in the fixed maturity portfolio at December 31, 1995 were approximately $381 million of below investment grade securities. Interest rate risk has been managed within a tight duration band, and credit risk has been managed by maintaining high average bond ratings and diversified sector exposure. In pursuing investment and risk management objectives, Aetna P&C has utilized assets whose market value has been at least partially determined by, among other things, levels of or changes in domestic and/or foreign interest rates (short-term or long-term), exchange rates, prepayment rates, equity markets or credit ratings/spreads. See "--Use of Derivatives and Other Investments." Using financial modeling and other techniques, Aetna P&C has regularly evaluated the appropriateness of the investments relative to Aetna P&C's management-approved investment guidelines and the business objectives of the portfolios (including evaluating the interest rate, liquidity, credit and equity price risk resulting from derivative and other portfolio activities). During 1995, Aetna P&C operated within such investment guidelines by maintaining a mix of investments that diversifies assets and reflects the characteristics of the liabilities which they support. The change in Aetna P&C's invested assets from December 31, 1994 to December 31, 1995 reflected increases in debt securities due to appreciation of value resulting from a decrease in interest rates and reinvestment of proceeds from sales of equity securities, and a net decrease in the mortgage loan and real estate portfolios. Debt securities reflected net unrealized capital gains of $416 million at December 31, 1995, compared with net unrealized capital losses of $600 million at December 31, 1994. The net decrease in the mortgage loan and real estate portfolios of $389 million principally reflected prepayments, payments at maturity on mortgage loans, write-offs on foreclosures and sales of foreclosed properties and loans. The net decrease in the equity securities portfolio of $518 million principally reflected sales which were completed in an effort to reduce volatility in statutory surplus, and increase income, as well as in connection with the pending sale of Aetna P&C. Such decreases were partially offset by market appreciation in the equity securities portfolio. Aetna P&C continued to reduce the equity securities portfolio through the closing date of the Acquisition through sales, including the sale of a significant portion of holdings in MBIA Inc. to the public, and sales to other affiliates of Aetna. 54 The fair value and amortized cost of Aetna P&C's CMO balances at December 31 were as follows:
1995 1994 ------------------ ------------------ FAIR AMORTIZED FAIR AMORTIZED VALUE COST VALUE COST ----- --------- ----- --------- (Millions) Total CMOs(1)....................................................... $ 306 $ 304 $ 278 $ 313
- ------------ (1) At December 31, 1995 and 1994, approximately 38% and 44%, respectively, of Aetna P&C's CMO holdings were collateralized by residential mortgage loans, on which the timely payment of principal and interest is backed by specified government agencies (e.g., GNMA, FNMA, FHLMC). The principal risks inherent in holding CMOs are prepayment and extension risks related to dramatic decreases and increases in interest rates whereby the value of the CMOs would be subject to variability on the repayment of principal from the underlying mortgages earlier or later than originally anticipated. If due to declining interest rates principal was to be repaid earlier than originally anticipated, Aetna P&C could be affected by a decrease in investment income due to the reinvestment of these funds at a lower interest rate. Such prepayments may also result in a duration mismatch between assets and liabilities, which could be corrected as cash from prepayments could be reinvested at an appropriate duration to adjust the mismatch. Conversely, if due to increasing interest rates principal was to be repaid more slowly than originally anticipated, Aetna P&C could be affected by a decrease in cash flow, which reduces the ability to reinvest expected principal repayments at higher interest rates. Such slower payments may also result in a duration mismatch between assets and liabilities, which could be corrected as available cash flow could be reinvested at an appropriate duration to adjust the mismatch. During 1995, the mortgage loan portfolio net of impairment reserves was reduced 27% from $1.5 billion at December 31, 1994 to $1.1 billion at year-end 1995. Aetna P&C continued to manage the mortgage loan portfolio during 1995 to reduce the balance in absolute terms and relative to invested assets, and to reduce overall risk. The $392 million decrease in the total mortgage loan portfolio since December 31, 1994 reflects the effect of repayments of maturing loans, loan prepayments and foreclosures (actual and in substance). Aetna P&C has a comprehensive process for managing mortgage loans which has included an ongoing risk assessment to evaluate key attributes of the mortgage investment, specifically, debt service coverage, cash flow sustainability, property condition, loan to value, market/economic trends, deal structure, borrower strength and ability to refinance. Action plans have been established with the objective of reducing potential risk and maximizing the return on the investment. In addition, a collateral valuation has been performed on a regular basis for mortgage loans with a balance greater than $5 million (approximately 90% of the total principal balance of the portfolio), to help determine whether adjustments to impairment reserves were warranted. Aetna P&C has a restructuring program for troubled debt, the primary objective of which has been to restructure eligible loans in a manner which creates a market rate transaction which will perform in accordance with its restructured terms. The program has been applied to those loans which have sound property and borrower fundamentals but suffer from excess debt. An important feature of these loans is that in exchange for principal forgiveness on a portion of the loan, Aetna P&C has typically retained the right to participate in property appreciation to the extent market conditions improve in the future. In those situations where the property fundamentals do not support a restructuring of the loan, Aetna P&C has generally acquired the collateral through foreclosure. Loans with a principal balance of $9 million and collateral with a fair market value of $7 million were foreclosed upon in 1995. Additional loans with a principal balance of $19 million were in the process of foreclosure at year end, down from $58 million at December 31, 1994. In certain cases, Aetna P&C has taken substantive possession of the property supporting the loan, coupled with the borrower surrendering its interest in the future economic benefits in the property. Where this has occurred, the loans have been considered in-substance foreclosures, written down to their fair market value less selling costs and classified as real estate held for sale. At December 31, 1995 and 1994, there were $54 million and $21 million, respectively, of in-substance foreclosures (net of write-offs of $65 million and $10 million, respectively). 55 Included in Aetna P&C's total mortgage loan balances were the following categories of mortgage loans:
POTENTIAL PROBLEM RESTRUCTURED PROBLEM LOANS LOANS LOANS(1) TOTAL ------- ------------ -------------- ----- (Millions) December 31, 1995 Total....................................................... $ 20 $ 36 $ 92 $ 148 ------- --- --- ----- Impairment reserves on loans............................................................................ $ 66 ----- Impairment reserves as a percentage of total............................................................ 44% ----- December 31, 1994 Total....................................................... $ 106 $ 88 $ 37 $ 231 ------- --- --- ----- Impairment reserves on loans............................................................................ $ 137 ----- Impairment reserves as a percentage of total............................................................ 59% -----
- ------------ (1) In connection with Aetna P&C's adoption of FAS Nos. 114 and 118 on January 1, 1995, Aetna P&C's management has revised the definition of "potential problem loans." See Notes 1 and 15 of Notes to the Combined Financial Statements of Aetna P&C. See Notes 3 and 15 of Notes to the Combined Financial Statements of Aetna P&C for further information relating to these investments. Restructured loans that have a market rate of interest at the time of the restructure (which represents the interest rate Aetna P&C would charge for a new loan with comparable risk) and demonstrate sustainable performance (as generally evidenced by six months of pre- or post-restructuring payment performance in accordance with the restructured terms) may be returned to performing status. Candidates for such treatment have been re-underwritten and are required to meet specific guidelines which have been intended to provide reasonable assurance that the loan would perform in accordance with its contract terms. In addition, such restructured loans have been designed to enhance Aetna P&C's security position in the collateral, maximize borrower commitment to the property, and, in many cases, ensure Aetna P&C's participation in any appreciation of the property as market conditions improve. During 1995, two loans which had been restructured, with a carrying value of $20 million (net of write-offs of $15 million) and an average current yield of 9%, were classified as performing. USE OF DERIVATIVES AND OTHER INVESTMENTS Aetna P&C's hedging activity has been limited and has principally consisted of using forward contracts and interest rate swaps to hedge interest rate risk and currency risk. These instruments, viewed separately, subject Aetna P&C to varying degrees of market and credit risk. However, when used for hedging, the expectation is that these instruments would reduce overall market risk. Market risk is the possibility that future changes in market prices may decrease the market value of one or all of these financial instruments. Credit risk arises from the potential inability of counterparties to perform under the terms of the contracts. Management does not believe that the current level of hedging activity will have a material effect on Aetna P&C's liquidity or results of operations. See Note 13 of Notes to the Combined Financial Statements of Aetna P&C for a discussion of Aetna P&C's hedging activities. Aetna P&C also had investments in certain debt instruments with derivative characteristics, including those where market value is at least partially determined by, among other things, levels of or changes in domestic interest rates (short-term or long-term), prepayment rates, or credit ratings/spreads. The amortized cost and fair value of these collateralized mortgage obligations as of December 31, 1995 was $304 million and $306 million, respectively. 56 OUTLOOK The Company will continue to focus on its core property and casualty insurance product lines and markets, with particular emphasis on Commercial Accounts and Specialty Accounts, the markets that the Company believes have the greatest potential for growth in premiums and profitability. A variety of factors continue to affect the property and casualty insurance market and the Company's core business outlook, including the competitive pressures affecting pricing and profitability, inflation in the cost of medical care, litigation and losses from involuntary markets. In most of Commercial Lines, pricing did not improve in 1995. For Commercial Accounts and Select Accounts, the duration of the current downturn in the underwriting cycle continues to place pressure on the pricing of guaranteed cost products, as price increases have not exceeded loss cost inflation for several years. The Company's focus is to retain existing profitable business and obtain new accounts where it can maintain its selective underwriting policy. The Company will continue to adhere to strict guidelines to maintain high quality underwriting, which could affect future premium levels. National Accounts business, although primarily fee-for-service, continues to be very competitive on price. In relation to submitted and future asbestos and environmental-related claims, the Company carries on a continuing review of its overall position, its reserving techniques and reinsurance recoverables. In this area of exposure, the Company has endeavored to litigate individual cases and settle claims on favorable terms. Given the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties, it is not presently possible to quantify the ultimate exposure or range of exposure represented by these claims to the Company's financial condition, results of operations or liquidity. The Company believes that it is reasonably possible that the outcome of the uncertainties regarding environmental and asbestos claims could result in a liability exceeding reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. In Personal Lines, inflation in the cost of automobile repairs, medical care and litigation of liability claims in 1995 resulted in pressure on current underwriting margins. Personal Lines management strategy includes the control of operating expenses to improve competitiveness and profitability, growth in sales through independent agents in target markets and other distribution channels and a reduction of exposure to catastrophe losses. In an effort to reduce its exposure to catastrophic hurricane losses, Travelers P&C has reduced agent commissions on homeowners insurance in certain markets, strengthened underwriting standards and implemented price increases in certain hurricane-prone areas, subject to restrictions imposed by insurance regulatory authorities. Changes in the general interest rate environment affect the return received on newly invested and reinvested funds. While a rising interest rate environment enhances the returns available, it reduces the market value of existing fixed maturity investments and the availability of gains on disposition. A decline in interest rates reduces the returns available on investment of funds but could create the opportunity for realized investment gains on disposition of fixed maturity investments. As required by various state laws and regulations, the Company's insurance subsidiaries are required to participate in state-administered guaranty associations established for the benefit of the policyholders of insolvent insurance companies. Management believes that such payments will not have a material impact on the Company's results of operations, financial condition or liquidity. Certain social, economic and political issues have led to an increased number of legislative and regulatory proposals aimed at addressing the cost and availability of certain types of insurance. While most of these provisions have failed to become law, these initiatives may continue as legislators and regulators try to respond to public availability and affordability concerns and the resulting laws, if any, could adversely affect Travelers P&C's ability to write business with appropriate returns. The allocation of the purchase price to the assets and liabilities of Aetna P&C is subject to valuations as of the date of the Acquisition based on appraisals and other studies, which are not yet completed. Accordingly, the final allocations will differ from the amounts reflected herein. Adjustments of claims and claims adjustment expense reserves and certain other insurance accounts resulting from the valuation of these accounts will be recorded in operations in the period or periods determined. The Company is continuing to review the insurance reserves of Aetna P&C, including the effect of applying the Company's strategies, policies and practices in determining such reserves, primarily relating to cumulative injury claims, insurance products involving financial guarantees based upon fair value of underlying collateral and certain reinsurance recoverables. 57 Cumulative injury claims often involve an allegation by a claimant against an insured that the claimant has suffered injuries as a result of long-term or continuous exposure to harmful products or substances. Such harmful products or substances include, but are not limited to, lead paint, pesticides, pharmaceutical products, silicone-based personal products, solvents and other deleterious substances. Numerous complex issues exist when such claims are presented. The claimant's theories of liability must be evaluated, evidence pertaining to a causal link between injury and exposure to a substance must be reviewed, the potential role of other causes of injury must be analyzed, the potential liability of other defendants must be explored, an assessment of the claimant's damages must be made and the law of the jurisdiction must be applied. Based on the reviews at this stage, it is possible that additional reserves of up to approximately $750 million in the aggregate may be recorded upon completion of these reviews, which would result in after-tax charges to income of up to approximately $488 million in the aggregate, primarily relating to reserves for cumulative injury claims, insurance products involving financial guarantees based on the fair value of underlying collateral and certain insurance receivables. Stockholders' equity would be correspondingly reduced by an equivalent after-tax amount as a result of these charges. The Company believes that its reviews are likely to be completed in 1996, although there can be no assurance as to the ultimate timing thereof. LIQUIDITY AND CAPITAL RESOURCES TAP was formed in January 1996 to hold the property and casualty insurance subsidiaries of TIGI. TIGI contributed to TAP all of the outstanding shares of common stock of Travelers Indemnity on April 1, 1996. On April 2, 1996, TAP acquired the domestic property and casualty insurance subsidiaries of Aetna for approximately $4.16 billion. TAP is a holding company and has no direct operations. TAP's principal asset is the capital stock of its insurance subsidiaries. For a description of the Acquisition and the manner in which it was funded, see "Recent History" and "Unaudited Pro Forma Financial Information." All of the net proceeds from the Equity Offering will be used by TAP to repay a portion of the borrowings under the Credit Agreement. The net proceeds to TAP from the Trust Preferred Securities Offerings and the Debt Offerings are expected to be used to repay the remaining borrowings under the Credit Agreement and to redeem the Series Z Preferred Stock. Any remaining proceeds will be used for general corporate purposes, which may include capital contributions to subsidiaries of TAP and/or the reduction or refinancing of borrowings of TAP or its subsidiaries. The liquidity requirements of the Company's business have been met primarily by funds generated from operations, asset maturities and income received on investments. Cash provided from these sources is used primarily for claims and claim adjustment expense payments and operating expenses. Catastrophe claims, the timing and amount of which are inherently unpredictable, may create increased liquidity requirements. Additional sources of cash flow include the sale of invested assets and financing activities. The Company believes that its future liquidity needs will be met from all of the above sources. Net cash flows are generally invested in marketable securities. The Company closely monitors the duration of these investments, and investment purchases and sales are executed with the objective of having adequate funds available to satisfy the Company's maturing liabilities. As the Company's investment strategy focuses on asset and liability durations, and not specific cash flows, asset sales may be required to satisfy liability obligations and/or rebalance asset portfolios. Including Aetna P&C, the Company's combined invested assets at December 31, 1995 totaled $26.7 billion and consisted primarily of highly liquid debt securities of $22.5 billion, mortgage loans and real estate of $1.562 billion, equity securities of $1.102 billion, short-term investments of $924 million and other investments of $578 million. Cash flow needs at TAP will include stockholder dividends and debt service. TAP anticipates that its cash flow needs will be met primarily through dividends from operating subsidiaries. In addition, TAP currently has available to it a $200 million line of credit for working capital and other general corporate purposes from a subsidiary of Travelers Group. The lender has no obligation to make any loan to TAP under this line of credit. See "Certain Transactions--Relationships with TIGI and Travelers Group." Moreover, the Company will continue to be able to make borrowings under the Credit Agreement up to an aggregate amount outstanding of $2.65 billion. See "Certain Indebtedness." Because the principal operating subsidiaries of the Company are Connecticut insurance companies, the amount of dividends that each such entity may pay to the parent company is restricted. The insurance holding company law of Connecticut requires notice to, and approval by, the state insurance commissioner for the declaration or payment of any dividend that together with other distributions made within the preceding twelve months exceeds the greater of (i) 10% of the insurer's surplus or (ii) the insurer's net income for the twelve-month period ending the preceding December 31st, in each case determined in accordance with 58 statutory accounting practices. Such declaration or payment is further limited by adjusted unassigned funds (surplus), as determined in accordance with statutory accounting practices. The insurance holding company laws of other states in which the Company's subsidiaries are domiciled generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends. After giving pro forma effect to the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings, annual debt service requirements are expected to be approximately $177 million. Common Stock dividends are expected to be approximately $119 million annually. In 1996, the maximum amount of dividends that Travelers Indemnity may pay to TAP without prior approval by the Connecticut Insurance Department is $299 million. Aetna Casualty and Standard Fire are not expected to pay dividends in 1996. In addition, pursuant to the Intercompany Agreement, TAP may not pay any dividends on the Common Stock without the prior written consent of Travelers Group, so long as Travelers Group maintains certain minimum ownership requirements of the Common Stock. That agreement also limits the Company's ability to incur indebtedness, issue equity securities and make certain capital expenditures, among other things, without the prior written consent of Travelers Group. See "Certain Transactions--Relationships with TIGI and Travelers Group." The Credit Agreement, the Indenture, each Guarantee and each Declaration and the Series Z Preferred Stock contain certain provisions that may have the effect of limiting the Company's ability to pay dividends on the Common Stock. The Credit Agreement requires TAP to maintain Consolidated Stockholders' Equity (as defined in the Credit Agreement) of at least $4.175 billion plus 25% of Post-Acquisition consolidated net income, and provides that TAP may not incur consolidated debt of more than 45% of the sum of TAP's Consolidated Debt (as defined in the Credit Agreement) and Consolidated Stockholders' Equity, in each case subject to certain adjustments. See "Description of Capital Stock" and "Certain Indebtedness". The NAIC adopted RBC requirements for property-casualty companies in December 1993, effective with reporting for 1994. The RBC requirements are to be used as early warning tools by the NAIC and states to identify companies that merit further regulatory action. The formulas have not been designed to differentiate among adequately capitalized companies that operate with levels of capital higher than RBC requirements. Therefore, it is inappropriate and ineffective to use the formulas to rate or to rank such companies. At December 31, 1995 and 1994, all of the Company's property-casualty companies had adjusted capital in excess of amounts that would require regulatory action. The Company has a net deferred tax asset at December 31, 1995 which relates to temporary differences that are expected to reverse as net ordinary deductions for tax purposes. The Company will have to generate approximately $3.7 billion of taxable income, before reversal of these temporary differences, primarily over the next 10 to 15 years, to realize the deferred tax assets of Travelers P&C and Aetna P&C combined. The application of purchase accounting to the assets and liabilities of Aetna P&C is expected to result in an increase in the deferred tax asset of up to approximately $600 million. Realization of this deferred tax asset will require additional taxable income over the next 15 years of approximately $1.7 billion. Management expects to realize the deferred tax asset based upon its expectation of future positive taxable income, after reversal of these deductible temporary differences, in the consolidated federal income tax return of Travelers Group. The taxable income of the consolidated return of Travelers Group, after reversal of the deductible temporary differences, is expected to be at least $1 billion annually. At December 31, 1995, Aetna P&C has a net operating loss carryforward of $349 million, $111 million of which expires in the year 2008, $226 million of which expires in the year 2009, and $12 million of which expires in the year 2010. Aetna management estimates that the net operating loss carryforward was utilized before closing of the Acquisition. The Company's management believes that, because of Aetna P&C's flexibility in planning taxable investment income, any remaining losses will be fully utilized. Certain of the Company's loss reserves are for environmental and asbestos claims. There is a high degree of uncertainty with respect to future exposure from environmental claims. Significant issues exist primarily as to whether there is coverage for claims, the liability of the insureds and diverging legal interpretations and judgments state by state relating to, among other things: when the loss occurred and which policies provide coverage; which claims are covered; whether there is an insured obligation to defend; how policy limits are determined; how policy exclusions are applied and interpreted; whether clean-up costs represent insured property damage; and other issues. As a result of various state and federal regulatory efforts aimed at environmental remediation (particularly "Superfund"), the insurance industry has been, and continues to be, involved in extensive litigation involving policy coverage and liability issues. In addition to regulatory pressures, the Company believes that certain court decisions have expanded insurance coverage beyond the original intent of the insurers and insureds. The results of court decisions affecting the industry's coverage positions continue to be inconsistent. 59 Accordingly, the ultimate responsibility and liability for environmental remediation costs remain uncertain. See "Business--Regulation" and "Business--Environmental and Asbestos Claims." Similarly, there is a high degree of uncertainty with respect to future exposure from asbestos claims because of significant issues surrounding the liabilities of the insureds, diverging legal interpretations of judgments state by state relating to, among other things, when the loss occurred and what policies provide coverage; what claims are covered; whether there is an insured obligation to defend; how policy limits are determined; how policy exclusions are applied and interpreted; whether clean-up costs represent insured property damage; and other matters. In addition, new groups of plaintiffs, whose exposure to asbestos was less direct and whose injuries were often speculative, have been filing lawsuits in increasing numbers. See "Business--Environmental and Asbestos Claims." Given the inconsistencies of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties, it is not presently possible to quantify the ultimate exposure or range of exposure represented by environmental and asbestos claims to the Company's financial condition, results of operations or liquidity. The Company believes that it is reasonably possible that the outcome of the uncertainties regarding environmental and asbestos claims could result in a liability exceeding the reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. See "Business--Environmental and Asbestos Claims." In connection with the 1992 sale of American Re Corporation ("Am Re") by Aetna, Am Re and Aetna Casualty entered into a reinsurance agreement which provides that to the extent Am Re incurred losses in 1991 and prior years that were still outstanding at January 1, 1992 in excess of $2.7 billion (or $362 million in excess of Am Re's reserves as of December 31, 1991, adjusted for certain reinsurance transactions), Aetna Casualty has an 80% participation in payments on those losses up to a maximum payment by Aetna Casualty of $500 million. In 1995, Am Re increased reserves for asbestos, environmental and other latent liabilities. As a result of the increase, losses of approximately $228 million ($120 million after discount), which were largely workers' compensation life table indemnity claims, were ceded to Aetna Casualty. There was no material effect on Aetna P&C's 1995 earnings since Aetna Casualty had previously established related reserves. It is reasonably possible that additional undiscounted losses of up to approximately $270 million (pre-tax) could be ceded to the Company in the future. Depending upon the development of such additional reserves recognized by Am Re, given the inherent uncertainties of estimating insurance reserves, it is possible that such development may result in a charge to operations that would be material to the Company in a future period or periods. However, given the Company's estimates of paid loss development related to these reserves as well as the aggregate maximum payment of $500 million required under the reinsurance agreement, the Company believes that payments pursuant to the reinsurance agreement will not have a material adverse effect on the Company's financial condition or liquidity. See Note 14 of Notes to the Combined Financial Statements of Aetna P&C included elsewhere herein. ACCOUNTING STANDARDS NOT YET ADOPTED Statement of Financial Accounting Standards No. 121, "Accounting for Long-Lived Assets and for Long-Lived Assets to be Disposed Of" establishes accounting standards for the impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. This statement requires write down to fair value when long-lived assets to be held and used are impaired. It also requires long-lived assets to be disposed of (e.g., real estate held for sale) to be carried at the lower of cost or fair value less cost to sell and does not allow such assets to be depreciated. The adoption of this statement, effective January 1, 1996, will not have a material effect on the Company's results of operations, financial condition or liquidity. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123). This statement addresses alternative accounting treatments for stock-based compensation, such as stock options and restricted stock. FAS 123 permits either expensing the value of stock-based compensation over the period earned or disclosing in the financial statement footnotes the pro forma impact to net income as if the value of stock-based compensation awards had been expensed. The value of awards would be measured at the grant date based upon estimated fair value, using option pricing models. The requirements of this statement will be effective for 1996 financial statements, although earlier adoption is permissible if an entity elects to expense the cost of stock-based compensation. The Company, along with affiliated companies, participates in stock option and incentive plans sponsored by Travelers Group. The Company is currently evaluating the disclosure requirements and expense recognition alternatives addressed by this statement. 60 BUSINESS OVERVIEW The Company is the fourth largest property and casualty insurance company in the United States, based on 1994 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. The Company provides a wide range of commercial and personal property and casualty insurance products and services to businesses, government units, associations and individuals. Commercial coverages and personal coverages accounted for 76% and 24%, respectively, of the Company's combined net written premiums in 1995 of $10.5 billion (including premium equivalents for Travelers P&C). After giving pro forma effect to the Transactions, the Equity Offering, the Trust Preferred Securities Offerings and the Debt Offerings, at December 31, 1995, the Company had total assets and stockholders' equity of $49.5 billion and $6.1 billion, respectively. On April 2, 1996, TAP completed the Acquisition. The Company believes that the businesses of Aetna P&C and Travelers P&C provide complementary product offerings and distribution systems. The Company believes that it can effectively integrate these businesses, which will enable it to capitalize on the strengths of Travelers P&C and Aetna P&C and to create a stronger leadership position in the property and casualty insurance industry. The Company further believes that it has the following competitive advantages: (i) brand names that are among the most broadly recognized in the industry; (ii) a management team selected from the most qualified professionals, primarily at Travelers P&C and Aetna P&C, including certain senior managers who have worked together for several years at Travelers P&C and have achieved significant increases in profitability at Travelers P&C through cost reductions, effective underwriting and pricing practices and catastrophe exposure management policies; (iii) nationally leading market shares in several important commercial and personal product lines; and (iv) a strong financial position. COMMERCIAL LINES. The Company is the third largest writer of commercial lines insurance in the United States based on 1994 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. The Company's Commercial Lines offers a broad array of property and casualty insurance and insurance-related services. Commercial Lines are organized into four marketing groups that are designed to focus on a particular client base or industry segment to provide products and services that specifically address customers' needs: National Accounts, primarily serving large national corporations; Commercial Accounts, serving mid-size businesses; Select Accounts, serving small businesses; and Specialty Accounts, providing a variety of specialty coverages. The Company also has a dedicated group within Commercial Accounts that serves the construction industry. The Company distributes its commercial products through approximately 6,000 brokers and independent agencies located throughout the United States. See "Business--Commercial Lines." The commercial coverages marketed by the Company include workers' compensation, general liability (including product liability), multiple peril, commercial automobile, property (including fire and allied lines), fidelity and surety and several other miscellaneous coverages. The Company also underwrites specialty coverages through three separate units, Travelers Specialty, Gulf Specialty and Bond Specialty, which have historically focused on unique risks that typically require specialized underwriting. Coverages offered by Travelers Specialty include general liability for selected product liability risks, medical malpractice and umbrella and excess liability. Coverages offered by Gulf Specialty include directors and officers liability insurance and errors and omissions insurance and fidelity and surety coverage. Coverages offered by Bond Specialty through Aetna Casualty and Surety Company of America ("Aetna C&S of America") include fidelity and surety and fiduciary liability insurance and directors and officers and other professional liability insurance. In addition, the Company offers various risk management services, generally including claims settlement, loss control and engineering services, to businesses that choose to self-insure certain exposures, to states and insurance carriers that participate in state involuntary workers' compensation pools and to employers seeking to manage workers' compensation medical and disability costs. In 1995, Commercial Lines generated combined net written premiums of $5.1 billion and, for Travelers P&C, premium equivalents of $2.8 billion. PERSONAL LINES. The Company is the largest writer of personal lines insurance through independent agents and the sixth largest writer of personal lines insurance overall in the United States based on 1994 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. The Company's Personal Lines primarily offers personal automobile and homeowners insurance. The Company distributes its Personal Lines products through approximately 5,500 independent agents located throughout the United States. The Company is pursuing a number of initiatives to broaden its distribution of Personal Lines products, including developing special products for affinity groups, employee groups and other sponsoring 61 organizations and establishing co-marketing arrangements with other insurers. Travelers P&C has recently begun marketing personal automobile and homeowners insurance through the independent agents of PFS. This program was established in 14 states as of December 31, 1995, and is expected to reach approximately 75% of all states by the end of 1996. PFS agents are currently selling approximately 1,500 new automobile and homeowners policies each month. In 1995, Personal Lines generated combined net written premiums of $2.5 billion. The Company maintains a conservative, high quality and highly liquid investment portfolio. At December 31, 1995, the Company's combined investment portfolio totalled $26.7 billion, of which $23.4 billion, or 87.8%, was comprised of fixed income securities and short-term investments. The composite rating of the fixed income portfolio at such date was Aa, using ratings provided by Moody's. Non-investment grade securities represented 2.9% of the total portfolio at such date. At December 31, 1995, common stocks and other equity investments represented 4.1% of the combined investment portfolio and real estate and mortgage loans represented 5.9% of the total portfolio. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business--Investments." Most of the Company's insurance subsidiaries are members of one of three separate intercompany property and casualty reinsurance pooling arrangements. Each of these pools permits each participating company to rely on the capacity of the entire pool rather than on its own capital and surplus. Under the arrangements of each insurance pool, the members pool all insurance business that is written and prorate the combined premiums, losses and expenses. Each insurance pool receives separate ratings. For a description of the pools and the current claims-paying and financial strength ratings of the Company's property-casualty insurance pools and of Aetna C&S of America by A.M. Best, Duff & Phelps, Moody's and Standard & Poor's, see "--Ratings." The Company generally does not do business outside the United States, except a limited amount of business in Canada and the United Kingdom. THE STRATEGIC PLAN The Company's strategic objectives are to enhance its position as a consistently profitable market leader and to become a low-cost provider of property and casualty insurance in the United States. Since 1993, Travelers P&C's experienced management team has pursued this objective at Travelers P&C by eliminating redundant expenses, reducing overhead and streamlining the corporate infrastructure, realigning its business structure to give more authority to regional and field offices, establishing a performance-based compensation program to promote greater accountability at the operating business level, advancing its leading Commercial Lines presence, improving its underwriting approach and implementing enhanced catastrophe exposure management policies. These initiatives have resulted in substantial productivity and efficiency gains. Since 1993, Travelers P&C has realized annualized expense savings of approximately $180 million and an increase in after-tax operating income (excluding realized gains and losses) to $373 million in 1995 from $248 million in 1993 (before giving effect to a $194 million after-tax charge in 1993 due primarily to an increase in environmental and asbestos reserves). Travelers P&C has also benefited during this period from the financial strength provided by Travelers Group, which strength contributed to an upgrade in early 1994 in Travelers P&C's A.M. Best rating. The expense savings of approximately $180 million at Travelers P&C were realized from expenses contained in the general and administrative expense category over the two year period from 1993 through 1995. Offsetting these continuing expense savings in 1995 were approximately $30 million of expenses classified as general and administrative expenses for the first time in 1995 as a result of the consolidation of one subsidiary of Travelers P&C in 1995 which was accounted for on the equity method prior to 1995, and the inclusion in 1995 of approximately $15 million of one-time start up costs for new business ventures. Net of these additions, general and administrative expenses at Travelers P&C continued to decline in 1995. Aetna P&C experienced losses from continuing operations before income tax benefits and cumulative effect adjustments of $405.7 million, $91.2 million and $213.5 million in 1995, 1994 and 1993, respectively, and had net losses of $242.9 million and $37.3 million in 1995 and 1994, respectively (as compared to net income of $239.0 million in 1993). As one of the first and most integral steps toward reaching its objectives, the Company has selected a management team comprised of the individuals at each of Travelers P&C and Aetna P&C with the broadest complement of skills. Of the top 300 members of the Company's management team, which includes field personnel, approximately 50% represent individuals from Aetna P&C and 50% represent individuals from Travelers P&C. This team also includes two members of senior management from outside Travelers P&C and 62 Aetna P&C to lead the claims and finance functions of the Company. The Company believes that the management strengths of this group, together with stronger financial resources available to the combined Company, will promote the Company's achievement of the goals described below. The Company believes that the acquisition and integration of Aetna P&C present additional opportunities for this experienced management team to continue to improve productivity and efficiency, to further reduce costs and to improve the Company's overall financial strength. Management has established the following key strategic objectives for the Company: BECOME A LOW-COST PROVIDER OF PROPERTY AND CASUALTY INSURANCE. The Company believes that a critical competitive advantage in the property and casualty insurance industry is to be a low-cost provider of insurance products. Beginning in 1993, Travelers P&C made significant changes that reduced costs and enhanced productivity. The Company will implement similar cost reductions and productivity enhancements at Aetna P&C, including reducing overhead expenses, making changes in the corporate infrastructure of Aetna P&C to make it more consistent with the decentralized, streamlined structure at Travelers P&C, and eliminating redundant expenses between the two companies. The Company has identified $300 million in projected annual cost savings to be achieved over the next two years, however, there can be no assurance that such savings will be achieved. In addition, the Company has conducted a business-by-business review of each of Aetna P&C and Travelers P&C to select the most effective technology and systems in the marketing, underwriting and claims areas and to identify additional opportunities to reduce costs and to become more responsive to customer needs. These projected annual cost savings include $230 million of salaries and benefits associated with the projected elimination of 3,300 positions, rent expense reductions of $28 million and reductions in other expenses of approximately $42 million. MAINTAIN FINANCIAL STRENGTH AND SEEK TO IMPROVE RATINGS. The Company believes that it is well capitalized and that its financial strength creates a competitive advantage in retaining and attracting business. Travelers P&C and Aetna P&C, the tenth and ninth largest property and casualty insurance companies in the United States, respectively, combined to become the fourth largest property and casualty insurance company in the United States, in each case based on 1994 direct written premiums published by A.M. Best. The Company believes that the combined Company's market share, strong balance sheet and cash flow, together with management's experience in growing companies through acquisitions, create an effective platform for the Company's participation in the continuing consolidation in the property and casualty insurance industry where the Company believes new opportunities will be increasingly available. The Company is not currently engaged in any significant discussions and has no pending agreements or understandings concerning any material acquisitions. After giving effect to the Equity Offerings and the Debt and Preferred Offerings, at December 31, 1995 the Company had pro forma stockholders' equity of $6.1 billion and a pro forma long-term debt to capitalization ratio of 17.9%. See "Capitalization." The Company plans to maintain its sound financial position through its selective underwriting practices, conservative reserving policies and a high quality investment portfolio. Over time, the Company will seek to improve the claims-paying ratings of its property and casualty insurance operations. CONTINUE TO FOCUS ON CORE PRODUCT LINES USING A DISCIPLINED UNDERWRITING APPROACH. The Company will continue to focus on its core property and casualty insurance product lines and markets in which it has developed expertise in using selective and consistent underwriting policies that are applied across product lines and markets. The Company emphasizes a profit-oriented rather than a premium volume or market share-oriented approach to underwriting. Key elements of this approach include: (i) closely monitoring the quality of the business identified by the Company, its brokers and its agents to assess loss experience and pricing parameters; and (ii) performing periodic reviews and audits of field offices and agents to ensure that the Company's policies and procedures are being consistently and appropriately applied. The Company has also developed an approach to underwriting Commercial Lines business built upon significant underwriting, claims, engineering and actuarial experience that provides specialized knowledge about various industry segments and catastrophe management to analyze risk and account characteristics in determining pricing parameters. The Company believes that this approach enables it to select acceptable risks and to tailor its products and pricing to the specific needs of those Commercial Lines customers who generally require customized insurance products and services. The Company intends to continue to enhance and expand the use of this approach in both Travelers P&C and Aetna P&C businesses. 63 EMPHASIZE CUSTOMER-ORIENTED FOCUS. To continue to provide a broad array of new products and services within the Company's core product lines and markets and to foster simpler, closer relationships with customers, the Company has adopted an industry-specific orientation within its Commercial Lines marketing groups that is based on account characteristics and targeted industry segments. The Company also intends to make changes in the corporate infrastructure of Aetna P&C so that it becomes more consistent with the decentralized, streamlined structure at Travelers P&C, thereby allowing the Company's field personnel to be more responsive to customer needs. The Company will seek to foster point-of-sale transactions by shifting decision-making authority, within defined parameters, to field marketing representatives who interact directly with agents, brokers and insureds. This process is linked with a strong collaborative underwriting review effort both in the Company's regional locations and in the home office. The Company will also seek to enhance customer relations by providing timely, responsive pricing quotes and claims service. EFFECTIVELY MANAGE DISTRIBUTION SYSTEMS AND CAPITALIZE ON CROSS-SELLING OPPORTUNITIES. The Company believes that a critical competitive advantage in the property and casualty insurance industry is a loyal, high quality distribution network which focuses on the insurer's products and services. The Company will seek to maintain strong relationships with its distribution force, including independent agents, selected small to medium-sized brokers having a strong local or regional presence and large national brokerage firms. As a result of the Acquisition, the Company will be able to offer its agents and brokers cross-selling opportunities from a broader product line. In so doing, the Company believes that it will be better positioned to capture a greater percentage of business handled by well established and growing agencies. Examples of cross-selling opportunities that are expected to be made available to the Company's distribution network include the Bond Specialty products and the construction industry market expertise that previously had been available only to agents of Aetna P&C and the workers' compensation expertise in the National Accounts market that is one of the strengths of Travelers P&C. MANAGE CATASTROPHE, ENVIRONMENTAL AND ASBESTOS LOSS EXPOSURE. The Company will continue to manage actively its exposure to catastrophe losses by seeking to control exposure in high-risk areas by employing sophisticated computer modeling techniques to review significant outstanding coverages to determine where non-renewal is advisable and by implementing price increases where appropriate (in each case subject to restrictions imposed by insurance regulatory authorities). The Company will continue to manage its environmental liability exposures by aggressively reviewing and settling claims where appropriate. The environmental and asbestos claims of Travelers P&C are managed by a dedicated group of professionals organized as a separate business unit that works closely with members of senior management. The Company believes that this approach gives it consistency in claims handling and policy coverage interpretation. MANAGE CAPITAL RESOURCES. The Company intends to maximize stockholder value by: (i) pursuing premium growth to the extent allowed by market conditions; (ii) making further acquisitions, subject to market conditions; and (iii) increasing return on stockholders' equity. SELECTED PRODUCT, MARKET AND RATIO INFORMATION PRODUCTS. The following table sets forth by product line net written premiums for each of Travelers P&C and Aetna P&C individually and for Travelers P&C and Aetna P&C on a combined basis and premium equivalents for Travelers P&C only for the periods indicated. For a description of the product lines referred to in the table below, see "--Commercial Lines--Product Lines" and "--Personal Lines--Product Lines." Over the past five years, National Accounts customers have moved increasingly from traditional insurance coverages to service-type products, primarily for workers' compensation coverage and to a lesser extent in general liability and commercial automobile coverages. These types of products include services such as claims settlement, loss control, engineering and risk management. The volume of business handled by Travelers P&C in servicing relationships is measured by "premium equivalents." Premium equivalents are determined in the pricing process and represent Travelers P&C's estimates of premiums that its customers would have been charged under a fully insured arrangement, based on expected losses associated with non-risk-bearing components of each account. Premium equivalents do not represent actual premium revenues. The information presented in the tables below includes premium equivalents for Travelers P&C only. Because Travelers P&C workers' compensation coverages include a significant amount of fee-for-service business, premium equivalents are material to Travelers P&C overall Commercial Lines volume. Aetna P&C workers' compensation 64 coverages include significantly less fee-for-service business. Historically, Aetna P&C has not tracked premium equivalents and such amounts are not available. NET WRITTEN PREMIUMS AND PREMIUM EQUIVALENTS BY PRODUCT LINE
PERCENTAGE OF TOTAL NET WRITTEN COMBINED PREMIUMS AND TRAVELERS P&C AETNA P&C TRAVELERS P&C AND PREMIUM YEAR ENDED YEAR ENDED AETNA P&C EQUIVALENTS DECEMBER 31, DECEMBER 31, YEAR ENDED DECEMBER 31, YEAR ENDED ------------------------- ------------------------ --------------------------- DECEMBER 31, 1995 1994 1993 1995 1994 1993 1995 1994 1993 1995 ------- ------ ------ ------ ------ ------ ------- ------- ------- ------------ (Dollars in millions) Commercial Lines: Workers' compensation........ $ 743 $ 849 $ 819 $ 569 $ 768 $ 807 $ 1,312 $ 1,617 $ 1,626 12.4% General liability............ 412 361 395 403 515 530 815 876 925 7.8 Multiple peril............... 308 254 239 880 815 778 1,188 1,069 1,017 11.3 Commercial automobile........ 418 368 362 470 515 563 888 883 925 8.5 Property..................... 195 190 221 262 247 232 457 437 453 4.4 Fidelity and surety.......... 41 15 (2) 192 169 167 233 184 165 2.2 Other........................ 192 75 44 59 61 (51) 251 136 (7) 2.4 ------- ------ ------ ------ ------ ------ ------- ------- ------- ----- Net written premiums..... $ 2,309 $2,112 $2,078 $2,835 $3,090 $3,026 $ 5,144 $ 5,202 $ 5,104 49.0% ------- ------ ------ ------ ------ ------ ------- ------- ------- ----- Premium equivalents(1)... 2,821 2,990 2,911 NA NA NA 2,821 2,990 2,911 26.8 Total Commercial Lines.................. $ 5,130 $5,102 $4,989 $2,835 $3,090 $3,026 $ 7,965 $ 8,192 $ 8,015 75.8% ------- ------ ------ ------ ------ ------ ------- ------- ------- ----- Personal Lines: Personal automobile.......... 1,008 1,187 1,203 814 782 945 1,822 1,969 2,148 17.3 Homeowners................... 253 210 122 294 394 412 547 604 534 5.2 Other........................ 37 36 36 137 133 133 174 169 169 1.7 ------- ------ ------ ------ ------ ------ ------- ------- ------- ----- Total Personal Lines..... $ 1,298 $1,433 $1,361 $1,245 $1,309 $1,490 $ 2,543 $ 2,742 $ 2,851 24.2% ------- ------ ------ ------ ------ ------ ------- ------- ------- ----- Total......................... $ 6,428 $6,535 $6,350 $4,080 $4,399 $4,516 $10,508 $10,934 $10,866 100.0% ------- ------ ------ ------ ------ ------ ------- ------- ------- ----- ------- ------ ------ ------ ------ ------ ------- ------- ------- -----
- ------------ (1) Premium equivalents are provided for Travelers P&C only. MARKETS. The following table sets forth by market net written premiums for each of Travelers P&C and Aetna P&C individually and for Travelers P&C and Aetna P&C on a combined basis and premium equivalents for Travelers P&C only, for the periods indicated. For a description of the markets referred to in the table below, see "--Commercial Lines--Marketing" and "--Personal Lines--Marketing." NET WRITTEN PREMIUMS AND PREMIUM EQUIVALENTS BY MARKET
PERCENTAGE OF TOTAL NET WRITTEN COMBINED PREMIUMS AND TRAVELERS P&C AETNA P&C TRAVELERS P&C AND PREMIUM YEAR ENDED YEAR ENDED AETNA P&C EQUIVALENTS DECEMBER 31, DECEMBER 31, YEAR ENDED DECEMBER 31, YEAR ENDED ------------------------- ------------------------ --------------------------- DECEMBER 31, 1995 1994 1993 1995 1994 1993 1995 1994 1993 1995 ------- ------ ------ ------ ------ ------ ------- ------- ------- ------------ (Dollars in millions) Commercial Lines: National Accounts............ $ 3,483 $3,794 $3,810 $ 489 $ 669 $ 601 $ 3,972 $ 4,463 $ 4,411 37.8% Commercial Accounts.......... 771 702 606 1,132 1,337 1,369 1,903 2,039 1,975 18.1 Select Accounts.............. 542 466 490 924 827 811 1,466 1,293 1,301 14.0 Specialty Accounts........... 334 140 83 290 257 245 624 397 328 5.9 ------- ------ ------ ------ ------ ------ ------- ------- ------- ------ Total Commercial Lines..... 5,130 5,102 4,989 2,835 3,090 3,026 7,965 8,192 8,015 75.8 Personal Lines................ 1,298 1,433 1,361 1,245 1,309 1,490 2,543 2,742 2,851 24.2 ------- ------ ------ ------ ------ ------ ------- ------- ------- ------ Total Net Written Premiums and Premium Equivalents(1)........ $ 6,428 $6,535 $6,350 $4,080 $4,399 $4,516 $10,508 $10,934 $10,866 100.0% ------- ------ ------ ------ ------ ------ ------- ------- ------- ------ ------- ------ ------ ------ ------ ------ ------- ------- ------- ------
- ------------ (1) Premium equivalents are provided for Travelers P&C only. 65 COMBINED RATIOS. The following table sets forth the statutory loss and LAE ratios, underwriting expense ratios and combined ratios for the periods indicated for each of Travelers P&C and Aetna P&C individually and for Travelers P&C and Aetna P&C on a combined basis. The combined ratio is an industry measurement of the results of property and casualty insurance underwriting. This ratio is the sum of the ratio of incurred losses and loss adjustment expenses to net premiums earned (the loss and LAE ratio), the ratio of underwriting expenses incurred to net premiums written (the "underwriting expense ratio") and, where applicable, the ratio of dividends to policyholders to net premiums earned. A combined ratio under 100% generally indicates an underwriting profit; a combined ratio over 100% generally indicates an underwriting loss. However, investment income, federal income taxes and other non-underwriting income or expenses are not reflected in the combined ratio. The profitability of property and casualty insurance companies depends on income from underwriting, investment and service operations. Lines of business where claims are paid out over a longer period of time, such as workers' compensation, also provide investment income over a longer period of time and therefore can be profitable at higher combined ratios than lines where claims are paid out over a shorter period. Insurers with a high proportion of long-tail policies will generally have higher combined ratios than insurers with more short-tail business. The ratios shown in the table below are computed based upon statutory accounting practices, not GAAP. STATUTORY COMBINED RATIOS
COMBINED TRAVELERS P&C AND TRAVELERS P&C AETNA P&C AETNA P&C YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, ------------------------- ------------------------- ------------------------- 1995 1994 1993 1995 1994 1993 1995 1994 1993 ----- ----- ----- ----- ----- ----- ----- ----- ----- Commercial Lines: Loss and LAE ratio......... 80.6% 104.2%(1) 100.3%(2) 117.9%(3) 91.1% 83.8% 102.4% 96.1% 90.6% Underwriting expense ratio....................... 24.4 24.0 27.0 34.4 34.9 33.5 29.9 30.5 30.8 Combined ratio before policyholder dividends...... 105.0 128.2 127.3 152.3 126.0 117.3 132.3 126.6 121.4 Combined ratio............. 106.3 126.2 128.7 152.9 126.8 118.3(4) 133.1 126.4 122.5 Personal Lines: Loss and LAE ratio......... 74.5 71.0 71.2 69.3 79.3 76.5 71.9 75.1 74.1 Underwriting expense ratio....................... 29.9 29.4 33.2 31.6 36.0 36.2 30.7 32.5 34.7 Combined ratio............. 104.4 100.4 104.4 100.9 115.3 112.7 102.6 107.6 108.8 Total: Loss and LAE ratio......... 78.2 90.2 88.6 102.8 87.5 81.4 91.8 88.6 84.5 Underwriting expense ratio....................... 26.4 26.2 29.3 33.5 35.2 34.4 30.2 31.2 32.2 Combined ratio before policyholder dividends...... 104.6 116.4 117.9 136.3 122.7 115.8 122.0 119.8 116.7 Combined ratio............. 105.4 115.3 118.8 136.7 123.3 116.4 122.6 119.7 117.4
- ------------ (1) Includes statutory reserve increases for environmental claims and a reduction of ceded reinsurance balances amounting to $225 million. (2) Includes $299 million of reserve strengthening primarily for asbestos and environmental liabilities. (3) Includes reserve strengthening of $750 million for environmental-related claims and $335 million for asbestos-related claims. (4) In 1993, Aetna P&C recorded a cumulative effect adjustment related to a change in accounting to report workers' compensation life table indemnity claims on a discounted basis. Excluding the discounting of workers' compensation reserves, the Aetna P&C 1993 combined ratio would have been 131.2%. 66 COMMERCIAL LINES PRODUCT LINES The Company writes a broad range of commercial property and casualty insurance for risks of all sizes. The core products in the Company's Commercial Lines are as follows: WORKERS' COMPENSATION provides coverage for the obligation of an employer under state law to provide its employees with specified benefits for work-related injuries, deaths and diseases, regardless of fault. There are typically four types of benefits payable under workers' compensation policies: medical benefits, disability benefits, death benefits and vocational rehabilitation benefits. Workers' compensation policies are often written in conjunction with other commercial policies. The Company offers three types of workers' compensation products: (i) guaranteed cost products, in which policy premiums charged are fixed and do not vary as a result of the insured's loss experience; (ii) retrospectively rated policies, which are adjusted based on actual loss experience of the insured during the policy period; and (iii) service programs, which are generally sold to the Company's larger National Accounts, where the Company receives fees for providing loss prevention, risk management, claims administration and benefit administration services to organizations pursuant to service agreements. The Company also participates in state assigned risk pools servicing workers' compensation policies. The Company emphasizes managed care cost containment strategies, which involve employers, employees and care providers in a cooperative effort that focuses on the injured employee's early return to work, cost-effective quality care and customer service in this market. Workers' compensation comprehensive claim and managed care cost containment services are integrated through the Company's claims management system to maximize cost savings on both service delivery and loss payout. For the year ended December 31, 1995, the Company's workers' compensation line generated $1.3 billion of combined net written premiums and, for Travelers P&C, $2.2 billion of premium equivalents. Based on direct written premiums published by A.M. Best, Travelers P&C's and Aetna P&C's combined share of the United States workers' compensation insurance market was approximately 6.4% in 1994. GENERAL LIABILITY provides coverage for liability exposures including bodily injury and property damage arising from products sold and general business operations. General liability also includes coverage for directors' and officers' liability arising in their official capacities, errors and omissions insurance for employees, agents, professionals and others arising from acts or failures to act under specified circumstances, as well as medical malpractice, commercial umbrella and excess insurance. For the year ended December 31, 1995, the Company's general liability line generated $815 million of combined net written premiums and, for Travelers P&C, $276 million of premium equivalents. Based on direct written premiums published by A.M. Best, Travelers P&C's and Aetna P&C's combined share of the United States general liability insurance market was approximately 5.2% in 1994. MULTIPLE PERIL provides coverage for businesses against third-party liability from accidents occurring on their premises or arising out of their operations, such as injuries sustained from products sold. It also insures business property for damage, such as that caused by fire, wind, hail, water, theft and vandalism, and protects businesses from financial loss due to business interruption. For the year ended December 31, 1995, the Company's multiple peril line generated $1.2 billion of combined net written premiums. Based on direct written premiums published by A.M. Best, Travelers P&C's and Aetna P&C's combined share of the United States multiple peril insurance market was approximately 5.9% in 1994. COMMERCIAL AUTOMOBILE provides coverage for businesses against losses incurred from personal bodily injury, bodily injury to third parties, property damage to an insured's vehicle, and property damage to other vehicles and other property resulting from the ownership, maintenance or use of automobiles and trucks in a business. For the year ended December 31, 1995, the Company's commercial automobile line generated $888 million of combined net written premiums and, for Travelers P&C, $318 million of premium equivalents. Based on direct written premiums published by A.M. Best, Travelers P&C's and Aetna P&C's combined share of the United States commercial automobile insurance market was approximately 5.7% in 1994. PROPERTY provides coverage for loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, earthquakes, hail, explosions, severe winter weather and other events such as theft and vandalism, fires and storms and financial loss due to business interruption. Property also includes inland marine, which provides coverage for goods in transit and unique, one-of-a-kind exposures. For the year ended December 31, 1995, the Company's property line generated $457 million of combined net written premiums. Based 67 on direct written premiums published by A.M. Best, Travelers P&C's and Aetna P&C's combined share of the United States property insurance market was approximately 5.9% in 1994. FIDELITY AND SURETY provides fidelity insurance coverage that guarantees faithful performance of an obligation or indemnifies an insured for loss due to embezzlement or misappropriation of funds. Surety provides a third party guarantee of a statutory or contractual obligation between two other parties. Surety is generally provided for construction performance, legal matters such as appeals, trustees in bankruptcy and probate and other performance bonds. For the year ended December 31, 1995, the Company's fidelity and surety line generated $233 million of combined net written premiums. Based on direct written premiums published by A.M. Best, Travelers P&C's and Aetna P&C's combined share of the United States fidelity and surety insurance market was approximately 7.0% in 1994. OTHER coverages include boiler and machinery insurance, which provides coverage for loss or damage resulting from the malfunction of boilers and machinery, as well as miscellaneous assumed reinsurance and international lines of business. For the year ended December 31, 1995, these other coverages generated $251 million of combined net written premiums. MARKETING The Company's Commercial Lines are organized into four marketing groups that are designed to focus on a particular client base or industry segment to provide products and services that specifically address customers' needs: National Accounts, primarily serving large national corporations; Commercial Accounts, serving mid-size businesses; Select Accounts, serving small businesses; and Specialty Accounts, providing a variety of specialty coverages. The Company also has a dedicated group within Commercial Accounts that serves the construction industry. Travelers P&C distributes its commercial products primarily through approximately 2,700 brokers and independent agencies located throughout the United States that are serviced by 43 field offices. Aetna P&C's commercial products are sold through approximately 3,300 brokers and independent agencies throughout the United States supervised and supported by 22 district offices with over 70 other points of service throughout the country. The Company intends to offer property and casualty products of both Travelers P&C and Aetna P&C through a combination of both distribution channels. See "--The Strategic Plan." The Company seeks to establish relationships with well-established, independent insurance agencies and brokers. In selecting new independent agencies and brokers to distribute the Company's products, the Company considers each agency's or broker's profitability, financial stability, staff experience and strategic fit with the Company's operating and marketing plans. Once an agency or broker is appointed, the Company carefully monitors its performance. NATIONAL ACCOUNTS The Company's National Accounts serves large companies, as well as employee groups, associations and franchises. The Company's National Accounts also includes the Company's alternative market business (the "Alternative Market"), which primarily covers workers' compensation products and services. National Accounts customers typically generate annual direct written premiums and premium equivalents of over $1 million and generally select products under retrospectively rated plans, large self-insured retentions or some other loss- responsive arrangement. National Accounts programs involve both traditional insurance (risk transfer) and risk service (claims settlement, loss control and risk management). Customers are usually national in scope and range in size from businesses with sales of approximately $10 million per year to Fortune 2000 corporations. Products are marketed through national brokers and regional agents with offices throughout the United States. Based on combined net written premiums of $1.2 billion and, for Travelers P&C, premium equivalents of $2.8 billion, National Accounts constituted approximately 50% of the Commercial Lines business in 1995. National Accounts customers often demand risk service programs where the ultimate cost is based on their own loss experience. Programs offered by the Company include claims settlement, loss control and risk management services and are generally offered in connection with a retrospectively rated insurance policy or a self-insured program. Workers' compensation accounted for approximately 70% of the products sold in 1995 to National Accounts customers, based on combined net written premiums and Travelers P&C premium equivalents. 68 The primary strategic objectives of the Company's National Accounts are to increase selectively risk-bearing business, to emphasize customer service, to take advantage of cross-selling opportunities afforded by the Acquisition and to diversify the products offered to National Accounts customers by offering loss-responsive, guaranteed cost and excess and specialty products. See "--The Strategic Plan." The Alternative Market business of Travelers P&C's Commercial Lines sells claims and policy management services to workers' compensation assigned risk plans and self-insurance pools throughout the United States and to niche voluntary markets. Since 1993, state assigned risk plan contracts have been awarded through a formal state-by-state bid process. Contracts, which are generally for three-year terms, are awarded by state agencies based on quality of service and price. Travelers P&C has emerged as the largest assigned risk plan servicing insurer in the industry with an approximately 25% share of the market in 1995. Assigned risk plan contracts generated approximately $543 million in premium equivalents in 1995 for Travelers P&C. Travelers P&C also services self-insurance groups, sells excess workers' compensation coverage to these groups and markets various programs to other insurers. Self-insurance groups and programs for other insurers generated net written premiums and premium equivalents of $74 million in 1995. National Accounts also participates in various involuntary assigned risk pools, which provide insurance coverage to individuals or other entities that otherwise are unable to purchase such coverage in the voluntary market. Participation in these pools in most states is generally in proportion to voluntary writings of related lines of business in that state. COMMERCIAL ACCOUNTS The Company's Commercial Accounts sells a broad range of property and casualty insurance products through a large network of independent agents and brokers. Commercial Accounts targets businesses with 75 to 1,000 employees that generate between $50,000 and $1 million in annual direct written premiums and premium equivalents. The Company offers a full line of products to its Commercial Accounts customers, with an emphasis on guaranteed cost products. The Company also offers retrospectively rated or large deductible programs to these customers. Based on combined net written premiums of $1.9 billion and, for Travelers P&C, premium equivalents of $41 million, Commercial Accounts constituted approximately 24% of the Commercial Lines business in 1995. Commercial Accounts targets certain industries, including the manufacturing industry, an industry in which Travelers P&C has claims, engineering and underwriting expertise, and the construction industry, an industry in which Aetna P&C has claims, engineering and underwriting expertise and to which the Company has established dedicated operations. Manufacturing industry businesses generally include metal products, industrial machinery manufacturing, food processing, advanced technology, mineral products, wood products and plastic and rubber products manufacturing. Construction generally includes street and road construction, underground utility construction, site and exterior and interior special trades. Specific industry knowledge enables the Company to select as customers better managed companies in an industry segment, to tailor specialized coverages for those companies, and to link price to the individual exposure and to control risk. Instead of relying on rating bureaus to establish prices for products, the Company uses its proprietary data, which it has compiled from many years of data generated by its extensive underwriting and pricing experience. Accordingly, subject to applicable state insurance regulations, prices are derived from numerous variables that apply to specific risks, as well as factors related to the insured. The Company believes that relying on extensive proprietary data to assess individual risk characteristics, rather than relying on data from industry rating bureaus, provides it with a competitive advantage in pricing and underwriting commercial risks. The Company uses components of this approach in its other lines of business, specifically in connection with loss control and claims management processing. The Company is developing new proprietary programs for retailers, wholesalers, financial institutions, telecommunications companies and transportation services that it plans to introduce in 1996. Through a network of field offices, the Company's highly trained marketing and underwriting specialists who have point of sale authority work closely with local brokers and agents to tailor insurance coverage to individual customer needs. Construction. The Company has established dedicated operations that exclusively target the construction industry, including street and road construction, underground utility construction, site and exterior and interior special trades. The Company offers all product lines to the construction market, both guaranteed cost and loss-responsive products, including property, general liability, automobile, workers' compensation and inland marine coverages to midsize and national customers. The dedicated construction operations enable the Company to select better run construction firms as customers, to tailor specialized coverages and to link pricing to exposure. Construction's products are distributed through independent agents and brokers throughout the United States. This operation uses the same underwriting philosophy and claims and engineering processing as Commercial 69 Accounts. The Company utilizes its large staff of engineering and underwriting construction specialists, along with claims and legal personnel with extensive construction experience, in its underwriting decisions to compete more effectively in this market. SELECT ACCOUNTS Select Accounts serves individuals who have commercial exposures and firms with one to 75 employees, typically generating up to $50,000 in annual direct written premiums per account. Products offered to Select Accounts are generally guaranteed cost policies, often a packaged product covering property and general liability exposures. Products are sold through independent agents, who are often the same agents that sell the Company's Commercial Accounts and Personal Lines products. Based on combined net written premiums of $1.5 billion, Select Accounts constituted approximately 18% of the Commercial Lines business in 1995. Personnel in the Company's field offices, which are located throughout the United States, work closely with agents to ensure a strong local presence in the marketplace. The Company utilizes a marketing and underwriting approach based on agency automation and defined underwriting policies. Agency automation allows agents access to the Company's price quotation and policy issuance systems and enables agents to provide faster and more cost-effective service to customers. Agents that do not utilize the automated quotation and policy issuance systems work with the Company's sales and marketing representatives who have point of sale authority. Agents serving Select Accounts are given much greater control and discretion over underwriting decisions, within predefined parameters, than brokers selling to larger accounts. Because underwriting criteria and pricing tend to be more standardized for smaller businesses, Select Accounts uses a standard industry classification (S.I.C.) process to allow agents and field marketing representatives to make underwriting and pricing decisions within predetermined classifications. Business in other classes is subject to consultative review by in-house underwriters. Aetna P&C's field marketing representatives are equipped with laptop computers, which permit them to access the Company's underwriting and pricing systems from the agent's office. This capability enables the agent to respond more promptly to its customers. The Company plans to expand the use of this approach where appropriate to better meet its customers' needs. The Company believes that its breadth of products, highly qualified field staff and its technology offer distinct competitive advantages. SPECIALTY ACCOUNTS Specialty Accounts markets products to national, midsize and small customers, which products are distributed through both wholesale brokers and retail agents and brokers throughout the United States. The Company's fast response time on underwriting decisions, industry expertise and quality service are important to maintaining relationships with Specialty Accounts insureds and producers. The Company believes that it has a competitive advantage with respect to many of these products as a result of its ability to cross-sell with National Accounts, Commercial Accounts and Select Accounts. Based on combined net written premiums of $624 million, Specialty Accounts constituted approximately 8% of the Commercial Lines business in 1995. The Company has three separate marketing and underwriting groups within Specialty Accounts: Travelers Specialty provides a broad range of products targeting risks that do not fall within the underwriting guidelines of the other Commercial Lines segments and that require highly specialized underwriting. The core products include general liability for select product liability risks, umbrella and excess liability, medical malpractice, various types of professional liability, errors and omissions liability, excess property, and various coverages that target the transportation industry. Gulf Specialty focuses on many non-traditional lines of business with a particular emphasis on the financial services market. Products include directors and officers liability insurance, errors and omissions coverage for bankers, investment counselors and mutual fund advisors, and fidelity and surety coverage for related classes. In addition, Gulf Specialty offers errors and omissions coverage for professionals and non-professionals such as lawyers, architects and engineers, insurance agents, podiatrists and chiropractors. Gulf Specialty also writes umbrella coverage for various industries, provides insurance products to the entertainment industry and provides other industry-specific programs. Bond Specialty's range of products includes fidelity and surety bonds, directors and officers liability coverage, fiduciary liability insurance and other types of liability insurance and services. The customer base ranges from large financial services companies and commercial entities to small businesses and individuals. Products and 70 services are distributed primarily through agents and brokers. Bond Specialty currently has an agency agreement with Executive Risk Management Associates ("ERMA"), a partnership owned by Executive Risk, Inc. The agreement provides that ERMA will act as Aetna Casualty's exclusive distributor of directors and officers insurance, but does not bind any of TAP's other subsidiaries. The agency agreement generally requires a minimum two-year notice of termination and no such notice may be delivered before January 1, 1997. PRICING AND UNDERWRITING Pricing levels for property and casualty insurance products offered by the Company's Commercial Lines are generally developed based upon the frequency and severity of estimated losses, the expenses of producing business and administering claims, and a reasonable allowance for profit. The Company's strategy emphasizes a profit-oriented rather than premium volume or market share-oriented approach to underwriting. The Company's National Accounts business, although primarily fee-for-service, continues to be very competitive on price. Commercial Accounts and Select Accounts primarily sell guaranteed cost products. Price increases for such guaranteed cost products have not kept pace with loss cost inflation in recent years. A significant portion of Commercial Lines business is written with retrospectively rated insurance policies as well as high deductible policies in which the ultimate cost of insurance for a given policy year is dependent on the loss experience of the insured. Retrospectively rated policies are primarily used in workers' compensation coverage. Although the payment terms and long-term nature of the loss development reduces insurance risk, it introduces some additional credit risk. Receivables from holders of retrospectively rated policies totaled approximately $1.2 billion on a combined basis at December 31, 1995. Collateral, primarily letters of credit and, to a lesser extent, cash collateral, is generally requested for contracts that provide for deferred collection of ultimate premiums. The amount of collateral requested is predicated upon the creditworthiness of the customer and the nature of the insured risks. Commercial Lines continually monitors the credit exposure on individual accounts and the adequacy of collateral. Under certain insurance contracts with deductible features, the Company is obligated to pay the claimant the full amount of the claim. The Company is subsequently reimbursed by the contractholder for the deductible amount, and is subject to credit risk until such reimbursement is made. At December 31, 1995, contractholder receivables were approximately $2.1 billion on a combined basis. Travelers P&C has developed an underwriting methodology that incorporates underwriting, claims, engineering, actuarial and product development disciplines for particular industries. This approach is designed to maintain high quality underwriting and pricing discipline. This approach utilizes proprietary data gathered and analyzed by Travelers P&C with respect to its Commercial Lines business over many years. The underwriters and engineers use this information to assess and evaluate risks prior to quotation. This information provides specialized knowledge about industry segments and catastrophe management and helps analyze risk based on account characteristics and pricing parameters designed to ensure that the Company does not compromise its underwriting integrity. This process is linked with strong underwriting interaction and review at the Company's and agents' locations. The Company plans to introduce this approach at Aetna P&C and will continue to enhance the analysis of its data. Travelers P&C and Aetna P&C are also members of and participate in the underwriting operations of insurance and reinsurance pools and associations, several of which make independent underwriting decisions on behalf of their members. These pools insure specialized risks such as property exposures related to aviation, nuclear power plants and transportation of energy materials. The Company continually reviews its exposure to catastrophic losses and attempts to mitigate such exposure. The Company uses sophisticated computer modeling techniques to assess underwriting risks and renewal of business in catastrophe-prone areas. 71 GEOGRAPHIC DISTRIBUTION The following table shows the distribution of Commercial Lines direct written premiums by Travelers P&C and Aetna P&C on a combined basis and by each of Travelers P&C and Aetna P&C for the states that accounted for the majority of premium volume for the year ended December 31, 1995:
STATE COMBINED TRAVELERS P&C AETNA P&C - ------------------------------------------------------------------- -------- ------------- --------- (% of total) New York........................................................... 14.9% 12.8% 16.7% California......................................................... 8.1 6.3 9.7 Texas.............................................................. 6.5 8.0 5.0 Massachusetts...................................................... 6.0 6.2 5.9 New Jersey......................................................... 5.1 4.6 5.6 Pennsylvania....................................................... 4.5 4.2 4.7 Florida............................................................ 4.3 4.8 3.8 Connecticut........................................................ 3.7 2.3 4.9 Illinois........................................................... 3.7 4.7 2.9 North Carolina..................................................... 3.0 2.5 3.4 Michigan........................................................... 2.6 3.0 2.2 Virginia........................................................... 2.6 2.0 3.1 Tennessee.......................................................... 2.4 3.2 1.7 Missouri........................................................... 2.3 3.1 1.7 All others(1)...................................................... 30.3 32.3 28.7 -------- ----- --------- TOTAL.............................................................. 100.0% 100.0% 100.0% -------- ----- --------- -------- ----- ---------
- ------------ (1) No other single state accounted for 3.0% or more of the total direct written premiums written in 1995 by Travelers P&C, Aetna P&C or the Company on a combined basis. PERSONAL LINES PRODUCT LINES The Company writes virtually all types of property and casualty insurance covering personal risks. The primary coverages in Personal Lines are personal automobile and homeowners insurance sold to individuals, which accounted for 93% of the net written premiums generated by Personal Lines in 1995. The Company has approximately 3.9 million personal automobile and homeowners policies in force at December 31, 1995. The Company is the largest writer of personal lines insurance through independent agents and the sixth largest writer of personal lines insurance overall in the United States based on 1994 direct written premiums published by A.M. Best, after giving effect to the Acquisition and recent industry consolidation. PERSONAL AUTOMOBILE provides coverage for liability to others for both bodily injury and property damage and for physical damage to an insured's own vehicle from collision and various other perils. In addition, many states require policies to provide first-party personal injury protection, frequently referred to as no-fault coverage. For the year ended December 31, 1995, the Company's personal automobile policies generated $1.8 billion of combined net written premiums. Travelers P&C's and Aetna P&C's combined share of the United States personal automobile insurance market was approximately 1.7% in 1994 based on direct written premiums published by A.M. Best. HOMEOWNERS provides protection against losses to dwellings and contents from a wide variety of perils, as well as coverage for liability arising from ownership or occupancy. The Company writes homeowners insurance for dwellings, condominiums, mobile homes and rental property contents. For the year ended December 31, 1995, the Company's homeowners policies generated $547 million of combined net written premiums. The Company's share of the United States homeowners insurance market was approximately 3.1% on a combined basis in 1994, based on direct written premiums published by A.M. Best. OTHER. Other products include coverage for boats, personal articles such as jewelry, and umbrella liability protection. For the year ended December 31, 1995, the Company generated $174 million of combined net written premiums on such policies. 72 MARKETING The Company's Personal Lines products are distributed primarily through approximately 5,500 independent agents located throughout the United States, supported by a network of 25 field marketing offices and six customer service centers. The principal markets for Personal Lines insurance are in states along the East coast, in the South, and in the Midwest. In the states of New Jersey and Massachusetts, Travelers P&C operates stand-alone domestic companies to enhance its competitive capability in these highly regulated markets. Separate business units also exist for marketing to affinity groups and through the PFS sales force. Each of these business units is positioned to manage the unique regulatory, distribution, risk profile and growth opportunity environments that it faces. Insurance companies generally market personal automobile and homeowners insurance through one of two distribution systems: independent agents or direct writing. The independent agents that distribute the Company's Personal Lines products usually represent several unrelated property and casualty companies. In contrast, direct writing companies operate either by mail or through exclusive agents or sales representatives. Due in part to the expense advantage that direct writers may have relative to companies using independent agents, the direct writing companies have gradually been able to expand their market share. The Company's Personal Lines continues to focus on the independent agency distribution system, recognizing the service and underwriting advantages the agent can deliver. In addition to its agency distribution system, the Company is pursuing a number of initiatives to broaden its distribution of Personal Lines products, including developing special products for affinity groups, employee groups and other sponsoring organizations and establishing co-marketing arrangements with other insurers. In 1994, Travelers P&C began writing personal automobile and homeowners insurance through independent agents of PFS, an affiliate of the Company, in order to broaden the distribution of its Personal Lines products. This program was established in 14 states as of December 31, 1995, and is expected to reach approximately 75% of all states by the end of 1996. The PFS sales force primarily sells life insurance products issued by affiliates of the Company. In 1995, Aetna P&C entered into a marketing agreement with GEICO to write the majority of GEICO's homeowners business, and to receive referrals from GEICO for new homeowners business in order to add historically profitable business and to help geographically diversify the Aetna P&C homeowners line of business. New business referrals began in July 1995, and on January 1, 1996, Aetna P&C began writing renewal policies. To assist in meeting catastrophe management objectives, the arrangement includes a three-year quota share reinsurance agreement that cedes some risk back to GEICO, and it includes limits on Aetna P&C's obligation to write new and renewal business in certain catastrophe-prone areas. The Company believes that its focus on service, including prompt and efficient claims handling, a high level of automation and development of long-term relationships with individual agents gives it a competitive advantage in the Personal Lines market. PRICING AND UNDERWRITING Pricing for personal automobile insurance is driven by changes in the relative frequency of claims and by inflation in the cost of automobile repairs, medical care and litigation of liability claims. As a result, the profitability of the business is largely dependent on promptly identifying and rectifying disparities between premium levels and expected claim costs, and obtaining approval of the state regulatory authorities for indicated rate increases. Premiums charged for physical damage coverage reflect insured car values and, accordingly, premium levels are somewhat related to the volume of new car sales. Pricing in the homeowners business is also driven by changes in the frequency of claims and by inflation in building supplies, labor costs and household possessions. Most homeowners policies offer automatic increases in coverage to reflect growth in replacement costs and property values. In addition to the normal risks associated with any multiple peril coverage, the profitability and pricing of homeowners insurance is affected by the incidence of natural disasters, particularly tornadoes, earthquakes and hurricanes. The high level of catastrophe losses in recent periods has resulted in a reduced availability of homeowners insurance and has led to higher prices for homeowners policies in some markets. In order to reduce its exposure to catastrophic hurricane losses, the Company has reduced agent commissions on homeowners insurance in certain markets, strengthened underwriting standards and implemented price increases in certain hurricane-prone areas, subject to restrictions imposed by insurance regulatory authorities. The Company uses sophisticated computer modeling techniques to assess whether it should renew business in catastrophe-prone areas. Changes to methods of marketing and underwriting in coastal areas of Florida and New York and in California are subject to state-imposed restrictions, the general effect of which is to retard an insurer's ability to withdraw from such areas. 73 Insurers writing property liability policies are generally unable to increase rates until sometime after the costs associated with coverage have increased, primarily as a result of state insurance rate regulation laws. The pace at which an insurer can change rates in response to competition or to increased costs depends, in part, on whether the applicable rate regulation law requires prior approval of a rate increase or notification to the regulator either before or after a rate increase is imposed. In states having prior approval laws, a rate must be approved by the regulator before it may be used by the insurer. In states having "file-and-use" laws, the insurer must file the rate with the regulator, but does not need to wait for approval before using it. A "use-and-file" law requires an insurer to file rates within a certain period of time after the insurer begins using the new rate. Approximately one-half of the states, including New York and Pennsylvania, require prior approval of rate increases. Underwriting of Personal Lines products is conducted primarily by independent agents. Agents underwrite Personal Lines policies under strict underwriting guidelines established and monitored by the Company. Each agent is assigned to a specific employee of the Company responsible for working with the agent on business plan development, marketing, and overall growth and profitability. The Company's agency level management information enables quick understanding of results and identification of problems and opportunities. Personal Lines implemented various programs over the past several years in order to improve financial results, including expense reductions, the termination of contracts of underperforming agents and the withdrawal from markets where Personal Lines had a small market share or saw little potential for long-term, profitable growth. While these actions reduced the overall size of the Company's Personal Lines business, the core personal automobile and homeowners insurance businesses grew in 1995 in areas targeted for growth, in terms of the number of policies and premium volume. GEOGRAPHIC DISTRIBUTION The following table shows the distribution of Personal Lines direct written premiums by Travelers P&C and Aetna P&C on a combined basis and by each of Travelers P&C and Aetna P&C for the states that accounted for the majority of premium volume for the year ended December 31, 1995:
STATE COMBINED TRAVELERS P&C AETNA P&C - ------------------------------------------------------------------- -------- ------------- --------- (% of total) New York........................................................... 21.1% 21.9% 20.3% Pennsylvania....................................................... 10.2 6.2 14.2 Florida............................................................ 9.4 8.0 10.8 Massachusetts...................................................... 8.9 15.1 2.8 Connecticut........................................................ 7.1 4.8 9.4 New Jersey......................................................... 7.0 9.1 4.9 Texas.............................................................. 6.9 3.5 10.3 Virginia........................................................... 3.5 4.7 2.3 Georgia............................................................ 2.8 4.7 0.9 California......................................................... 2.7 0.2 5.2 All others(1)...................................................... 20.4 21.8 18.9 -------- ----- --------- Total.............................................................. 100.0% 100.0% 100.0% -------- ----- --------- -------- ----- ---------
- ------------ (1) No other single state accounted for 3.0% or more of total direct written premiums written in 1995 by Travelers P&C, Aetna P&C or the Company on a combined basis. CLAIMS ADMINISTRATION The Company employs approximately 10,000 claims employees located throughout the United States. These employees include telephone and road adjusters, appraisers, litigation specialists, staff attorneys, regional and home office management and support staff. The Company handles over 90% of its claims internally and employs external adjusters primarily where geographic location makes it impractical to use the Company's own adjusters. The Company has an investigative unit that handles claims that the Company suspects may be fraudulent. The Company also employs a staff of lawyers who are responsible for handling the majority of the Company's claims litigation. The Company's claims handlers include professionals with the technical expertise necessary to deal with more complex coverage, liability and damage issues. 74 In its handling of claims, the Company strives to balance customer expectations of service with its business objectives of effectively managing loss exposure and controlling claims expense. In an effort to resolve claims efficiently, the Company matches claims settlement authority to the ability of its claims personnel and matches its in-house expertise with the issues involved in the claim. Generally, as a claim develops, it is evaluated by one or more senior claims technicians prior to the ultimate settlement of the claim. Travelers P&C's new Personal Lines claims workstation, implemented in 1995, has improved the speed and quality of Personal Lines claims service, and has helped loss payout performance. Use of technology such as VRUs (voice response units) in conjunction with preferred provider programs for glass and tow claims has lowered the cost of settling those claims and shortened the time to claim payment. The claim department also provides automated feedback from claims handlers to underwriters to help with risk assessment and accurate pricing information. The home office claims department periodically conducts internal file reviews of claims offices to monitor adherence to claims policies and procedures, the adequacy of case reserves, claims loss control, claims expense control, productivity and service standards. Regional claims management periodically audits sample files of claims representatives as part of their supervisory process. Environmental, asbestos and cumulative injury claims are segregated from other claims and are handled separately by the Company's Special Liability Group, a special unit staffed by dedicated legal, finance and engineering professionals. See "--Environmental and Asbestos Claims." REINSURANCE The Company reinsures a portion of the risks it underwrites in an effort to control its exposure to losses, stabilize earnings, and protect surplus. The Company cedes to reinsurers a portion of these risks and pays premiums based upon the risk and exposure of the policies subject to such reinsurance. Reinsurance is subject to collectibility in all cases and to aggregate loss limits in certain cases. Although the reinsurer is liable to the Company to the extent of the reinsurance ceded, the Company remains primarily liable as the direct insurer on all risks reinsured. Reinsurance recoverables are reported after allowances for uncollectible amounts. The Company also holds collateral, including escrow funds and letters of credit, under certain reinsurance agreements. The Company monitors the financial condition of reinsurers on an ongoing basis, and reviews its reinsurance arrangements periodically. Reinsurers are selected based on their financial condition and business practices. Both Travelers P&C and Aetna P&C utilize a variety of reinsurance agreements, primarily with non-affiliated reinsurers, to control their exposure to large property and casualty losses. The Company utilizes the following types of reinsurance: (i) facultative reinsurance, in which reinsurance is provided for all or a portion of the insurance provided by a single policy and each policy reinsured is separately negotiated; (ii) treaty reinsurance, in which reinsurance is provided for a specified type or category of risks; and (iii) catastrophe reinsurance, in which the ceding company is indemnified for an amount of loss in excess of a specified retention with respect to losses resulting from a catastrophic event. The Company's primary reinsurers, except Lloyd's (which is not rated), are rated "A-" or higher by A.M. Best. The ratings and amounts of insurance ceded at December 31, 1995 follow (in millions):
REINSURER AMOUNTS CEDED RATING OF REINSURER - ----------------------------------------------- ------------- ------------------------------- General Reinsurance Corporation................ $ 365 A++ highest of 15 ratings American Re Corporation........................ 240 A+ 2nd highest of 15 ratings Employers Reinsurance Corporation.............. 97 A++ highest of 15 ratings Transatlantic Reinsurance Company.............. 69 A+ 2nd highest of 15 ratings Prudential Reinsurance Company................. 65 A 3rd highest of 15 ratings Nippon Fire & Marine Insurance Company......... 62 A 3rd highest of 15 ratings Fireman's Fund Insurance Company............... 58 A 3rd highest of 15 ratings TIG Reinsurance Company........................ 49 A 3rd highest of 15 ratings Gerling Global Reinsurance Corporation......... 45 A- 4th highest of 15 ratings
75 As of December 31, 1995, the Company had ceded to Lloyd's and General Reinsurance Corporation, two of the Company's largest reinsurers, approximately $482 million and $365 million, respectively, of insurance losses, loss adjustment expenses and unearned premiums. Lloyd's is currently undergoing a restructuring to solidify its capital base and to segregate claims for years before 1993. Travelers P&C is in arbitration with underwriters at Lloyd's in New York State to enforce reinsurance contracts with respect to recoveries for certain asbestos claims. The dispute involves the ability of Travelers P&C to aggregate asbestos claims under a market agreement between Lloyd's and Travelers P&C or under the applicable reinsurance treaties. See "Business--Legal Proceedings." The outcomes of the restructuring of Lloyd's and the arbitration referred to above are uncertain and the impact, if any, on collectibility of amounts recoverable by the Company from Lloyd's cannot be quantified at this time. The Company believes that it is possible that an unfavorable resolution of these matters could have a material adverse effect on the Company's operating results in a future period. However, the Company believes that it is not likely that the outcome of these matters could have a material adverse effect on the Company's financial condition or liquidity. Aetna P&C and Travelers P&C both participate in pools with other insurers to provide capacity for unique and high-valued risks such as property exposures related to aviation, nuclear power plants and transportation of energy materials. The Company's maximum net exposure to this type of business at December 31, 1995 was $29 million per risk. TRAVELERS P&C At December 31, 1995, Travelers P&C had $5.4 billion in reinsurance recoverables. Of this amount, $2.8 billion relating to workers' compensation service business was ceded to industry pools and associations, which have the strength of the participating insurance companies supporting these cessions, and the remainder is due from reinsurers. Of the $2.6 billion ceded to reinsurers at December 31, 1995, $189 million was collateralized by letters of credit against the asset, $343 million was environmental and asbestos-related and the remainder reflects reinsurance in support of ongoing business. The descriptions below relate to reinsurance arrangements of Travelers P&C in effect at January 1, 1996. Net Retention Policy. Currently, for third-party liability, including automobile no-fault, the reinsurance agreements used by the Commercial Accounts and Select Accounts of Travelers P&C limit the net retention to a maximum of $4 million per insured, per occurrence. For commercial property insurance, there is a $5 million retention per insured with 100% reinsurance coverage for risks with higher limits. For National Accounts, reinsurance arrangements are typically tiered, or layered, such that only levels of risk acceptable to Travelers P&C are retained. The reinsurance agreement in place for Travelers P&C's Personal Lines umbrella policies covers 90% of each loss between $1 million and $5 million. Catastrophe Reinsurance. Travelers P&C utilizes reinsurance agreements with nonaffiliated reinsurers to control its exposure to losses resulting from one occurrence. For the accumulation of net property losses arising out of one occurrence, reinsurance coverage averages 74% of total losses between $175 million and $375 million. For multiple workers' compensation losses arising from a single occurrence, reinsurance coverage averages 100% of losses between $10 million and $160 million and, for losses caused by property perils, reinsurance coverage averages 74% of losses between $175 million and $345 million. For commercial property insurance sold through Commercial Accounts and Select Accounts, 15% of all losses are reinsured in 1996, subject to an occurrence limitation of 200% of ceded premium or $225 million, whichever is greater. For Personal Lines homeowners insurance, in 1996, 16.25% of losses are reinsured up to a maximum recovery of $76 million per occurrence. AETNA P&C Approximately one-third of the property-casualty reinsurance ceded by Aetna P&C arises in connection with its servicing relationships with various pools (frequently involuntary pools). Aetna P&C services or writes a portion of the pool's individual policies, handling all premium and loss transactions. These "service" premiums and losses are then 100% ceded (net of an expense reimbursement) to the pools, whose members are jointly liable to Aetna P&C as a servicer. The descriptions below relate to reinsurance arrangements of Aetna P&C in effect at January 1, 1996. 76 Net Retention Policy. Currently, Aetna P&C limits losses from umbrella liability policies by purchasing reinsurance treaties that reduce its net retention to a maximum of $9 million on each policy. Aetna P&C also purchased a reinsurance treaty that reduces its net retention from excess liability risks to a maximum of $7 million on each policy. In the event that an insured purchases both a primary umbrella and an excess liability policy, Aetna's P&C's net retention would be up to $16 million per occurrence. National Accounts also purchases casualty clash protection for its net retention providing $20 million of reinsurance coverage for the Company's liability in excess of the first $10 million of liability. Aetna P&C has purchased a personal umbrella treaty that provides $4 million of reinsurance coverage for the Company's liability in excess of the first $1 million per risk and per occurrence (clash) limit. Aetna P&C has also purchased a reinsurance agreement to limit losses from directors and officers liability and trust department errors and omissions to $2.5 million per insured, per occurrence. Aetna P&C limits losses from commercial property policies by purchasing reinsurance treaties that reduce its net retention to $8 million each policy, each risk (as defined in the original policy). For surety protection, Bond Specialty has reinsurance coverage for 81% of up to $50 million of liability in excess of the first $50 million of liability. Bond Specialty's accident year results are protected by an aggregate excess of loss treaty that provides 41.2% of approximately $47 million of reinsurance coverage in excess of a $108 million retention. Additional net property and casualty retentions in excess of treaty limits may be retained by Aetna P&C as determined by an evaluation of the risk characteristics. Catastrophe Reinsurance. For the accumulation of net property losses arising out of one occurrence, Aetna P&C purchases catastrophe coverage for 90% of losses between $150 million and $325 million. Aetna P&C has an excess workers' compensation excess of loss treaty covering $18 million excess of $2 million per event and a workers' compensation catastrophe excess of loss treaty covering $180 million excess of $20 million per event. For Personal Lines homeowners insurance, a 32.5% quota share is purchased with a per occurrence limit of 120% of ceded earned premium, a ceded loss ratio cap of 200%, and a loss ratio retention of 100% of losses between 50% and 62.5% and 50% of losses between 62.5% and 70%. REINSURANCE FUND The Company also participates in the Florida Hurricane Catastrophe Fund (the "FHCF"), which is a state-mandated catastrophe reinsurance fund. FHCF is partially funded by premiums from insurance companies that write residential property business in Florida and assessments on insurance companies that write other property and casualty insurance, excluding workers' compensation. FHCF's resources are limited to these contributions and to its borrowing capacity at the time of a significant catastrophe. There can be no assurance that these resources will be sufficient to meet the obligations of FHCF. The Company's recovery of less than contracted amounts could have a material adverse effect on the Company's results of operations in the event of a significant catastrophe in Florida. RESERVES Property and casualty loss reserves are established to account for the estimated ultimate costs of claims and claim adjustment expenses for claims that have been reported but not yet settled, reopened claims and claims that have been incurred but not reported. The Company establishes reserves by line of business, coverage and year. The process of estimating loss reserves is an imprecise science subject to a number of variables. These variables are impacted by both internal and external events such as changes in claims handling procedures, inflation, judicial trends and legislative changes. Many of these items are not directly quantifiable, particularly on a prospective basis. Additionally, there may be significant reporting lags between the occurrence of the insured event and the time it is actually reported to the insurer. The Company continually refines reserve estimates in a regular ongoing process as experience develops and further claims are reported and settled. The Company reflects adjustments to reserves in the results of the periods in which such adjustments are made. In establishing reserves, the Company takes into account estimated recoveries for reinsurance, salvage and subrogation. The Company derives estimates for unreported claims, future reopened claims and development on reported claims principally from actuarial analyses of historical patterns of claims development by accident year for each line of business and market segment. Similarly, the Company derives estimates of unpaid claim adjustment expenses principally from actuarial analyses of historical development patterns of the relationship of claim 77 adjustment expenses to losses by accident year for each line of business and market segment. For a description of the Company's reserving methods for environmental and asbestos claims, see "--Environmental and Asbestos Claims." Discounting. The liability for losses for certain long-term disability payments under workers' compensation insurance has been discounted using a maximum interest rate of 5%. At December 31, 1995, 1994 and 1993 the amounts of discount for Travelers P&C were $528 million, $476 million and $567 million, respectively. The amounts of discount recorded by Aetna P&C were $678 million, $644 million and $634 million at December 31, 1995, 1994 and 1993, respectively. In 1993, Aetna P&C's discount reflected the cumulative effect of adjustment related to a change in accounting to report workers' compensation life table indemnity claims on a discounted basis. For a reconciliation of beginning and ending property and casualty insurance claims and claim adjustment expense reserves of Travelers P&C and Aetna P&C for each of the last three years, see Note 7 of the Notes to the Consolidated Financial Statements of TAP and Note 12 of the Notes to the Combined Financial Statements of Aetna P&C, in each case included elsewhere herein. The following tables set forth the year-end reserves from 1985 through 1995 and the subsequent changes in those reserves. The data in the tables are presented in accordance with reporting requirements of the Commission. Care must be taken to avoid misinterpretation by those unfamiliar with such information or familiar with other data commonly reported by the insurance industry. The following data is not accident year data, but rather a display of 1985-1995 year-end reserves and the subsequent changes in those reserves. For instance, the "cumulative deficiency or redundancy" shown in the following tables for each year represents the aggregate amount by which original estimates of reserves as of that year end have changed in subsequent years. Accordingly, the cumulative deficiency for a year relates only to reserves at that year end and such amounts are not additive. Expressed another way, if the original reserves at the end of 1985 included $4 million for a loss which is finally settled in 1995 for $5 million, the $1 million deficiency (the excess of the actual settlement of $5 million over the original estimate of $4 million) would be included in the cumulative deficiencies in each of the years 1985-1994 shown in the following tables. A substantial portion of the cumulative deficiencies in each of the years 1985-1994 arises from claims on policies written prior to the mid-1970s involving liability exposures such as asbestos. In the post-1984 period, the Company has developed more stringent underwriting standards and policy exclusions and significantly contracted or terminated the writing of such risks. See "--Environmental and Asbestos Claims." General conditions and trends that have affected the development of these liabilities in the past will not necessarily recur in the future; however, deficiencies will occur in the future due to the discount on the workers' compensation reserves. Therefore, it would be difficult to develop meaningful extrapolation of estimated future redundancies or deficiencies in loss reserves from the data in the following tables. A significant portion of National Accounts business is underwritten with retrospectively rated insurance policies in which the ultimate cost of insurance for a given year is dependent on the loss experience of the insured. The following tables do not reflect amounts recoverable from insureds in the retrospective rating process. Such recoverables tend to mitigate significantly the impact of the cumulative deficiencies. Retrospective rating is particularly significant for National Accounts business for workers' compensation, and to a lesser extent in general liability and commercial automobile coverages. This mechanism affords the Company a significant measure of financial protection against adverse development on a large block of net reserves. The differences between the reserves for claims and claim adjustment expenses shown in the following tables, which are prepared in accordance with GAAP, and those reported in the annual statements of Travelers P&C and Aetna P&C filed with state insurance departments, which are prepared in accordance with statutory accounting practices, were: in the case of Travelers P&C, $(7) million, $(26) million and $32 million for the years 1995, 1994 and 1993, respectively; and in the case of Aetna P&C, there were no differences. 78
TRAVELERS P&C DECEMBER 31, ---------------------------------------------------------------------------------------- 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- (Dollars in millions) Reserves for claims and claim adjustment expenses originally estimated:............ $ 4,766 $ 5,743 $ 6,569 $ 6,954 $ 7,729 $ 8,022 $ 8,360 $ 8,955 $ 9,319 $ 9,712 Cumulative amounts paid as of: One year later............................. 1,481 1,578 2,061 1,828 2,091 2,135 1,869 2,005 1,706 1,595 Two years later............................ 2,329 2,804 3,132 3,101 3,488 3,422 3,161 3,199 2,843 Three years later.......................... 3,179 3,495 4,003 4,063 4,415 4,351 4,041 4,063 Four years later........................... 3,622 4,079 4,666 4,710 5,095 4,996 4,706 Five years later........................... 4,027 4,550 5,141 5,227 5,597 5,492 Six years later............................ 4,372 4,903 5,550 5,620 5,995 Seven years later.......................... 4,641 5,235 5,870 5,952 Eight years later.......................... 4,930 5,512 6,152 Nine years later........................... 5,180 5,759 Ten years later............................ 5,407 ]Reserves re-estimated as of: One year later............................. 5,067 5,846 6,732 7,080 7,832 8,128 8,362 9,058 9,270 9,486 Two years later............................ 5,252 6,062 6,890 7,243 7,929 8,197 8,637 9,139 9,234 Three years later.......................... 5,444 6,227 7,057 7,405 8,077 8,592 8,906 9,183 Four years later........................... 5,678 6,465 7,246 7,585 8,560 9,003 9,026 Five years later........................... 5,898 6,607 7,466 8,098 8,991 9,159 Six years later............................ 6,067 6,828 7,988 8,531 9,189 Seven years later.......................... 6,258 7,379 8,411 8,715 Eight years later.......................... 6,780 7,763 8,567 Nine years later........................... 7,192 7,936 Ten years later............................ 7,313 Cumulative deficiency (redundancy)......... 2,547 2,193 1,998 1,761 1,460 1,137 666 228 (85) (226) Gross liability--end of year............... $15,013 Reinsurance recoverables................... 5,301 ------- Net liability--end of year................. $ 9,712 ------- ------- Gross reestimated liability--latest........ $15,234 Reestimated reinsurance recoverables--latest....................... 5,748 ------- Net reestimated liability--latest.......... $ 9,486 ------- ------- Gross cumulative deficiency (redundancy)... $ 221 ------- ------- 1995 ------- Reserves for claims and claim adjustment expenses originally estimated:............ $10,090 Cumulative amounts paid as of: One year later............................. Two years later............................ Three years later.......................... Four years later........................... Five years later........................... Six years later............................ Seven years later.......................... Eight years later.......................... Nine years later........................... Ten years later............................ ]Reserves re-estimated as of: One year later............................. Two years later............................ Three years later.......................... Four years later........................... Five years later........................... Six years later............................ Seven years later.......................... Eight years later.......................... Nine years later........................... Ten years later............................ Cumulative deficiency (redundancy)......... Gross liability--end of year............... $15,213 Reinsurance recoverables................... 5,123 ------- Net liability--end of year................. $10,090 ------- ------- Gross reestimated liability--latest........ Reestimated reinsurance recoverables--latest....................... Net reestimated liability--latest.......... Gross cumulative deficiency (redundancy)...
79
AETNA P&C DECEMBER 31, ---------------------------------------------------------------------------------------- 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- (Dollars in millions) Reserves for claims and claim adjustment expenses originally estimated............. $ 6,500 $ 7,418 $ 8,597 $ 9,735 $10,454 $10,943 $11,288 $11,581 $11,259 $11,022 Cumulative amount paid as of: One year later............................. 2,056 2,167 2,538 3,116 3,050 3,057 2,945 2,858 2,709 2,563 Two years later............................ 3,348 3,702 4,521 4,921 4,957 5,088 5,055 4,809 4,591 Three years later.......................... 4,400 5,143 5,759 6,205 6,352 6,667 6,506 6,326 Four years later........................... 5,459 6,019 6,634 7,156 7,512 7,695 7,722 Five years later........................... 6,065 6,638 7,295 7,984 8,238 8,635 Six years later............................ 6,511 7,133 7,927 8,496 8,998 Seven years later.......................... 6,887 7,636 8,300 9,068 Eight years later.......................... 7,303 7,930 8,787 Nine years later........................... 7,566 8,366 Ten years later............................ 7,966 Reserves re-estimated as of: One year later............................. 6,701 7,644 8,922 9,912 10,530 11,000 11,732 11,632 11,522 12,159 Two years later............................ 6,961 8,095 9,217 10,092 10,688 11,617 11,949 11,975 12,676 Three years later.......................... 7,443 8,446 9,442 10,358 11,268 11,923 12,359 13,161 Four years later........................... 7,818 8,709 9,713 10,883 11,506 12,403 13,577 Five years later........................... 8,054 8,990 10,221 11,107 12,080 13,655 Six years later............................ 8,330 9,480 10,404 11,671 13,348 Seven years later.......................... 8,812 9,676 10,975 12,919 Eight years later.......................... 9,029 10,253 12,240 Nine years later........................... 9,610 11,525 Ten years later............................ 10,887 Cumulative deficiency...................... 4,387 4,107 3,643 3,184 2,894 2,712 2,289 1,580 1,417 1,137 Gross liability--end of year............... $15,977 Deductible recoverables.................... 352 Reinsurance recoverables................... 4,603 ------- Net liability--end of year................. $11,022 ------- ------- Gross reestimated liability--latest........ $17,057 Deductible recoverables.................... 352 Reestimated reinsurance recoverables-- latest..................................... 4,546 ------- Net reestimated liability--latest(1)(2).... $12,159 ------- ------- Gross cumulative deficiency................ $ 1,080 ------- ------- 1995 ------- Reserves for claims and claim adjustment expenses originally estimated............. $11,573 Cumulative amount paid as of: One year later............................. Two years later............................ Three years later.......................... Four years later........................... Five years later........................... Six years later............................ Seven years later.......................... Eight years later.......................... Nine years later........................... Ten years later............................ Reserves re-estimated as of: One year later............................. Two years later............................ Three years later.......................... Four years later........................... Five years later........................... Six years later............................ Seven years later.......................... Eight years later.......................... Nine years later........................... Ten years later............................ Cumulative deficiency...................... Gross liability--end of year............... $16,558 Deductible recoverables.................... 412 Reinsurance recoverables................... 4,573 ------- Net liability--end of year................. $11,573 ------- ------- Gross reestimated liability--latest........ Deductible recoverables.................... Reestimated reinsurance recoverables-- latest..................................... Net reestimated liability--latest(1)(2).... Gross cumulative deficiency................
- ------------ (1) The reestimated liability at December 31, 1993 includes $574 million related to development in workers' compensation reserves in the fourth quarter of 1993. This affected the reestimated liability by reserve year as follows: $574 million in 1992; $565 million in 1991; $534 million in 1990; $484 million in 1989; $433 million in 1988; $396 million in 1987; $372 million in 1986; and $346 million in 1985. (2) The reestimated liability at December 31, 1993 includes development related to the discounting of workers' compensation life table indemnity claims. This affected the reestimated liability by reserve year as follows: $(634) million in 1993; $(614) million in 1992; $(577) million in 1991; $(528) million in 1990; $(473) million in 1989; $(417) million in 1988; $(362) million in 1987; $(317) million in 1986; and $(274) million in 1985. 80 ENVIRONMENTAL AND ASBESTOS CLAIMS Travelers P&C and Aetna P&C have each established a special claims unit that is segregated from their other claims areas to deal exclusively with environmental and asbestos exposures. ENVIRONMENTAL CLAIMS As a result of various state and federal regulatory efforts aimed at environmental remediation, the insurance industry has been, and continues to be, involved in extensive litigation involving policy coverage and liability issues. The Comprehensive Environmental Response, Compensation and Liability Act was first enacted in 1980, and significantly expanded in 1984. CERCLA enables private parties and the federal and state governments to take action with respect to releases and threatened releases of hazardous substances and to recover their response costs from certain liable parties or such parties may be ordered to undertake remedial action directly. Liability under CERCLA may be joint and several with other responsible persons. In addition to the regulatory pressures, the Company believes that certain court decisions have expanded insurance coverage beyond the original intent of the insurers and insureds, frequently involving policies that were issued prior to the mid-1970s. The results of court decisions affecting the industry's coverage positions continue to be inconsistent. Accordingly, the ultimate responsibility and liability for environmental remediation costs remain uncertain. The review of environmental claims includes an assessment of the probable liability, available coverage, judicial interpretations and historical value of similar claims. In addition, the unique facts presented in each claim are evaluated individually and collectively. Due consideration is given to the many variables presented in each claim, such as: the nature of the alleged activities of the insured at each site; the allegations of environmental damage at each site; the number of sites; the total number of potentially responsible parties at each site; the nature of environmental harm and the corresponding remedy at a site; the nature of government enforcement activities at each site; the ownership and general use of each site; the willingness and ability of other potentially responsible parties to contribute to the cost of the required remediation at each site; the overall nature of the insurance relationship between the Company and the insured; the identification of other insurers; the potential coverage available, if any; the number of years of coverage, if any; the obligation to provide a defense to insureds, if any; and the applicable law in each jurisdiction. Analysis of these and other factors on a case-by-case basis results in the ultimate reserve assessment. Environmental loss and loss expense reserves of Travelers P&C at December 31, 1995 were $404 million, net of reinsurance of $50 million. Approximately 24% of such loss and loss expense reserves (approximately $95 million) were case reserves for resolved claims. Travelers P&C does not post case reserves for environmental claims in which there is a coverage dispute until the dispute is resolved. Until then, the estimated amounts for disputed coverage claims are carried in a bulk reserve, together with unreported environmental losses. The property and casualty insurance industry does not have a standard method of calculating claim activity for environmental losses. Generally, for environmental claims, Travelers P&C establishes a claim file for each insured on a per site, per claimant basis. If there is more than one claimant, e.g., a federal and a state agency, this method will result in two claims being set up for a policyholder at that one site. Travelers P&C adheres to this method of calculating claims activity on all environmental-related claims, whether such claims are tendered on primary, excess or umbrella policies. Travelers P&C generally has been successful in resolving its coverage litigation and continues to reduce its potential exposure through favorable settlements with certain insureds. These settlement agreements with certain insureds are based on the variables presented in each piece of coverage litigation. Generally the settlement dollars paid in disputed coverage claims are a percentage of the total coverage sought by such insureds. In addition, with respect to settlement of many of the environmental claims there is a "buy-back" of the future environmental liability risks under the policy by Travelers P&C, together with appropriate indemnities and hold harmless provisions to protect Travelers P&C. Environmental loss and loss expense reserves of Aetna P&C at December 31, 1995 were $977 million, net of reinsurance of $29 million. Approximately 18% of such loss and loss expense reserves (approximately $176 million) were case reserves for pending and resolved claims. The Company expects to implement Travelers P&C's strategy with regard to environmental-related claims at Aetna P&C in the future by vigorously litigating coverage and related issues and by reducing Aetna P&C's potential exposure through favorable settlement with insureds. 81 ASBESTOS CLAIMS In the area of asbestos claims, the Company believes that the property and casualty insurance industry has suffered from judicial interpretations that have attempted to maximize insurance availability from both a coverage and liability standpoint far beyond the intentions of the contracting parties. These policies generally were issued prior to the 1980s. Originally the cases involved mainly plant workers and traditional asbestos manufacturers and distributors. However, in the mid-1980s, a new group of plaintiffs, whose exposure to asbestos was less direct and whose injuries were often speculative, began to file lawsuits in increasing numbers against the traditional defendants as well as peripheral defendants who had produced products that may have contained small amounts of encapsulated asbestos. These claims continue to arise and on an individual basis generally involve smaller companies with smaller limits of potential coverage. There has emerged a group of non-product claims by plaintiffs, mostly independent labor union workers, mainly against companies, alleging exposure to asbestos while working at these companies' premises. In addition, various insurers, including the Company, remain defendants in an action brought in Philadelphia regarding potential consolidation and resolution of future asbestos bodily injury claims. The cumulative effect of these claims and the judicial actions on the Company and its insureds currently is uncertain. Also, various classes of asbestos defendants, such as major product manufacturers, peripheral and regional product defendants as well as premises owners, continue to tender asbestos-related claims to the insurance industry. Because each insured presents different liability and coverage issues, the Company evaluates those issues on an insured-by-insured basis. The Company's evaluations have not resulted in any meaningful data from which an average asbestos defense or indemnity payment may be determined. The varying defense and indemnity payments made by the Company on behalf of its insureds have also precluded the Company from deriving any meaningful data by which it can predict whether its defense and indemnity payments for asbestos claims (on average or in the aggregate) will remain the same or change in the future. Asbestos loss and loss expense reserves of Travelers P&C at December 31, 1995 were $402 million, net of reinsurance of $293 million. Approximately 82% of the net asbestos reserves at December 31, 1995 represented incurred but not reported losses. Asbestos loss and loss expense reserves of Aetna P&C at December 31, 1995 were $687 million, net of reinsurance of $89 million. Approximately 66% of the net asbestos reserves at December 31, 1995 represented incurred but not reported losses. UNCERTAINTY REGARDING ADEQUACY OF ENVIRONMENTAL AND ASBESTOS RESERVES In relation to submitted and future asbestos and environmental-related claims, the Company carries on a continuing review of its overall position, its reserving techniques and reinsurance recoverables. In these areas of exposure, the Company has endeavored to litigate individual cases and settle claims on favorable terms. Given the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties, it is not presently possible to quantify the ultimate exposure or range of exposure represented by these claims to the Company's financial condition, results of operations or liquidity. The Company believes that it is reasonably possible that the outcome of the uncertainties regarding environmental and asbestos claims could result in a liability exceeding the reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. INSURANCE POOLS Most of the Company's insurance subsidiaries are members of one of three separate intercompany property and casualty reinsurance pooling arrangements: the Travelers Indemnity pool; the Aetna Insurance pool and the Gulf pool. Each of these insurance pools permits each participating company to rely on the capacity of the entire pool rather than on its own capital and surplus. Under the arrangements of each insurance pool, the members pool substantially all insurance business that is written and prorate the combined premiums, losses and expenses. RATINGS Insurance companies are rated by rating agencies to provide both industry participants and insurance consumers with meaningful information on specific insurance companies. Higher ratings generally indicate 82 financial stability and a strong ability to pay claims. These ratings are based upon factors relevant to policyholders and are not directed toward protection of investors. Such ratings are neither a rating of securities nor a recommendation to buy, hold or sell any security. Ratings focus on the following factors: capital resources, financial strength, demonstrated management expertise in the insurance business, credit analysis, systems development, marketing, investment operations, minimum policyholders' surplus requirements and capital sufficiency to meet projected growth, as well as access to such traditional capital as may be necessary to continue to meet standards for capital adequacy. The following table summarizes the current claims-paying and financial strength ratings of the Company's property-casualty insurance pools and Aetna C&S of America by A.M. Best, Duff & Phelps, Moody's and Standard & Poor's.
STANDARD A.M. BEST DUFF & PHELPS MOODY'S & POOR'S --------- ------------- ------- -------- Travelers Indemnity pool(1)................................... A AA- A1 A+ Aetna Insurance pool(2)....................................... A- A+ A1 A+ Gulf pool(3).................................................. A+ -- -- Aq Aetna C&S of America.......................................... A(4) A+(5) A1(5) A+(5)
- ------------ (1) The Travelers Indemnity pool consists of The Travelers Indemnity Company, The Phoenix Insurance Company, The Charter Oak Fire Insurance Company, The Travelers Indemnity Company of Connecticut, The Travelers Indemnity Company of America, The Travelers Indemnity Company of Missouri and The Travelers Indemnity Company of Illinois. Effective January 1, 1996, TravCo Insurance Company and The Travelers Home and Marine Insurance Company joined the Travelers Indemnity pool. (2) The Aetna Insurance pool consists of The Aetna Casualty and Surety Company, The Standard Fire Insurance Company, Aetna Casualty & Surety Company of Illinois, The Farmington Casualty Company, The Automobile Insurance Company of Hartford, Connecticut, Aetna Casualty Company of Connecticut, Aetna Commercial Insurance Company, Aetna Insurance Company, Aetna Insurance Company of Illinois and Aetna Personal Security Insurance Company. (3) The Gulf pool consists of Gulf Insurance Company, Gulf Underwriters Insurance Company, Select Insurance Company, Atlantic Insurance Company and Gulf Group Lloyds. (4) Aetna C&S of America was separated from the Aetna Insurance pool and began receiving separate ratings from A.M. Best as of January 1, 1995. (5) Aetna C&S of America receives the same rating as the Aetna Insurance pool from Duff & Phelps, Moody's and Standard & Poor's. In November 1995, the Travelers Indemnity pool was put on credit watch by Standard & Poor's with a negative outlook. In April 1996, the Travelers Indemnity pool's rating was downgraded from AA- to A+ by Standard & Poor's. In July 1995, the Aetna Insurance pool's rating was downgraded from A+ to A by Standard & Poor's and from AA- to A+ by Duff & Phelps. In April 1996, the Aetna Insurance pool's rating was upgraded from A to A+ by Standard & Poor's. The following table presents the position of each rating set forth above assigned by the agencies indicated below in the continuum of ratings assigned by such agencies.
DUFF & STANDARD & A.M. BEST PHELPS MOODY'S POOR'S --------- ------ ------- ---------- Rating Categories Available.................................... 15 18 19 18 - - ------ ------- Travelers Indemnity Pool....................................... 3 4 5 5 Aetna Insurance Pool........................................... 4 5 5 5 Gulf Pool...................................................... 2 N/A N/A 6(1) Aetna C&S of America........................................... 3 5 5 5
- ------------ (1) Sixth of 18 ratings contained in Standard & Poor's "q" rating scale. INVESTMENTS Insurance company investments must comply with applicable laws and regulations which prescribe the kind, quality and concentration of investments. In general, these laws and regulations permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, real estate mortgages and real estate. The Company's investment policies are determined by TAP's Board of Directors and are reviewed on a regular basis. The Company's investment strategy is designed to maximize after-tax total return with an emphasis on after-tax operating income, while meeting desired liquidity and balance sheet volatility targets. At December 31, 1995, the combined carrying value of the Company's investment portfolio was $26.7 billion, of which 87.8% was invested in fixed maturity investments and short-term investments, 5.9% in mortgage loans and real estate, 4.1% in common stocks and other equity securities and 2.2% in other investments. The average duration of the fixed maturity portfolio, including short-term investments, was 4.6 years at such date. Non-investment grade securities totalled $783 million, representing approximately 2.9% of the Company's combined investment portfolio as of December 31, 1995. 83 The following tables set forth information regarding the combined investments of the Company. The table below reflects the average amount of combined investments, net investment income earned and the yield thereon for the years ended December 31, 1995, 1994 and 1993. See Note 16 of Notes to the Consolidated Financial Statements of TAP and Note 3 of Notes to the Combined Financial Statements of Aetna P&C for information regarding the investment portfolio of each of Travelers P&C and Aetna P&C, respectively.
YEAR ENDED DECEMBER 31, ----------------------------------- 1995 1994 1993 --------- --------- --------- (Dollars in millions) Average investments................................................. $24,824.9 $24,068.0 $24,589.7 Net investment income............................................... $ 1,611.8 $ 1,397.3 $ 1,620.3 Average yield(1)(2)................................................. 6.4% 6.0% 7.1% Average tax equivalent yield(1)(2).................................. 6.9% 6.5% 7.8% Average tax equivalent yield excluding real estate(1)(2)............ 6.8% 6.3% 7.6%
- ------------ (1) Excluding realized and unrealized capital gains and losses. (2) Annualized. The following table summarizes, by type, the combined investments of the Company at December 31, 1995. See Note 16 of Notes to the Consolidated Financial Statements of TAP and Note 3 of Notes to the Combined Financial Statements of Aetna P&C for additional information regarding the investments, by type, of each of Travelers P&C and Aetna P&C, respectively.
AT DECEMBER 31, 1995 ------------------------- PERCENT AMOUNT OF PORTFOLIO --------- ------------ (Dollars in millions) Mortgage-backed securities--principally obligations of U.S. Government agencies.................................................. $ 3,271.4 12.3% U.S. Treasury securities and obligations of U.S. Government corporations and agencies.................................................... 4,410.8 16.5 Obligations of states and political subdivisions............................... 4,585.1 17.2 Debt securities issued by foreign governments.................................. 1,283.8 4.8 Corporate debt securities...................................................... 8,734.4 32.7 Redeemable preferred stock..................................................... 221.1 0.8 --------- ----- Total fixed maturities....................................................... 22,506.6 84.3 Equity securities.............................................................. 1,102.4 4.1 Mortgage loans................................................................. 1,274.5 4.8 Real estate held for sale...................................................... 287.5 1.1 Short-term investments......................................................... 923.7 3.5 Other investments.............................................................. 578.2 2.2 --------- ----- Total investments............................................................ $26,672.9 100.0% --------- ----- --------- -----
84 The following table sets forth the contractual maturity distribution of the Company's combined fixed maturity investments and short-term investments at December 31, 1995. See Note 16 of Notes to the Consolidated Financial Statements of TAP and Note 3 of Notes to the Combined Financial Statements of Aetna P&C for the expected maturity distribution of fixed maturity investments and short-term investments of each of Travelers P&C and Aetna P&C, respectively.
AT DECEMBER 31, 1995 ------------------------- PERCENT AMOUNT OF PORTFOLIO --------- ------------ (Dollars in millions) Due in one year or less........................................................ $ 2,161.5 9.2% Due after one year through five years.......................................... 6,481.8 27.7 Due after five years through ten years......................................... 5,635.3 24.0 Due after ten years............................................................ 9,151.7 39.1 --------- ----- Total fixed maturity and short-term investments.............................. $23,430.3 100.0% --------- ----- --------- -----
The following table sets forth the Company's combined fixed maturity investment portfolio classified by Moody's ratings as of December 31, 1995:
AT DECEMBER 31, 1995 -------------------------------- PERCENT OF TOTAL CARRYING CARRYING VALUE VALUE -------------- -------------- (Dollars in millions) Rating: Aaa........................................................................ $ 10,647.4 47.3% Aa......................................................................... 3,406.8 15.1 A.......................................................................... 4,692.7 20.9 Baa........................................................................ 2,976.7 13.2 -------------- ----- Total investment grade................................................... 21,723.6 96.5 Non-investment grade....................................................... 783.0 3.5 -------------- ----- Total fixed maturity investments......................................... $ 22,506.6 100.0% -------------- ----- -------------- -----
MORTGAGE LOANS AND REAL ESTATE At December 31, 1995, the combined mortgage loan and real estate portfolios of the Company consisted of approximately $1.3 billion and $0.3 billion, respectively. Travelers P&C has continued a program of disposing of its real estate investments and some of its mortgage loans and of reinvesting the proceeds to obtain current market yields and the Company will continue this strategy with respect to the Aetna P&C portfolio. The accelerated liquidation strategy for foreclosed real estate and certain mortgage loans has mitigated the negative impact that these underperforming portfolios have had on the investment income of Travelers P&C and the Company believes that continuation of this strategy will have similar mitigating effects. The Company expects that approximately half of maturing commercial mortgage loans in its portfolio will be refinanced, restructured, sold or foreclosed. Restructured loans are defined as loans the terms of which have been changed from the original contract generally by lowering the pay rate of interest in the early years after modification. Loans which have pay rates of interest after modification that are equal to or above market rates are not included in the underperforming mortgage loan inventory. At December 31, 1995 and 1994, approximately $68 million and $233 million, or 5% and 14%, respectively, of the combined mortgage loan portfolio of the Company was classified as underperforming. Underperforming mortgage loans include delinquent loans, loans in the process of foreclosure and loans modified at interest rates below market. Management evaluates the real estate portfolio on an ongoing basis, assessing the probabilities of loss with respect to a comprehensive series of projections, including a host of variables relating to the borrower, the property, the term of the loan, the tenant composition, rental rates, other supply and demand factors, and overall economic conditions. 85 The following table summarizes by property type the mortgage loan portfolio and real estate held for sale included in the combined investment portfolio of the Company as of December 31, 1995 and 1994.
MORTGAGE LOANS REAL ESTATE -------------------- ------------------ 1995 1994 1995 1994 -------- -------- -------- ------ (Dollars in millions) Property Type: Commercial: Office....................................................... $ 591.0 $ 764.2 $ 139.7 $133.1 Apartment.................................................... 243.3 269.1 4.8 19.8 Hotel........................................................ 74.4 147.0 56.8 46.3 Retail....................................................... 285.4 415.8 20.2 24.4 Industrial................................................... 51.9 55.6 22.6 22.2 Other........................................................ 52.1 62.7 41.5 38.5 -------- -------- -------- ------ Total commercial............................................... 1,298.1 1,714.4 285.3 284.3 Agriculture.................................................... 20.8 26.3 2.2 7.4 Residential.................................................... -- 7.3 -- 0.2 Less: valuation reserve........................................ (44.4) (58.5) -- -- -------- -------- -------- ------ Total.......................................................... $1,274.5 $1,689.5 $ 287.5 $291.9 -------- -------- -------- ------ -------- -------- -------- ------
For additional information regarding the mortgage loan and real estate held for sale portfolios of Travelers P&C and Aetna P&C, see Note 16 of Notes to the Consolidated Financial Statements of TAP and Notes 3 and 15 of Notes to the Combined Financial Statements of Aetna P&C, respectively. Actual maturities will differ from contractual maturities because borrowers may have the right to prepay loans with or without prepayment penalties. The Company's unscheduled payments and sales of mortgage loans were $227 million in 1995 and $275 million in 1994. The average remaining life of the mortgage portfolio is six years. DERIVATIVES See Note 10 of Notes to the Consolidated Financial Statements of TAP and Note 13 of Notes to the Combined Financial Statements of Aetna P&C for a discussion of the policies and transactions related to derivatives of TAP and Aetna P&C, respectively. COMPETITION The property and casualty insurance industry is highly competitive in the areas of price, service, agent relationships and, in the case of personal property and casualty business, method of distribution (i.e., use of independent agents, captive agents and/or employees). There are approximately 3,400 property-casualty insurance companies in the United States. Of those companies, approximately 800 operate in all or most states and write the vast majority of the business in the industry while over 2,500 offer one or more personal property-casualty products similar to those marketed by the Company. In addition, an increasing amount of commercial risks are covered by purchaser self-insurance, high deductibles, risk-purchasing groups, risk-retention groups and captive companies. COMMERCIAL LINES. The insurance industry is represented in the commercial lines marketplace by many insurance companies of varying size. The industry is comprised of small local firms, large regional firms and large national firms, as well as self-insurance programs or captive insurers. Market competition works to set the price charged for insurance products and the level of service provided within the insurance regulatory framework. Growth is driven by a company's ability to provide insurance and services at a price that is reasonable and acceptable to the customer. In addition, the marketplace is affected by available capacity of the insurance industry as measured by policyholders' surplus. Surplus expands and contracts primarily in conjunction with profit levels generated by the industry. Growth in premium and service business is also measured by a company's ability to retain existing customers and to attract new customers. The National Accounts market is highly competitive. Competition is based primarily on quality and service and, to a lesser extent, on the basis of price. National Accounts business is generally written through national brokers and regional agents. The Company also competes for state contracts to provide claims and policy management services. These contracts, which generally have three-year terms, are selected by state agencies 86 through a bid process based on quality of service and price. Travelers P&C has emerged as the largest assigned risk plan service insurer in the industry with approximately 25% of the market in 1995. The Commercial Accounts market is highly competitive. Commercial Accounts business has historically been written through independent agents and brokers, although some companies use direct writing. Competitors in this market are primarily national property-casualty insurance companies willing to write most classes of business using traditional products and pricing and, to a lesser extent, companies who have developed niche programs for specific industry segments. Companies compete on price, product offerings and response time in policy issuance and claim service. As a result, reduced overhead and improved efficiency through automation to reduce costs and response time are key to success in this market. The Construction market has become a focused industry segment for several large insurance companies. Construction market business is written through agents and brokers. Insurance companies compete in this market based upon price, product offering and claims service. The Company utilizes its specialized underwriters and engineers who have extensive experience and knowledge of the construction industry to work with agents and brokers to compete effectively in this market. The Select Accounts market is highly competitive and is written through agents. Both national and regional property-casualty insurance companies compete in the Select Accounts market. Customers in this market are generally low risk, "main street" businesses, and risks are underwritten and priced using standard industry practices. The Company has established a strong marketing relationship with its distribution network and has provided it with defined underwriting policies, competitive prices and automated environments. The market in which Specialty Accounts competes includes small to mid-sized niche companies that target certain lines of insurance and larger, multi-line companies that focus on various segments of the Specialty Accounts market. PERSONAL LINES. Personal lines insurance is written by hundreds of insurance companies of varying sizes. Although national companies write the majority of the business, the Company also faces competition from local or regional companies in various markets because of their expense structure or because they specialize in providing coverage to particular risk groups. The Company believes that the principal competitive factors are price, service, perceived stability of the insurer and name recognition. The Company also competes with other independent agency companies for business in each of the agencies representing it who also offer policies of competing companies. At the agency level, the Company believes that competition is primarily based on the level of service, including claims handling, level of automation and the development of long-term relationships with the individual agents. The Company also competes with insurance companies that use captive agents or salaried employees to sell their products. Because these companies generally do not pay commissions, they may be able to obtain business at a lower cost than the Company, which sells its products primarily through independent agents and brokers. Due to the expense advantage, the direct writing companies have gradually been able to expand their market share. REGULATION STATE REGULATION TAP's insurance subsidiaries are subject to regulation and supervision in the various states and jurisdictions in which they transact business. The extent of regulation varies but generally has its source in statutes that delegate regulatory, supervisory and administrative authority to a department of insurance of each state. The regulation, supervision and administration relate, among other things, to the standards of solvency that must be met and maintained, the licensing of insurers and their agents, the nature of and limitations on investments, premium rates, restrictions on the size of risks that may be insured under a single policy, reserves and provisions for unearned premiums, losses and other purposes, deposits of securities for the benefit of policyholders, approval of policy forms and the regulation of market conduct including underwriting and claims practices. In addition, many states have enacted variations of competitive rate-making laws which allow insurers to set certain premium rates for certain classes of insurance without having to obtain the prior approval of the state insurance department. State insurance departments also conduct periodic examinations of the affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of companies and other matters. 87 At the present time, TAP's insurance subsidiaries are collectively licensed to transact insurance business in all states, the District of Columbia, Guam, Puerto Rico, and the U.S. Virgin Islands, as well as Canada and the United Kingdom. Although TAP is not regulated as an insurance company, it is the owner of the capital stock of its insurance subsidiaries and as such is subject to the state insurance holding company statutes, as well as certain other laws, of each of the states of domicile of its insurance subsidiaries. All holding company statutes, as well as certain other laws, require disclosure and, in some instances, prior approval of significant transactions between an insurance company and an affiliate. The holding company statutes, as well as certain other laws, also require, among other things, prior approval of an acquisition of control of a domestic insurer and the payment of extraordinary dividends or distributions. TAP's insurance subsidiaries are subject to various state statutory and regulatory restrictions in each company's state of domicile, which limit the amount of dividends or distributions by an insurance company to its stockholders. As a holding company whose principal assets are the capital stock of Travelers Indemnity, Aetna Casualty and Standard Fire, TAP relies primarily on dividends from these subsidiaries to meet its obligations for payment of interest and principal on outstanding debt obligations, dividends to stockholders and corporate expenses. The ability of these subsidiaries to pay dividends to TAP in the future will depend on their statutory surplus, future earnings and regulatory restrictions. Aetna Casualty and Standard Fire are not expected to pay dividends in 1996. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." TAP's principal insurance subsidiaries are domiciled in the State of Connecticut. The insurance holding company law of Connecticut requires notice to, and approval by, the state insurance commissioner for the declaration or payment of any dividend, which together with other distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's surplus or (ii) the insurer's net income for the twelve-month period ending the preceding December 31st, in each case determined in accordance with statutory accounting practices. Such declaration or payment is further limited by adjusted unassigned funds (surplus), as determined in accordance with statutory accounting practices. The insurance holding company laws of other states in which the Company's insurance subsidiaries are domiciled generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends. All states require insurers licensed to do business in their state to bear a portion of the loss suffered by certain insureds as a result of the insolvency of other insurers. Depending upon state law, insurers can be assessed an amount that is generally equal to between 1% and 2% of premiums written for the relevant lines of insurance in that state each year to pay the claims of an insolvent insurer. Most of these payments are recoverable through future policy surcharges and premium tax reductions, although significant increases in assessments could limit the ability of the Company's insurance subsidiaries to recover such assessments. In addition, there have been some legislative efforts to limit or repeal the tax offset provisions, which efforts, to date, have been generally unsuccessful. These assessments may increase or decrease in the future depending upon the rate of insolvencies of insurance companies. The Company also participates in the FHCF, which is a state-mandated catastrophe reinsurance fund. In 1993, the Florida legislature created the FHCF to provide reimbursement to insurers for a portion of their future catastrophic hurricane losses. The FHCF is partially funded by premiums from the insurance companies that write residential property business in Florida and assessments on insurance companies that write other property and casualty insurance in Florida, excluding workers' compensation. FHCF's resources are limited to these contributions and to its borrowing capacity at the time of a significant catastrophe in Florida. In response to the crisis in the homeowners insurance market in California, the California legislature has passed legislation that allows insurers to offer a new policy with a maximum deductible of 15%. The legislation was designed to allow insurers to reduce the potential solvency risk from earthquake losses while remaining in the homeowners market. Tentative approval has been given to the California Insurance Commissioner to form a privately funded state-run earthquake pool. TAP's insurance subsidiaries are also required to participate in various involuntary assigned risk pools, principally involving workers' compensation and automobile insurance, which provide various insurance coverages to individuals or other entities that otherwise are unable to purchase such coverage in the voluntary market. Participation in these pools in most states is generally in proportion to voluntary writings of related lines of business 88 in that state. The underwriting results of these pools traditionally have been unprofitable, although the effect of their performance has been partially mitigated in certain lines of insurance by the states' allowance of increases in rates for business voluntarily written by pool participants in such states. Earned premiums related to such pools and assigned risks for the combined Aetna P&C and Travelers P&C entities were $315 million, $509 million and $604 million in 1995, 1994 and 1993, respectively. The related underwriting losses for the combined Aetna P&C and Travelers P&C entities were $152 million, $300 million and $504 million in 1995, 1994 and 1993, respectively. In recent years various consumer movements have put pressure on elected officials to regulate or rollback property and casualty insurance rates. While most of these provisions have failed to become law, these initiatives may continue as legislators and regulators try to respond to public availability and affordability concerns and the resulting laws, if any, could adversely affect the Company's ability to write business with appropriate returns. Insurers writing property liability policies are generally unable to increase rates until sometime after the costs associated with coverage have increased, primarily as a result of state insurance rate regulation laws. The pace at which an insurer can change rates in response to competition or to increased costs depends, in part, on whether the applicable rate regulation law requires prior approval of a rate increase or notification to the regulator either before or after a rate increase is imposed. In states having prior approval laws, a rate must be approved by the regulator before it may be used by the insurer. In states having "file-and-use" laws, the insurer must file the rate with the regulator, but does not need to wait for approval before using it. A "use-and-file" law requires an insurer to file rates within a certain period of time after the insurer begins using the new rate. Approximately one half of the states, including New York and Pennsylvania, require prior approval of rate increases. INSURANCE REGULATIONS CONCERNING CHANGE OF CONTROL Many state insurance regulatory laws intended primarily for the protection of policyholders contain provisions that require advance approval by state agencies of any change in control of an insurance company or insurance holding company that is domiciled (or, in some cases, having such substantial business that it is deemed to be commercially domiciled) in that state. TAP owns, directly or indirectly, all of the shares of stock of certain property and casualty insurance companies domiciled in the States of Connecticut, Georgia, Illinois, Indiana, Massachusetts, Missouri, New Jersey and Texas. "Control" is generally presumed to exist through the ownership of 10% or more of the voting securities of a domestic insurance company or of any company which controls a domestic insurance company. TAP may also own indirectly more than 10% of the voting securities of certain property and casualty insurance companies domiciled or commercially domiciled in Delaware and California. Any purchaser of shares of Common Stock representing 10% or more of the voting power of TAP will be presumed to have acquired control of TAP's domestic insurance subsidiaries unless, following application by such purchaser in each insurance subsidiary's state of domicile, the relevant Insurance Commissioner determines otherwise. In addition, many state insurance regulatory laws contain provisions that require prenotification to state agencies of a change in control of a nondomestic admitted insurance company in that state. While such prenotification statutes do not authorize the state agency to disapprove the change of control, such statutes do authorize issuance of a cease and desist order with respect to the nondomestic admitted insurer if certain conditions exist such as undue market concentration. Any future transactions that would constitute a change in control of TAP would generally require prior approval by the insurance departments of the states in which TAP's insurance subsidiaries are domiciled or commercially domiciled and may require preacquisition notification in those states which have adopted preacquisition notification provisions and in which such insurance subsidiaries are admitted to transact business. Certain insurance subsidiaries of TAP are authorized to conduct insurance business in the United Kingdom. Authorized insurers in the United Kingdom are subject to certain change of control restrictions in the Insurance Companies Act 1982 which require the approval of The Department of Trade and Industry if any person is to become a "controller" (which is defined as a person entitled to exercise control of 15% or more of the voting power) of an authorized insurance company. Certain other insurance subsidiaries of TAP are authorized to conduct insurance business in Canada. Authorized insurers in Canada are subject to certain change of control restrictions in Section 407 of the Insurance Companies Act which requires the approval of the Minister of Finance if any person acquires a "significant interest" (beneficial ownership, directly or through one or more entities controlled by such person, of 10% of the outstanding shares of such Company) in an authorized insurance company. 89 Such requirements may deter, delay or prevent certain transactions affecting the control of or the ownership of Common Stock, including transactions that could be advantageous to the stockholders of TAP. Insurance Regulatory Information System The NAIC has developed a set of financial relationships or "tests" called the Insurance Regulatory Information System ("IRIS") that were designed for early identification of companies that may require special attention by insurance regulatory authorities. These tests were developed primarily to assist state insurance departments in executing their statutory mandate to oversee the financial condition of insurance companies. Insurance companies submit data on an annual basis to the NAIC, which in turn analyzes the data using ratios covering twelve categories of financial data with defined "usual ranges" for each category. Falling outside the usual range of IRIS ratios is not considered a failing result; rather, unusual values are viewed as part of the regulatory early monitoring system. Furthermore, in some years, it may not be unusual for financially sound companies to have several ratios with results outside the usual ranges. An insurance company may fall out of the usual range for one or more ratios because of specific transactions that are in themselves immaterial or eliminated at the consolidated level. Generally, an insurance company will become subject to regulatory scrutiny if it falls outside the usual ranges of four or more of the ratios. In normal years, 15% of the companies included in the IRIS system are expected by the NAIC to be outside the usual range on four or more ratios. In each of the last three years, certain of the Company's insurance subsidiaries have been outside of the usual range for certain IRIS ratios. The table below displays the ratios outside the usual ranges for the principal insurance subsidiaries of the Company:
PRINCIPAL TRAVELERS P&C INSURERS ---------------------------------- PRINCIPAL AETNA P&C INSURERS UNUSUAL THE PHOENIX ---------------------------------------------- VALUES TRAVELERS INSURANCE AETNA C&S EQUAL TO OR INDEMNITY COMPANY AETNA CASUALTY STANDARD FIRE OF AMERICA ------------ ---------------- ---------------- ---------------- ---------------- ---------- RATIO NAME/DESCRIPTION OVER UNDER 1995 1994 1993 ]1995 1994 1993 1995 1994 1993 1995 1994 1993 1995 1994 - --------------------------------- ---- ----- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- Change in Writings 33 (33) (71) 90 Two-Year Overall Operating Ratio 100 105 104 110 110 114 112 100 105 105 Change in Surplus 50 (10) 55 (13) (22) 91 (11) Liabilities To Liquid Assets 105 106 107 109 110 106 One-Year Reserve Development to Surplus 20 38 24 Two-Year Reserve Development to Surplus 20 41 61 21 29 46 Estimated Current Reserve Deficiency To Surplus 25 46 139 RATIO NAME/DESCRIPTION 1993 - --------------------------------- ---- Change in Writings Two-Year Overall Operating Ratio 106 Change in Surplus Liabilities To Liquid Assets One-Year Reserve Development to Surplus Two-Year Reserve Development to Surplus 29 Estimated Current Reserve Deficiency To Surplus
For 1993, as indicated in the table above, the principal Travelers P&C insurance subsidiaries (Travelers Indemnity and The Phoenix Insurance Company), had two IRIS ratios outside the usual ranges: the two-year overall operating ratio and the liabilities to liquid assets ratio. The two-year overall operating ratio results were adversely impacted by the magnitude of losses from Hurricane Andrew in 1992. As a result of these two principal insurance subsidiaries owning several other insurers, the liabilities to liquid assets ratio was outside the usual range because all liabilities are included while investments in affiliates are excluded in the calculation of this ratio. For 1994, the ratio of liabilities to liquid assets was outside the usual range for the same reason as in 1993. For 1995, the principal Travelers P&C insurance subsidiaries had no ratios outside the usual range. No regulatory action has been taken by any state insurance department or the NAIC with respect to IRIS ratios of any Travelers P&C insurance subsidiary for the three years ended December 31, 1995. For 1993 and 1994, as indicated in the table above, the principal Aetna P&C insurance subsidiaries (Aetna Casualty, Standard Fire and Aetna C&S of America) had IRIS ratios outside the usual ranges for the two-year overall ratio and the two-year reserve development to surplus ratio (except Standard Fire, which was only outside the range for the two-year overall ratio), primarily due to reserve additions for environmental and asbestos losses and workers' compensation claims. The change in surplus ratio was also outside the usual range for Aetna Casualty and Standard Fire for 1993 and Aetna C&S of America for 1994 as a result of the previously described reserve additions and the redeployment of capital, respectively. The liabilities to liquid assets ratio was outside the usual range for Aetna Casualty for 1993 because all liabilities are included while investments in affiliates are excluded in the calculation of this ratio. For 1995, the two-year overall operating ratio was outside the usual range for Aetna Casualty and Standard Fire because of actions taken during 1995 to further strengthen environmental and asbestos-related claims. The 90 change in writings ratio was outside the usual range for Standard Fire and Aetna C&S of America as a result of management's decision to transfer all of the bond business written by Aetna P&C into Aetna C&S of America. Concurrent with this change, capital was re-allocated among Aetna P&C insurers resulting in an unusual value in the change in surplus ratio for Standard Fire and Aetna C&S of America. The one-year reserve development to surplus and two-year reserve development to surplus ratios were also outside the usual range for Aetna Casualty and Standard Fire as a result of the above mentioned 1995 reserve additions. The estimated current reserve deficiency to surplus ratio was outside the usual range for Aetna Casualty and Aetna C&S of America for 1995. This ratio was distorted when Aetna P&C combined its two intercompany pooling arrangements (commercial lines and personal lines) into one pool. If this ratio were recalculated to have all items reflect the new agreement, the ratio would not produce an unusual value. The Company expects that regulators will be satisfied upon follow-up that in all cases the unusual values were not indicative of a solvency problem. The following table sets forth information regarding the premium to surplus ratios of Travelers P&C and Aetna P&C. SCHEDULE OF PREMIUM TO SURPLUS RATIOS (STATUTORY BASIS)(1)
TRAVELERS P&C AETNA P&C YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31, -------------------------- -------------------------- 1995 1994 1993 1995 1994 1993 ------ ------ ------ ------ ------ ------ (Dollars in millions) Net written premiums...................................... $3,621 $3,582 $3,635 $4,080 $4,399 $4,516 Capital and surplus....................................... 2,438 2,133 2,246 2,793 2,526 2,687 Ratio of net written premiums to capital and surplus...... 1.49x 1.68x 1.62x 1.46x 1.74x 1.68x
- ------------ (1) Including accident and health business. RISK-BASED CAPITAL (RBC) REQUIREMENTS In order to enhance the regulation of insurer solvency, the NAIC has adopted a formula and model law to implement RBC requirements for property and casualty insurance companies, designed to assess minimum capital requirements and to raise the level of protection that statutory surplus provides for policyholder obligations. The RBC formula for property and casualty insurance companies measures four major areas of risk facing property and casualty insurers: (i) underwriting, which encompasses the risk of adverse loss developments and inadequate pricing; (ii) declines in asset values arising from credit risk; (iii) declines in asset values arising from investment risks and (iv) off-balance sheet risk arising from adverse experience from non-controlled assets, guarantees for affiliates, contingent liabilities and reserve and premium growth. Pursuant to the model law, insurers having less statutory surplus than that required by the RBC calculation will be subject to varying degrees of regulatory action, depending on the level of capital inadequacy. The RBC model law provides for four levels of regulatory action. The extent of regulatory intervention and action increases as the level of surplus to RBC falls. The first level, the Company Action Level (as defined by the NAIC), requires an insurer to submit a plan of corrective actions to the regulator if surplus falls below 200% of the RBC amount. The Regulatory Action Level (as defined by the NAIC) requires an insurer to submit a plan containing corrective actions and permits the relevant Insurance Commissioner to perform an examination or other analysis and issue a corrective order if surplus falls below 150% of the RBC amount. The Authorized Control Level (as defined by the NAIC) allows the relevant Insurance Commissioner to rehabilitate or liquidate an insurer in addition to the aforementioned actions if surplus falls below 100% of the RBC amount. The fourth action level is the Mandatory Control Level (as defined by the NAIC) which requires the relevant Insurance Commissioner to rehabilitate or liquidate the insurer if surplus falls below 70% of the RBC amount. Based on the foregoing formula, at December 31, 1995, the RBC ratios of the Company's insurance subsidiaries were in excess of levels that would require regulatory action. FEDERAL REGULATION Although the federal government does not directly regulate the business of insurance, other than flood insurance, federal initiatives often have an impact on the insurance industry. Legislation has been introduced in Congress during the past several sessions that, if enacted, would result in substantially greater federal regulation of the insurance business. Current and proposed federal measures that may significantly affect the property and 91 casualty industry may include possible changes to CERCLA and the tax laws governing property and casualty insurance companies, proposed limits to product liability lawsuits and other tort reform proposals. It is not possible to predict whether such proposed legislation will be enacted, what form such legislation might take when enacted, or the potential effects of such legislation on the Company and its competitors. See "Risk Factors--Regulation." LEGAL PROCEEDINGS In the ordinary course of business, the Company receives claims asserting alleged injuries and damages from asbestos and other hazardous waste and toxic substances. In relation to these claims, the Company carries on a continuing review of its overall position, its reserving techniques and reinsurance recoverables. However, the property and casualty insurance industry does not have a standard method of calculating claims activity for environmental and asbestos losses. In each of these areas of exposure, the Company has endeavored to litigate individual cases and settle claims on favorable terms. Given the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties, it is not possible to quantify the ultimate exposure or range of exposure represented by these claims to the Company's financial condition, results of operations or liquidity. The Company believes that it is reasonably possible that the outcome of uncertainties regarding environmental and asbestos claims could result in a liability exceeding the reserves by an amount that would be material to operating results in a future period. However, the Company does not believe that it is likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. In The Travelers Insurance Company, et al., v. Richard John Ratcliffe Keeling, filed in New York Supreme Court in June 1991, Travelers P&C and certain of its affiliates seek to enforce reinsurance contracts against certain underwriters at Lloyd's and certain London companies with respect to recoveries for certain asbestos claims. In January 1994, the court stayed litigation of this matter in favor of arbitration. The issues before the arbitration panel include the underwriters' breach of contract and anticipated breach of their agreement with the plaintiffs on asbestos-related reinsurance claims. The Travelers P&C/Lloyd's dispute related to asbestos recoveries involves approximately $100 million of current ceded receivables and approximately $60 million collected by Travelers P&C as of December 31, 1995, plus future potential recoverables. The dispute will be determined by an arbitration panel at an arbitration commencing in May 1996, based on the panel's interpretation of the reinsurance arrangement between Travelers P&C and Lloyd's. A number of cases have been filed against several insurance companies and industry organizations relating to service fee charges and premium calculations on certain workers' compensation insurance. Certain subsidiaries of the Company are defendants in South Carolina ex rel. Medlock v. National Council on Compensation Insurance ("NCCI"), an action filed by the Attorney General of South Carolina in August 1994 in the Court of Common Pleas, County of Greenville, South Carolina; Four Way Plant Farm v. NCCI, a purported class action filed in September 1994 in the Circuit Court for Bullock County, Alabama; and NC Steel, Inc. v. NCCI, a purported class action filed in November 1993 in the Superior Court Division of the General Court of Justice, Wake County, North Carolina. In these cases, the plaintiffs generally allege that the administration of each state's workers' compensation assigned risk pool conspired with servicing carriers for the pool to collect excessive fees in violation of state antitrust and/or unfair trade practice laws. The plaintiffs seek unspecified compensatory, treble and/or punitive damages and injunctive relief. The Company believes it has meritorious defenses and intends to contest the allegations. In NC Steel, Inc. v. NCCI, the defendants' motion to dismiss was granted in February 1995, and the plaintiffs have appealed to the North Carolina Court of Appeals. In April 1994 certain subsidiaries of TAP were named as additional defendants in a purported class action pending in the 116th District of Dallas County, Texas, entitled Weatherford Roofing Company v. Employers National Insurance Company. The plaintiffs in this case allege that the workers' compensation carriers in Texas have conspired to collect excessive or improper premiums in violation of state insurance laws, antitrust laws and/or state unfair trade practices laws. The plaintiffs seek compensatory, treble and/or punitive damages as well as declaratory and injunctive relief. In a statutory demand letter, plaintiffs' counsel allege classwide compensatory damages, including interest through October 1994, of approximately $572 million. Since that time, court-approved settlements with certain other insurers have been based on single damage, or alleged overcharge, calculations which, if applied to Company-issued policies of class members, would yield single damages of $50 million or less. The Company believes it has meritorious defenses and intends to contest the allegations unless an attractive settlement opportunity arises. 92 The Company is involved in numerous other lawsuits (other than environmental and asbestos claims) arising, for the most part, in the ordinary course of its business operations either as a liability insurer defending third-party claims brought against its insureds or as an insurer defending coverage claims brought against it. Although there can be no assurances, the Company believes, based on information currently available, that the ultimate resolution of these legal proceedings would not be likely to have a material adverse effect on the Company's results of operations, financial condition or liquidity. See "--Environmental and Asbestos Claims" and Note 14 of Notes to the Combined Financial Statements of Aetna P&C and Note 11 of Notes to the Consolidated Financial Statements of TAP. On April 2, 1996, individual and institutional plaintiffs, on their own behalf and also purporting to represent a putative class of similarly situated persons who may lose their employment as a result of the Acquisition, filed an appeal captioned Capital Region Conference of Churches, et al. vs. State of Connecticut Department of Insurance, et al., (Judicial District of Hartford/New Britain at Hartford, Superior Court of the State of Connecticut) (the "Appeal"), from the Memorandum of Decision issued by the Deputy Commissioner of the State of Connecticut Department of Insurance approving the Acquisition. The Appeal alleges various procedural defects in the approval process. However, the Appeal does not seek a specific remedy. TIGI believes the Appeal is without merit and plans to vigorously to oppose it. On April 9, 1996, TIGI, Aetna Casualty and Standard Fire moved for dismissal of the Appeal. PROPERTIES The Company rents from Aetna approximately 373,000 square feet of office space at City Place, located at 185 Asylum Street, Hartford, Connecticut, under an eight-year sublease that expires in 2004, and approximately 225,000 square feet of office space at 575 Pigeon Hill Road, Windsor, Connecticut, under a two-year lease that expires in 1998 and is renewable by the Company for up to two additional three-year terms. The Company also rents from an affiliate of Travelers Group approximately 609,000 square feet of office space at One Tower Square, Hartford, Connecticut. In addition, the Company leases 137 field offices throughout the United States under leases with third parties and subleases with Aetna, and 247 field offices throughout the United States pursuant to intercompany arrangements with Travelers Group and its affiliates. See "Certain Transactions--Relationships with TIGI and Travelers Group." The Company owns an office building with approximately 267,000 square feet of office space in Tampa, Florida, of which it occupies approximately 125,000 square feet. EMPLOYEES As of December 31, 1995, the businesses that comprise the Company had a total of approximately 24,000 employees. The Company believes that its employee relations are satisfactory. None of the Company's employees is subject to collective bargaining agreements. 93 MANAGEMENT EXECUTIVE OFFICERS OF TAP Set forth below are the names, ages and positions of the executive officers of TAP as of the date hereof. Executive officers serve at the pleasure of the Board of Directors.
NAME AGE OFFICE - --------------------------------------- --- ---------------------------------------------------------- Robert I. Lipp......................... 57 Chairman of the Board, President and Chief Executive Officer Jay S. Fishman......................... 43 Vice Chairman and Chief Administrative Officer Charles J. Clarke...................... 60 Chairman and Chief Executive Officer--Commercial Lines Joseph P. Kiernan...................... 55 Chairman and Chief Executive Officer--Fidelity and Surety Robert P. Restrepo, Jr................. 45 Chairman and Chief Executive Officer--Personal Lines Alan M. Silberstein.................... 48 Chairman and Chief Executive Officer--Claims Ronald E. Foley........................ 50 Chairman and Chief Executive Officer--Risk Management William P. Hannon...................... 47 Chief Financial Officer Christine B. Mead...................... 40 Chief Accounting Officer
Set forth below is certain information concerning the executive officers of TAP as of the date hereof. Mr. Lipp has been Chairman of the Board, President and Chief Executive Officer of TAP since January 1996. Mr. Lipp is currently and has been a director and a Vice Chairman of Travelers Group since 1991 and has been Chief Executive Officer of TIGI since December 31, 1993. He also serves as Vice Chairman of Travelers Group. From 1991 to 1993, Mr. Lipp was Chairman and Chief Executive Officer of Travelers Group's Consumer Finance Services group. Prior to joining Travelers Group in 1986, he was a President and a director of Chemical Bank where he held senior executive positions for more than five years prior thereto. Mr. Lipp is a director of The New York City Ballet. Mr. Fishman has been Vice Chairman and Chief Administrative Officer of TAP since January 1996. Mr. Fishman is currently and has been Vice Chairman of TIGI since 1995 and Chief Financial Officer of TIGI since 1993. He also serves as Senior Vice President of Travelers Group. From 1991 to 1993, Mr. Fishman was Senior Vice President and Treasurer of Travelers Group and prior thereto, he served as Executive Vice President and Chief Financial Officer of Travelers Group's Consumer Finance Services group. Mr. Fishman joined Travelers Group in 1989 from Shearson Lehman Brothers Inc., where he was a Senior Vice President of Merchant Banking. Mr. Clarke has been Chairman and Chief Executive Officer--Commercial Lines of TAP since January 1996. Mr. Clarke was Chairman of Commercial Lines of Travelers P&C from 1990 to 1996. Prior thereto, Mr. Clarke was Senior Vice President of the National Accounts and the Reinsurance business units of Travelers P&C. Mr. Clarke served in several positions at Travelers P&C since 1958. Mr. Kiernan has been Chairman and Chief Executive Officer--Fidelity and Surety of TAP since March 1996. Mr. Kiernan was Vice President of Aetna's bond business from 1989 to March 1996 and has worked in the bond business lines at Aetna since 1963. From June 1995 to March 1996, Mr. Kiernan was Vice President of Standard Commercial Accounts of Aetna. Mr. Restrepo has been Chairman and Chief Executive Officer--Personal Lines of TAP since March 1996. Mr. Restrepo was Senior Vice President of the Personal Auto and Homeowners business units of Aetna from 1995 to 1996 and was head of the Homeowners business unit of Aetna from 1993 to 1996. Mr. Restrepo served in a variety of property/casualty business areas of Aetna since 1972. Mr. Silberstein has been Chairman and Chief Executive Officer--Claims of TAP since January 1996. Mr. Silberstein was Executive Vice President of Midlantic Bank since 1992. Prior to joining Midlantic Bank, Mr. Silberstein served as Executive Vice President and Director of Consumer Banking at Chemical Bank from 1990 to 1991. Mr. Foley has been Chairman and Chief Executive Officer--Risk Management of TAP since January 1996. Mr. Foley served as Chairman of Personal Lines of Travelers P&C from 1994 until his present appointment and from 1987 to 1991 and served as Chief Financial Officer of The Travelers Corporation from 1991 through 1993. 94 Mr. Hannon has been Chief Financial Officer of TAP since January 1996. Prior to joining TAP, Mr. Hannon served as Deputy Managing Partner of the Financial Services practice of KPMG Peat Marwick LLP, which he joined in 1969, and also served as a member of the firm's SEC reviewing partner's committee. Ms. Mead has been Chief Accounting Officer of TAP since January 1996. Ms. Mead has been Vice President and Controller of TIGI since May 1995 and has served in several positions with TIGI and its subsidiaries since 1989. DIRECTORS OF TAP Set forth below are the names, ages and terms of the directors of TAP as of the date hereof. Mr. Lipp has been a director of TAP since January 1996. All of the other directors were appointed upon consummation of the Acquisition. TAP's Board of Directors will be classified into three classes of equal size. The term of the initial Class I directors will terminate on the date of the 1997 annual meeting of TAP stockholders; the term of the initial Class II directors will terminate on the date of the 1998 annual meeting of TAP stockholders; and the term of the initial Class III directors will terminate on the date of the 1999 annual meeting of TAP stockholders. At each annual meeting of TAP stockholders, successors to the class of directors whose term expires at that annual meeting will be elected for a three-year term.
NAME AGE (1) TERM EXPIRING - ------------------------------------------------------ ------- ------------- Robert I. Lipp........................................ 57 1999 Kenneth J. Bialkin.................................... 66 1997 John J. Byrne......................................... 63 1998 James Dimon........................................... 39 1998 Dudley C. Mecum....................................... 61 1999 Roberto G. Mendoza.................................... 50 1998 Frank J. Tasco........................................ 68 1997 Sanford I. Weill...................................... 62 1999 Arthur Zankel......................................... 64 1997
-------------------------------- (1) All ages are as of March 1, 1996. Set forth below is certain information concerning the directors of TAP. Biographical information concerning Mr. Lipp is set forth above under "--Executive Officers of TAP." Mr. Bialkin has been a partner in the law firm of Skadden, Arps, Slate, Meagher & Flom for more than five years. Skadden, Arps, Slate, Meagher & Flom performs legal services for Travelers Group and its subsidiaries, including TAP, from time to time, and is acting as counsel to each of Travelers Group and TAP in connection with the Equity Offerings. Mr. Bialkin is also a director of Travelers Group, The Municipal Assistance Corporation for the City of New York, Oshap Technologies, Ltd., Tecnomatix Technologies Ltd. and Sapiens International Corporation N.V. Mr. Byrne has been Chairman of Fund American since 1985. Mr. Byrne has also served as President and Chief Executive Officer of Fund American since 1990, was Chief Executive Officer of Fund American from 1985 to 1990 and was Chief Executive Officer of Fireman's Fund Insurance Company from 1989 through January 2, 1991. Prior to that, he was Chief Executive Officer of GEICO Corporation from 1976 to 1985. Mr. Byrne is also a director of Financial Security Assurance Holdings Ltd., White Mountains Insurance Holdings, Terra Nova (Bermuda) Holdings Ltd., Trident, Southern Heritage Insurance Company and Merastar Insurance Company. Mr. Byrne is an advisory director of Mid-America Apartment Communities, Inc. and Potomac Electric Power Company. Mr. Dimon is President and Chief Operating Officer and a director of Travelers Group. He is also Chairman of the Board and Chief Executive Officer of Smith Barney. From May 1988 to June 1995 Mr. Dimon was Chief Financial Officer of Travelers Group and from May 1988 to September 1991 he was Executive Vice President of Travelers Group. Mr. Dimon was Chief Operating Officer of Smith Barney until January 1996 and was Senior Executive Vice President and Chief Administrative Officer of Smith Barney from 1990 to 1991. He is also a director, Chief Executive Officer and Chairman of the Board of Smith Barney Holdings Inc., the immediate parent 95 company of Smith Barney. From March 1994 to January 1996 he was Chief Operating Officer of the predecessor of Travelers Group. From 1982 to 1985, he was a Vice President of American Express Company and Assistant to the President, Sanford I. Weill. Mr. Dimon is a trustee of New York University Medical Center and Chairman of the Board of the New York Academy of Finance. Mr. Mecum has been a Partner in the firm of G.L Ohrstrom & Co., a merchant banking firm, since August 1989. He was President of Environmental and Engineering Services and was a senior executive and director of Combustion Engineering, Inc. from 1985 to December 1987. Mr. Mecum was Managing Partner of the New York office of Peat Marwick Mitchell & Co. (now KPMG Peat Marwick LLP) from 1979 to 1985. Mr. Mecum is a director of Travelers Group, Fingerhut Companies, Inc., Dyncorp, Vicorp Restaurants, Inc., Lyondell Petrochemical Corp. and Roper Industries, Inc. Mr. Mecum is also Chairman, President and Chief Executive Officer and a director of Hanow Industries Inc. Mr. Mendoza has been Vice Chairman and a director of J.P. Morgan & Co. Incorporated and a member of the firm's senior policy and planning group since January 1, 1990. Mr. Mendoza has held various positions at J.P. Morgan & Co. Incorporated since 1967. Mr. Mendoza is also a director of ACE Limited and Mid Ocean Reinsurance Company Ltd. Mr. Mendoza has been appointed as a director of TAP by Trident, one of the Private Investors, pursuant to the Shareholders Agreement. See "Certain Transactions--Private Investors." Mr. Tasco is the retired Chairman of the Board and Chief Executive Officer of Marsh & McLennan Companies, Inc. and is currently a director of that company. He is also a director of Travelers Group, New York Telephone Company and New England Telephone Company. Mr. Weill has been Chairman of the Board and Chief Executive Officer and a director of Travelers Group and its predecessor since 1986; he was also its President from 1986 to 1991. He was President of American Express Company from 1983 to 1985; Chairman of the Board and Chief Executive Officer of American Express Insurance Services, Inc. from 1984 to 1985; Chairman of the Board and Chief Executive Officer, or a principal executive officer, of Shearson Lehman Brothers Inc. from 1965 to 1984; Chairman of the Board of Shearson Lehman Brothers Holdings Inc. from 1984 to 1985; and a founding partner of Shearson's predecessor partnership from 1960 to 1965. Mr. Weill is Chairman of the Board of Trustees of Carnegie Hall, and a director of the Baltimore Symphony Orchestra. Mr. Weill is a member of the Board of Governors of New York Hospital and is Chairman of the Board of Overseers of Cornell University Medical Center and a member of the Joint Board of New York Hospital-Cornell University Medical College. He is on the Board of Overseers of Memorial Sloan-Kettering Cancer Center. He is a member of Cornell University's Johnson Graduate School of Management Advisory Board and a Board of Trustees Fellow. Mr. Weill is Chairman of the National Academy Foundation. He served as Chairman of the Joint Mayoral/City Council Commission on Early Child and Child Care Programs during the Dinkins Administration. Mr. Zankel has been Co-Managing Partner of First Manhattan Co., a research and investment management company, since 1980. He is also a director of Travelers Group, Vicorp Restaurants, Inc. and Fund American and a trustee of Skidmore College, Carnegie Hall and New York Foundation. COMMITTEES OF THE BOARD OF DIRECTORS The Board of Directors intends to establish three standing committees, an executive committee (the "Executive Committee"), an audit committee (the "Audit Committee") and a nominations and compensation committee (the "Compensation Committee"). At least two independent directors will serve on each of TAP's Audit Committee and Compensation Committee. The Executive Committee will be empowered to exercise the authority of the Board of Directors in the management of the business and affairs of TAP between meetings of the Board of Directors. The Audit Committee will review the scope and approach of the annual audit, the annual financial statements of TAP and the auditors' report thereon and the auditors' comments relative to the adequacy of TAP's system of internal controls and accounting systems. The Audit Committee will also recommend to the Board of Directors the appointment of independent public accountants for the following year. The Compensation Committee will review management compensation levels and provide recommendations to the Board of Directors regarding salaries and other compensation for TAP's officers, including bonuses and incentive programs. From time to time the Compensation Committee will act as a nominating committee in 96 recommending candidates to the Board of Directors as nominees for election at the annual meeting of stockholders or to fill such Board vacancies as may occur during the year. COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS Compensation of Directors. Pursuant to the By-Laws of TAP, the members of the Board of Directors may be compensated in a manner and at a rate determined from time to time by the Board of Directors. A director may elect to defer receipt of compensation, in which case the annual fee will be paid entirely in shares of Class A Common Stock. In the case of directors electing current receipt of compensation, only the portion approximately equal to the tax liability incurred by the director in respect of such compensation will be paid in cash, and the balance in Class A Common Stock. Each member of the Board of Directors of TAP will receive an annual fee of $50,000; however, directors who are employees of TAP or its affiliates will not receive any compensation for their services as directors. Executive Compensation. The following table sets forth the compensation paid to the Chief Executive Officer and each of the persons who were the four most highly compensated executive officers of Travelers P&C for services rendered in 1995 (all five individuals being collectively called the "Named Officers"). Travelers P&C participates in employee benefit plans of Travelers Group and as such, the restricted stock award and option grant information included in the table below relates to common stock and options of Travelers Group, not TAP. SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION LONG TERM COMPENSATION -------------------------------------- -------------------------------- TRAVELERS GROUP SECURITIES OTHER RESTRICTED UNDERLYING NAME AND ANNUAL STOCK TRAVELERS GROUP ALL OTHER PRINCIPAL POSITION YEAR SALARY(1) BONUS(1) COMPENSATION(2) AWARDS(3) OPTIONS COMPENSATION(4) - ------------------------------ ---- --------- ---------- --------------- --------------- --------------- --------------- Robert I. Lipp................ 1995 $ 600,000 $2,160,000 $ 5,333 $ 1,119,987 245,143 1,962 Chairman of the Board, President and Chief Executive Officer Jay S. Fishman................ 1995 300,000 660,000 106,283 319,955 97,123 1,211 Vice Chairman and Chief Administrative Officer Charles J. Clarke............. 1995 297,250 381,250 -- 224,970 35,541 25,547 Chairman and Chief Executive Officer--Commercial Lines Ronald E. Foley............... 1995 350,000 253,750 -- 161,666 33,232 5,034 Chairman and Chief Executive Officer--Risk Management Robert B. Green............... 1995 482,500 500,000 -- -- 11,041 30,472 Senior Vice President--Special Liability Group
- ------------ (1) For Mr. Lipp, it is estimated that 75% of such amounts reflect compensation for services provided to Travelers P&C and 25% of such amounts reflect compensation for services rendered to Travelers Group and its affiliates (other than TAP and its subsidiaries). For Mr. Fishman, it is estimated that 50% of such amounts reflect compensation for services provided to Travelers P&C and 50% of such amounts reflect compensation for services rendered to Travelers Group and its affiliates (other than TAP and its subsidiaries). (2) Represents for Mr. Lipp an amount reimbursed for payment of taxes; for Mr. Fishman, payment for Hartford housing expenses in the amount of $26,093, $29,952 for transportation paid for or provided by the Company and an amount reimbursed for payment of taxes. (3) Restricted stock awards were made under the Travelers Group Capital Accumulation Plan ("TRV CAP Plan"). The TRV CAP Plan provides for payment, mandatory as to senior executives and certain others within Travelers Group and its subsidiaries, of a portion of compensation in the form of awards of restricted stock at a discount (currently 25%) from market value. All of the awards listed in the table vest on the third anniversary of the date of grant if the executive continues employment with Travelers Group and its subsidiaries during the vesting period. From the date of grant, the recipient receives dividends or dividend equivalents on the shares of restricted stock at the same rate as dividends are paid on all outstanding shares of Travelers Group common stock. As of December 31, 1995, and including the grants made in January 1996 in respect of 1995, the total holdings of restricted stock under the TRV CAP Plan and the market value at such date of such shares for each of the persons in the Summary Compensation Table were as follows: Mr. Lipp: 43,083 shares ($2,698,073); Mr. Fishman: 11,965 shares ($749,308); Mr. Clarke: 9,159 shares ($573,582); Mr. Foley: 5,309 shares ($332,476). The year-end market price was $62.625 per share. (4) Includes the matching grant for 1995 pursuant to the Travelers Group 401(k) Savings Plan (the "TRV Savings Plan") in the form of Travelers Group common stock having a market value of $1,000 at December 31, 1995 for each of Messrs. Lipp and Fishman, and in the form of Travelers Group $4.53 ESOP Convertible Preferred Stock, Series C, having a market value of $ 3,750 at December 31, 1995 for each of Messrs. Clarke and Green, and a market value of $ 2,250 at December 31, 1995 for Mr. Foley. Also includes supplemental life insurance paid by TAP and a matching contribution for 1995 to the TESIP Restoration Plan of $11,524 and $21,250 for Messrs. Clarke and Green, respectively. 97 Mr. Green has announced that he will retire from his present position during 1996. Upon Mr. Green's retirement, he will receive the benefits described under "--Retirement Plans." Messrs. Lipp and Fishman, who are full time officers of the Company, will continue to hold certain offices at Travelers Group and its affiliates for which they may receive compensation. Grants of Stock Options. The following table sets forth information concerning the award of stock options to the Named Officers for services rendered to Travelers P&C during fiscal 1995. All of such options permit the Named Officers to purchase shares of Travelers Group common stock and were granted under the Travelers Group Stock Option Plan (the "TRV Option Plan"). Except as specifically provided below, all options were granted under the reload feature of the TRV Option Plan, which permits the grant of a new "reload" option upon exercise of stock options if certain conditions are met. The reload feature is described in note (2) to the table below. TRV OPTION GRANTS IN LAST FISCAL YEAR
INDIVIDUAL GRANTS(2) ------------------------------------------------------- NUMBER OF % OF TOTAL SECURITIES TRV OPTIONS GRANT UNDERLYING GRANTED TO DATE TRV OPTIONS EMPLOYEES EXERCISE OR PRESENT GRANTED(1) IN FISCAL BASE PRICE EXPIRATION VALUE NAME (#) YEAR(3) ($/SH) DATE ($)(4) - ---------------------------------------------- ----------- ----------- ----------- ---------- ----------- Robert I. Lipp................................ 11,382 $38.625 2/22/03 $ 36,365 30,306 $42.125 2/22/03 $ 105,238 10,820 $42.125 5/2/03 $ 37,572 30,686 $42.125 11/2/02 $ 106,557 31,228 $53.125 11/2/02 $ 135,842 7,941 $54.625 11/26/04 $ 36,151 19,145 $54.625 2/22/03 $ 87,158 26,650 $54.625 11/2/02 $ 121,324 26,985 $54.625 5/2/03 $ 122,849 50,000 $54.000 12/14/05 $ 589,500 Jay S. Fishman................................ 4,924 $38.000 6/1/99 $ 24,891 2,761 $38.000 4/27/01 $ 13,957 1,600 $38.000 5/22/02 $ 8,088 2,400 $38.000 4/25/02 $ 12,132 1,137 $42.125 5/22/02 $ 6,234 1,731 $42.125 4/25/02 $ 9,490 2,647 $42.125 4/27/01 $ 14,512 14,679 $47.750 6/1/99 $ 81,799 1,000 $47.750 5/22/02 $ 5,573 1,530 $47.750 4/25/02 $ 8,526 4,427 $47.750 4/27/01 $ 24,669 3,639 $47.750 2/26/04 $ 20,278 4,130 $54.625 6/1/99 $ 26,855 2,341 $54.625 5/22/02 $ 15,222 3,534 $54.625 4/25/02 $ 22,980 4,643 $54.625 4/27/01 $ 30,191 40,000 $54.000 12/14/05 $ 350,400 Charles J. Clarke............................. 2,990 $38.875 1/10/01 $ 9,732 4,518 $38.875 2/13/02 $ 14,706 3,642 $39.750 1/7/03 $ 11,745 4,398 $41.626 2/13/02 $ 13,392 7,595 $55.375 2/13/02 $ 31,671 2,869 $55.375 1/10/01 $ 11,964 3,374 $55.375 2/26/04 $ 14,070 6,155 $55.375 1/7/03 $ 25,666 Ronald E. Foley............................... 1,930 $37.000 1/10/01 $ 8,963 8,725 $37.000 2/13/02 $ 31,231 4,683 $38.750 2/13/02 $ 22,001 2,175 $47.750 2/13/02 $ 11,177 17,719 $47.750 1/7/03 $ 91,058 Robert B. Green............................... 3,828 $38.750 2/13/02 $ 14,263 7,213 $39.750 1/7/03 $ 25,447
98 - ------------ (1) All grants except the grants of 50,000 and 40,000 shares to Messrs. Lipp and Fishman, respectively, arose under the "reload" feature of the TRV Option Plan. (2) Options (other than reload options) vest in cumulative installments of 20% on each anniversary of the date of grant such that the options are fully exercisable on and after five years from the date of grant until ten years and one month following such grant. Participants are entitled to direct Travelers Group to withhold shares otherwise issuable upon an option exercise to cover in whole or in part the tax liability associated with such exercise. Participants may also cover such liability by surrendering previously owned shares (other than restricted stock). Participants may tender previously owned shares (including TRV CAP Plan restricted stock) to pay the exercise price of an option. Under the reload feature of the TRV Option Plan, participants who tender previously owned shares (including TRV CAP Plan restricted stock) to pay all or a portion of the exercise price of vested stock options or tender previously owned shares or have shares withheld to cover the associated tax liability may be eligible in the discretion of the committee administering the plan to receive a reload option covering the same number of shares as are tendered or withheld for such purposes. Such optionee may choose to receive either (i) unrestricted shares and no reload option, or (ii) shares subject to a period of restriction on the ability to sell or otherwise transfer such shares (except in certain circumstances) and a reload option to be granted in accordance with the applicable terms of the TRV Option Plan. The initial committee determination has set the restricted period at two years. Further, in order for an optionee to receive a reload option in connection with his or her exercise of a vested option, the market price of Travelers Group common stock on the date of exercise must equal or exceed the minimum market price level established by the committee from time to time (the "Market Price Requirement"). The committee administering the TRV Option Plan has established an initial Market Price Requirement equal to or greater than 120% of the exercise price of the option being exercised. The market value on the date of grant of a reload option establishes the exercise price of such option, and such option has a term equal to the remaining term of the original option, and will be exercisable six months after its date of grant. (3) For each of the Named Officers, the total TRV options granted in fiscal 1995 aggregated less than .5% of all options granted to Travelers Group employees in fiscal 1995. (4) The "Grant Date Present Value" numbers set forth in the table were derived by application of a variation of the Black-Scholes option pricing model. The following assumptions were used in employing such model: . stock price volatility was calculated by using the closing price of the Travelers Group common stock on the NYSE Composite Transactions Tape for the one-year period prior to the grant date of each option; . the risk-free interest rate for each option grant was the interpolated market yield on a Treasury bill with a term identical to the subject option, as reported by the Federal Reserve; . the dividend yield on the date of the option grant (based upon the actual dividend rate of 80 cents per share during 1995) was assumed to be constant over the life of the option; . exercise of the option was deemed to occur approximately one year after the date of grant with respect to options that vest six months after the date of grant and approximately four years after the date of grant with respect to options that vest at a rate of 20% per year, as appropriate, based upon each individual's historical experience of the average period between the grant date and exercise date for those options that have vested; . for Messrs. Foley and Green, a discount of 10% was applied to the option value derived from the model to reflect the nontransferability of the stock during the two-year period following the exercise date. . for Messrs. Lipp, Fishman and Clarke, a discount of 25% was applied to the option value derived from the model to reflect reduction in value (as measured by the estimated cost of protection) of the options due to their agreement, as members of the Travelers Group Planning Group, not to sell any Travelers Group common stock acquired through option exercises for as long as they are members of the Planning Group. For purposes of calculating the discount, a five-year holding period was assumed even though each of the individuals may be a member of the Planning Group for more than five years. The potential value of options granted depends entirely upon a long-term increase in the market price of the Travelers Group common stock; if the stock price does not increase, the options would be worthless and if the stock price does increase, this increase would benefit both option holders and all stockholders of Travelers Group commensurately. 99 Stock Options Exercised. The following table sets forth information concerning the exercise of stock options with respect to Travelers Group common stock during fiscal 1995 by each of the Named Officers and the fiscal year-end value of unexercised options. The "Value Realized" column reflects the difference between the market price on the date of exercise and the market price on the date of grant (which establishes the exercise price for the option) for all options exercised, even though the executive may have actually received fewer shares as a result of the surrender of previously owned shares to pay the exercise price or the tax liability, or the withholding of shares to cover the tax liability associated with option exercise. Accordingly, the "Value Realized" numbers do not necessarily reflect what the executive might receive, should he choose to sell the shares acquired by the option exercise, since the market price of the shares so acquired may at any time be higher or lower than the price on the exercise date of the option. AGGREGATED TRV OPTION EXERCISES IN LAST FISCAL YEAR, AND FISCAL YEAR-END OPTION VALUE
VALUE OF UNEXERCISED IN-THE-MONEY NUMBER OF SECURITIES TRV OPTIONS SHARES UNDERLYING UNEXERCISED AT FY-END UNDERLYING TRV OPTIONS AT FY-END (#) ($) EXERCISED VALUE ---------------------------- ----------- NAME TRV OPTIONS (#)(1) REALIZED ($)(2) EXERCISABLE UNEXERCISABLE EXERCISABLE - -------------------------- ------------------------------ --------------- ----------- ------------- ----------- Robert I. Lipp............ 229,291 $ 3,487,929 29,851 377,461 436,571 Jay S. Fishman............ 69,193 1,090,190 0 107,923 0 Charles J. Clarke......... 41,863 556,620 29,072 49,395 322,968 Ronald E. Foley........... 40,083 545,507 46,696 57,458 989,737 Robert B. Green........... 33,372 440,698 18,220 8,043 241,445 NAME UNEXERCISABLE - -------------------------- ------------- Robert I. Lipp............ 8,912,804 Jay S. Fishman............ 1,739,450 Charles J. Clarke......... 938,135 Ronald E. Foley........... 1,438,272 Robert B. Green........... 238,670
- ------------ (1) This column reflects the number of shares of Travelers Group common stock underlying options exercised in 1995 by the Named Officers. The actual number of shares received by each of these individuals from options exercised in 1995 (net of shares surrendered or withheld to cover the exercise price and tax liabilities) was: Mr. Lipp, 34,148 shares; Mr. Fishman, 12,069 shares; Mr. Clarke, 6,322 shares; Mr. Foley, 6,851 shares; and Mr. Green, 1,610 shares. (2) The "Value Realized" is in each case calculated as the difference between the market price on the date of exercise and the exercise price for option exercise. RETIREMENT PLANS. Benefits under the Travelers Group Pension Plan (the "TRV Retirement Plan") vest after five years of service with Travelers Group or its subsidiaries. The normal form of retirement benefit is, in the case of a married participant, a joint and survivor annuity payable over the life of the participant and his or her spouse, or in the case of an unmarried participant, an annuity payable over the participant's life. Instead of such normal form of payment, participants may elect to receive other types of annuities or a single sum payable at retirement or other termination of service. Messrs. Lipp and Fishman accrue benefits in accordance with the formula described below. Benefits accrue for the first five years of covered service at an annual rate varying between .75% and 4.0% of the participant's qualifying compensation, depending upon the participant's age at the time of accrual. "Qualifying compensation" generally includes base salary (before pre-tax contributions to the Travelers Group 401(k) Savings Plan or other benefit plans), overtime pay, commissions and bonuses. Under rules promulgated by the Internal Revenue Service (the "IRS"), a ceiling of $150,000 for 1995 (subject to annual adjustment) is imposed on the amount of compensation that may be considered "qualifying compensation" under the TRV Retirement Plan. During the period of the sixth through the fifteenth year of covered service, benefits accrue at an annual rate of between 1.25% and 5.0% of the participant's qualifying compensation, depending upon the participant's age at the time of accrual. After a participant has completed 15 years of covered service, benefits accrue at an annual rate varying between 1.25% and 7.0% of the participant's qualifying compensation, depending upon the participant's age at the time of accrual. There are also minimum benefits provided for under the TRV Retirement Plan. Subject to the statutory maximum benefits payable by a qualified plan (as described below), a participant also accrues annually an additional amount calculated as 1.0% to 2.5% of qualifying compensation (again depending upon his or her age) for that part of qualifying compensation in excess of the amount of the Social Security wage base. There is an interest accrual added to the participant's single sum entitlement. This interest amount is determined by multiplying the prior year's single sum by a percentage determined annually by Travelers Group. 100 The statutory maximum retirement benefit that may be paid to any one individual by a tax qualified defined benefit pension plan in 1995 is $120,000 annually. Years of service credited under the TRV Retirement Plan through December 31, 1995 for Messrs. Lipp and Fishman were 9 years and 6 years, respectively. The Company and certain Company subsidiaries provide certain pension benefits, in addition to the statutory maximum benefit payable under tax qualified pension plans, under non-funded, non-qualified retirement benefit equalization plans ("RBEPs"). The benefits payable under RBEPs are unfunded, and will come from the general assets of each plan's sponsor. The compensation covered by such plans is limited to a fixed amount of $300,000 (equal to twice the 1995 statutory maximum qualifying compensation without giving effect to any future adjustments) less amounts covered by the TRV Retirement Plan. No benefits were accrued in 1995 under any of the RBEPs for the account of the Named Officers. Benefits payable under the Travelers Group Supplemental Retirement Plan ("TRVSERP") covering supplemental retirement benefits to designated senior executives of Travelers Group and its subsidiaries are frozen. Messrs. Lipp and Fishman are SERP participants. The maximum benefit payable under the TRVSERP is also reduced by any benefits payable under the TRV Retirement Plan (or its predecessor plans, if applicable), under any applicable RBEP, under any other Travelers Group or subsidiary-sponsored qualified or non-qualified defined benefit or defined contribution pension plan (other than the Travelers Group 401(k) Savings Plan or other 401(k) plans), and under the Social Security benefit program. No benefits were accrued in 1995 under the TRVSERP for the account of any of the Named Officers. Estimated annual benefits under the benefit plans of Travelers Group for the Named Officers using the applicable formulas under the TRV Retirement Plan and the frozen RBEP and TRVSERP plans and assuming their retirement at age 65, would be as follows: Mr. Lipp, $288,986; and Mr. Fishman, $73,362. These estimates were calculated assuming that the interest accrual was 8% for 1989 through 1991, 6% for 1992 through 1993, 5.5% for 1994, 7% for 1995 and 5.5% thereafter until the participant retires at the age of 65, and that the current salary of the participant, the 1995 dollar ceiling on qualifying compensation (which was set by legislation adopted in 1993 at $150,000 annually), the 1995 Social Security wage base and the current regulatory formula to convert lump-sum payments to annual annuity figures each remains unchanged. Messrs. Clarke, Foley and Green accrue benefits in accordance with the formula described below. Under the retirement plan in effect through 1989 (the "old Travelers Retirement Plan"), retirement benefits were computed on an actuarial basis providing fixed benefits after a specified number of years of service. Generally, the plan provided vested benefits after five years of service equal to 2% of final average salary over a five-year period for each year of service up to 25 years plus two-thirds of 1% for each year of service over 25 years (up to a maximum of 15 additional years), less a portion of the primary Social Security amount, plus adjustments for cost-of-living increases of up to 3% each year. The following table sets forth estimated annual benefits payable under the plan in effect through 1989 to participating employees in the specified remuneration and years-of-service classifications, on a straight life annuity basis and before deduction for Social Security benefits.
YEARS OF CONTINUOUS SERVICE TO NORMAL RETIREMENT DATE(2)(3) FINAL AVERAGE ----------------------------------------------- SALARY(1) 10 20 30 40 - ------------- -------- -------- -------- -------- $ 700,000 $140,000 $280,000 $373,310 $420,000 800,000 160,000 320,000 426,640 480,000 900,000 180,000 360,000 479,970 540,000 1,000,000 200,000 400,000 533,300 600,000 1,100,000 220,000 440,000 586,000 660,000
- ------------ (1) "Final Average Salary" is the average of an employee's salary paid in any consecutive five-year period during the employee's last ten years of active employment which produces the highest average salary. (2) Assumes retirement at age 65, normal retirement date, although there is no reduction in benefits for an employee who retires at age 62 or thereafter. On January 1, 1996, the following individuals had the number of years of credited service indicated: Mr. Clarke--38 years, Mr. Green--30 years, Mr. Foley--24 years. (3) As a result of limitations under the Internal Revenue Code of 1986, as amended, a portion of these amounts may be paid under a supplemental benefit plan outside the qualified benefit plan. Employees who were participants in the old Travelers Retirement Plan on December 31, 1989 are entitled to a minimum benefit as calculated under that plan, without adjustment for cost-of-living increases. It is anticipated that Messrs. Clarke, Foley and Green will receive a minimum benefit computed under the prior plan and, 101 accordingly, the above table reflects the minimum benefits they are expected to receive. In addition, such employees, the sum of whose age and years of service on such date exceeded 55 will have such minimum benefit increased by an amount equal to the excess of their age and years of service on such date over 55, up to a maximum of 25, times 0.3% of their three-year final average salary, determined as described below. The excess of the age and years of service over 55 utilized in calculating such increased benefit for the following individuals is as indicated: Mr. Clarke--25 years, Mr. Green--20 years, Mr. Foley--13 years. Effective beginning in 1990, the old Travelers Retirement Plan was amended to provide vested benefits after five years of service equal to 1.3% of final average salary up to Covered Pay as determined by the federal government ($25,920 in 1995) and 1.6% of final average salary above Covered Pay for each year of service up to 30 years, without any reduction for Social Security benefits or adjustments for cost-of-living increases. The following table sets forth estimated annual benefits payable under the old Travelers Retirement Plan effective beginning in 1990 to participating employees in the specified remuneration and years-of-service classifications, on a straight life annuity basis.
YEARS OF CONTINUOUS SERVICE TO NORMAL RETIREMENT DATE(2)(3) FINAL AVERAGE ------------------------------------------------------------ SALARY(1) 10 15 20 25 30 - ------------- -------- -------- -------- -------- -------- $ 700,000 $112,000 $168,000 $224,000 $280,000 $336,000 800,000 128,000 192,000 256,000 320,000 384,000 900,000 144,000 216,000 288,000 360,000 432,000 1,000,000 160,000 240,000 320,000 400,000 480,000 1,100,000 176,000 264,000 352,000 440,000 528,000
- ------------ (1) "Final Average Salary" is the average of an employee's salary paid in any consecutive three-year period during the employee's last ten years of active employment which produces the highest average salary. (2) Assumes retirement at age 65, normal retirement date, although there is no reduction in benefits for an employee who retires at age 62 or thereafter. (3) As a result of limitations under the Internal Revenue Code, a portion of these amounts may be paid under a supplemental benefit plan outside the qualified benefit plan. Effective beginning on April 1, 1993, the old Travelers Retirement Plan was amended adopting a "cash balance benefit" method of benefit accrual. As of that date, each participant's accrued benefit was converted to an actuarially equivalent lump sum which became the opening balance of a hypothetical cash balance account. Future annual benefit accruals consisted of benefit credits and interest credits which were allocated to the cash balance account as described below. Basic benefit accruals were determined by applying a basic benefit accrual rate to the participant's salary (including management incentive plan earned awards paid during the year.) Additional benefit accruals were determined by applying an additional benefit accrual rate to the participant's salary (including management incentive plan earned awards paid during the year) in excess of the Social Security wage base. Basic benefit accrual rates varied by age and ranged from 3.0% for participants under age 25 to 12.0% for participants age 55 and over. Additional benefit accruals varied by age and ranged from .6% for participants under age 25 to 2.4% for participants age 55 and over. Interest credits were allocated to cash balance accounts at an annual rate of 6%. At retirement, the cash balance account is converted to a monthly annuity benefit amount. The estimated annual benefits payable upon retirement at normal retirement age under the "cash balance benefit" method of accrual for the following individuals is as indicated: Mr. Clarke--$319,308; Mr. Green-- $311,208; and Mr. Foley--$250,668. When they retire, their accrued benefits under two final average earnings formulas will be compared with the sum of their accrued benefit under the "cash balance benefit" method. Their actual pension benefit will be based on the highest benefit amount produced from these formulas/methods. For Mr. Green, the age and years of credited service stated above reflect provisions of agreements he has entered into with Travelers P&C. In addition to retirement benefits under the old Travelers Retirement Plan, the Company pays a retirement allowance of up to 13 weeks of base salary, based upon age at retirement, to employees who attained age 50 on or before December 31, 1989. This additional benefit is available to Mr. Clarke. 102 EMPLOYMENT AGREEMENTS The employment agreements described below are with certain executive officers of TAP, some of whom may be among the Named Officers for 1996. On December 31, 1993, TIGI entered into an employment agreement with Mr. Foley providing that Mr. Foley will be employed as a senior executive. The term of the agreement expires on December 31, 1996. The agreement provides for an annual base salary of not less than Mr. Foley's base salary in effect on the date of the agreement and provides that Mr. Foley is eligible to receive a discretionary bonus. If Mr. Foley's employment is terminated by the employer other than for cause or by Mr. Foley by reason of material breach by the employer of the employment agreement he will continue to receive his then current base salary for the remainder of the term, continue to participate in employee medical plans for a period of one year, and receive certain outplacement, tax and financial planning services. On January 4, 1996, Travelers Insurance Companies entered into a letter agreement with Mr. Alan Silberstein offering Mr. Silberstein employment as a Chairman and Chief Executive Officer--Claims. The agreement provides that Mr. Silberstein will receive a base salary of $375,000 per year, with guaranteed total compensation (including bonus) of not less than $700,000 for 1996. The agreement also provides for Mr. Silberstein to participate in the management bonus program and Capital Accumulation Plan, a one-time grant of a stock option for 60,000 shares of Travelers Group common stock; reimbursement for certain housing expenses; and participation in employee welfare benefit and pension plans. If Mr. Silberstein's employment is terminated other than for cause he will be entitled to receive a separation payment equal to (i) the difference between the amount earned and $700,000 if such termination occurs during the first year of employment and (ii) 50% of his annual base salary if such termination occurs in the second year of employment. On December 12, 1995, Travelers Insurance Companies entered into a letter agreement with Mr. William Hannon offering Mr. Hannon employment as Chief Financial Officer of TAP. The agreement provides that Mr. Hannon will receive a base salary of $400,000 per year, with a minimum bonus of $300,000 with respect to 1996. The agreement also provides for Mr. Hannon to participate in a bonus plan with a bonus opportunity of not less than his base salary; participation in the Capital Accumulation Plan; a one-time grant of a stock option for 40,000 shares of Travelers Group common stock which vests at 20% per year commencing on the first anniversary of the date of grant; reimbursement for certain housing expenses; and participation in employee welfare benefit and pension plans. Mr. Hannon's employment is at will and may be terminated at any time. Mr. Robert P. Restrepo and Mr. Joseph P. Kiernan (each, an "Executive") have employment agreements expiring on April 28, 1997 with Aetna, which agreements were assumed by the Company in connection with the Acquisition. Mr. Restrepo's and Mr. Kiernan's agreements provide for annual base salaries of $220,000 and $275,000, respectively, and an incentive compensation opportunity of at least 45% and 50%, respectively, of the base salary. In addition, the Executives received a one-time grant of a stock option for 10,000 shares of Aetna common stock. The second installment is forfeited if the Executive is offered, but does not accept, a comparable position at the end of the contract term. Generally, if the Executive's employment is terminated other than for cause or by the Executive with good reason (each as defined in the employment agreement), the Executive will receive an amount equal to two times the sum of his annual base salary and target bonus, retention bonus, outplacement services and a gross-up payment for any excise tax payable under Section 4999 of the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"). The agreements further provide that if the Executives remain employees at will at the end of the term of the agreement, and within one year the Company takes actions which would have given them the right to terminate employment during the term of the agreement for good reason, they may voluntarily terminate employment within 90 days, and receive the severance benefits specified under the agreement. TAP CAPITAL ACCUMULATION PLAN TAP has adopted, with stockholder approval, the Travelers/Aetna Property Casualty Corp. Capital Accumulation Plan (the "TAP CAP Plan"). The TAP CAP plan provides for the payment of a portion of the compensation of the Company's employees in the form of restricted shares of Class A Common Stock ("Restricted Stock"). In the discretion of the Compensation Committee, a participant may elect to receive non-qualified stock options to purchase shares of Class A Common Stock in place of a portion of the Restricted Stock. 103 TAP has reserved 4,000,000 shares of Class A Common Stock for issuance under the TAP CAP Plan. Shares awarded under the TAP CAP Plan may consist of shares that are authorized but unissued, or previously issued and reacquired by TAP, or both. TAP will repurchase one share of Class A Common Stock for each share of restricted stock awarded under the TAP CAP Plan, subject to market conditions and applicable regulatory requirements, if any, which may prevent TAP from making such repurchases from time to time. The total number of shares of Class A Common Stock reserved for issuance and the option price for options granted under the TAP CAP Plan may be adjusted upward or downward as the Compensation Committee in its sole discretion may determine in the event of any stock dividend, recapitalization, stock split or other capital adjustment or transaction materially affecting the Class A Common Stock. In the event Restricted Stock is forfeited, or an option granted under the TAP CAP Plan is forfeited, canceled or terminated, or expires prior to the end of the period during which such option may be exercised, the shares subject to such forfeited, canceled, terminated or expired option will be available for future issuances. Officers and certain other employees of the Company are designated to be eligible to participate in the TAP CAP Plan at the discretion of the Compensation Committee. Upon designation by the Compensation Committee, participation in the TAP CAP Plan is generally mandatory, although the Compensation Committee may in certain circumstances make participation elective. The Compensation Committee also has exclusive discretion to determine the percentage of cash compensation subject to the TAP CAP Plan and other terms of participation, to modify within certain limits the terms of participation and to make all other determinations that it deems necessary or desirable in the interpretation and administration of the TAP CAP Plan. The Compensation Committee has the authority to administer, construe and interpret the TAP CAP Plan, and its decisions are final, binding and conclusive. Under the TAP CAP Plan, a portion of each participant's annual compensation, determined in the discretion of the Compensation Committee, is paid in the form of Restricted Stock. If a sufficient number of repurchased shares is not available to cover awards of Restricted Stock, the number of shares awarded will be decreased in a manner determined by the Compensation Committee in its sole discretion. The price of the Restricted Stock for purposes of determining the number of shares to be issued is discounted 25% from fair market value or, at the discretion of the Compensation Committee, such other percentage as may be necessary to adequately reflect the impact of the restricted nature and potential forfeiture of the stock. For purposes of the TAP CAP Plan, "fair market value" of the Class A Common Stock shall be the average of the closing prices on the NYSE Composite Transactions Tape for the five trading days prior to the date of an award. The participant is not able to sell, pledge or otherwise dispose of the Restricted Stock, except by will or the laws of descent and distribution, for a restricted period of three years (or such other period as may be determined to be applicable in the sole discretion of the Compensation Committee). Prior to the expiration of the restricted period, unless the Compensation Committee determines otherwise, the participant has voting rights with respect to the Restricted Stock, and is entitled to receive regular dividends or dividend equivalents on such shares. The Compensation Committee will determine the effect of any extraordinary dividends or distributions on the Restricted Stock. Upon expiration of the restricted period, the participant obtains full dispositive power over his or her shares, including sale of such shares to TAP, although TAP is under no obligation to repurchase any shares from any TAP CAP Plan participant. The restrictions on the Restricted Stock immediately lapse upon the death of a participant. In the event of a participant's disability, awards of Restricted Stock will continue to vest during the period of disability and subsequent thereto if the participant resumes employment. In the event a participant voluntarily terminates his or her employment, or is involuntarily terminated "for cause" (as defined in the TAP CAP Plan) prior to the expiration of the restricted period, such participant forfeits his or her Restricted Stock. A participant who is involuntarily terminated without cause prior to the expiration of the restricted period or who retires from employment but does not meet the definition of "Retirement" forfeits his or her Restricted Stock and receives in return, without interest, a cash payment equal to the portion of his or her annual compensation that had been paid in the form of Restricted Stock (not the undiscounted fair market value of the Restricted Stock issued to him or her). A participant who Retires prior to the expiration of the Restricted Period receives his or her Restricted Stock upon the completion of the restricted period unless the Compensation Committee determines that such participant will receive instead a cash payment equal to the portion of his or her annual compensation that had been paid in the form of Restricted Stock, without interest on such amount. The TAP CAP Plan provides that where the vesting and/or exercisability of an award of Restricted Stock or an option extends past the date of termination of employment for a participant, the Restricted Stock and/or option will be forfeited if the Compensation Committee determines that the participant has engaged in certain types of conduct that fall within the definition "cause" 104 under the plan. In addition, the TAP CAP Plan provides that in the event of a change of control (as defined in the TAP CAP Plan) the restrictions on each outstanding award of Restricted Stock will immediately lapse and all outstanding options will become immediately exercisable with respect to all of the shares of Class A Common Stock subject to such options, unless such change in control is approved by a vote of at least two-thirds of the directors of TAP. The Compensation Committee may in its sole discretion permit the participant to elect to receive up to one-third of his or her award in the form of a grant of options (a participant who receives an option is referred to herein as an "Optionee"). The Compensation Committee in its sole discretion shall determine the number of shares of Class A Common Stock subject to an option and may adjust the maximum percentage of Restricted Stock that may be exchanged for options. Subject to the following, the Compensation Committee has sole authority and absolute discretion to determine the terms of any options (including the option price, the method of exercise, the term during which the options may be exercised and the other provisions of the option agreements) that may be granted under the TAP CAP Plan. The option price of each option granted shall not be less than the fair market value of the Class A Common Stock subject to the option as of the date of grant. No options granted under the TAP CAP Plan may be exercised more than ten years from the date of grant. Options granted under the TAP CAP Plan will vest pursuant to a schedule determined by the Compensation Committee, in its sole discretion, prior to the grant of the options. Shares received upon exercise of an option may not be sold for a period of one year, or such other period as determined by the Compensation Committee. Unless the Compensation Committee in its sole discretion extends or shortens the exercise period, a vested option remains exercisable until the earliest to occur of (i) the expiration of the term for which it was granted, (ii) the participant's voluntary termination of employment (other than for retirement), (iii) the date of the Optionee's involuntary termination of employment for cause, (iv) 30 days after the Optionee's involuntary termination of employment (other than for cause or due to death or disability) or (v) three years after retirement, which three-year period shall not be affected by the subsequent death of the participant. Upon the death of a participant prior to the termination of employment and during any period of disability, vested options continue to be exercisable through the expiration date of the option. The Compensation Committee will determine the rights of a participant with respect to unvested options in the event of death or disability; provided, however, that in the case of an Optionee who holds a vested, unexercised option and who dies or is disabled within 30 days of an involuntary termination (other than for cause), the option will expire at the earlier of the expiration of the term for which the option was granted or one year after the death or disability occurs. Upon exercise of an option, payment to the Company of the option price may be made in cash, check or, unless the Compensation Committee determines otherwise, a participant may use previously owned shares of Class A Common Stock or shares of Restricted Stock (awarded at least six months prior to such use) to pay all or a portion of the option exercise price for vested options granted under the TAP CAP Plan, or the participant may direct the Company to sell, on behalf of the participant, the number of shares that would be required to cover the exercise price of the option. Previously owned stock used to pay the option exercise price may include shares held by the Optionee jointly with his or her spouse. An equivalent number of option shares received upon exercise using shares of Restricted Stock would be subject to the same restrictions as the shares of Restricted Stock surrendered for such purpose. Unless the Compensation Committee determines otherwise, a participant may surrender previously owned shares (excluding shares of Restricted Stock, shares held in a 401(k) plan or an IRA) acquired more than six months prior to such tender, or may request the Company to withhold shares otherwise issuable upon exercise to pay any tax liability associated with such option exercise. The Compensation Committee may permit a one-time transfer of options to a trust for the benefit of immediate family members; otherwise, options granted under the TAP CAP Plan will not be transferable other than by will or the laws of descent and distribution. Federal Tax Consequences. The following brief summary of the principal federal income tax consequences of transactions under the TAP CAP Plan is based on current federal income tax laws. This summary is not intended to constitute tax advice and, among other things, does not address possible state, local or foreign tax consequences. Accordingly, a participant in the TAP CAP Plan should consult a tax advisor with respect to the tax aspects of transactions under the TAP CAP Plan. 105 A participant generally must include in ordinary taxable income the fair market value of the Restricted Stock at the earlier of the time such Restricted Stock is either transferable or no longer subject to a substantial risk of forfeiture ("Forfeiture Period") within the meaning of Section 83 of the Internal Revenue Code (including, in the case of a person subject to the reporting and short-swing profit provisions under Section 16 of the Exchange Act (a "Section 16 Person"), any period during which such Section 16 Person would be subject to a potential liability). Any participant (including a Section 16 Person) may elect pursuant to Section 83(b) of the Internal Revenue Code to take into ordinary taxable income in the year of transfer of the Restricted Stock by the Company to such person an amount equal to the fair market value of the Restricted Stock on the date of such transfer (as if the Restricted Stock were unrestricted and could be sold immediately); such an election must be made within 30 days of the date of such transfer. A participant's basis in Restricted Stock is equal to the amount of ordinary taxable income recognized with respect to such Restricted Stock. With respect to the sale of Restricted Stock after the expiration of the Forfeiture Period, any gain or loss will generally be treated as long-term or short-term capital gain or loss, depending on the participant's holding period in such Restricted Stock. The holding period for capital gains treatment will begin when the Forfeiture Period expires, unless the participant has made a Section 83(b) election, in which event the holding period will commence just after the date of transfer of the Restricted Stock by TAP to such person. The Company generally will be entitled to a deduction in the amount of a participant's income at the time such income is recognized as described above, subject to possible limitations on deductibility under Section 162(m) of the Internal Revenue Code of compensation paid to executives designated in that Section. The participant may elect to satisfy withholding tax liability by having the Company retain shares of Class A Common Stock having a fair market value equal to such liability. No income is realized by an Optionee upon the grant of an option. Upon the exercise of an option, the Optionee will recognize ordinary compensation income in an amount equal to the excess, if any, of the fair market value of the shares of Class A Common Stock obtained by exercise of the option over the aggregate option exercise price (the "Spread") at the time of exercise. Income and payroll taxes are required to be withheld by the Company on the amount of ordinary income resulting to the Optionee from the exercise of an option. The Spread is deductible by the Company for federal income tax purposes, subject to the possible limitations on deductibility of compensation paid to certain executives pursuant to Section 162(m) of the Internal Revenue Code. The Optionee's tax basis in shares of Class A Common Stock acquired by exercise of an option will be equal to the exercise price plus the amount taxable as ordinary income to the Optionee. Upon a sale of the shares of Class A Common Stock received by the Optionee upon exercise of the option, any gain or loss will generally be treated for federal income tax purposes as long-term or short-term capital gain or loss, depending upon the holding period of such stock. The holding period for long-term capital gain is presently more than one year. The Optionee's holding period for shares acquired pursuant to the exercise of an option begins on the date of exercise of such option (with respect to individuals, the excess of net long-term capital gain over net short-term capital loss is subject to a statutory maximum tax rate of 28%). If the Optionee pays the exercise price in full or in part with shares of previously acquired Class A Common Stock, such exercise will not affect the tax treatment described above. With respect to such exercise, no gain or loss generally will be recognized to the Optionee upon the surrender of the previously acquired shares to the Company. The shares received upon exercise that are equal in number to the previously acquired shares tendered will have the same tax basis as the previously acquired shares surrendered to the Company, and will have a holding period for determining capital gain or loss that includes the holding period of the shares surrendered. The value of the incremental shares received by the Optionee will be taxable to the Optionee as compensation. Such shares will have a tax basis equal to the compensation income recognized by the Optionee and the holding period will commence on the exercise date. Shares tendered to pay applicable income and payroll taxes arising from such exercise will generate taxable income or loss equal to the difference between the tax basis of such shares and the amount of income and payroll taxes satisfied with such shares. Such income or loss will be treated as long-term or short-term capital income or loss depending on the holding period of the shares surrendered. If the Optionee pays the exercise price with Restricted Stock, the basis of shares of restricted stock surrendered is zero (if a Section 83 (b) election has not been made) and income will be recognized upon the lapsing of restrictions, at which time the Optionee will have a basis in such stock equal to such income recognized. In the case of an Optionee who has made a Section 83(b) election to take into account an amount equal to the fair market value of the Restricted Stock on the date that the Restricted Stock is granted to the Optionee ("Section 83 restricted stock"), the basis of the Section 83 restricted stock subject to such election will be equal to the amount 106 taken into income. The incremental shares received will have a basis equal to the fair market value of such shares on the date of exercise. Amendments to or Discontinuance of the TAP CAP Plan. The TAP Board, without the approval of stockholders or TAP CAP Plan participants, may at any time terminate, amend or modify the TAP CAP Plan, provided that no such action may without a participant's written consent adversely affect Restricted Stock or options previously awarded and no amendment may become effective without approval of TAP stockholders that would increase the maximum number of shares of Class A Common Stock that may be issued as Restricted Stock or upon exercise of options (except in connection with certain capital adjustments described above). COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Upon consummation of the Equity Offering, at least two independent directors of TAP will serve on the Compensation Committee. It is not expected that any member of the Compensation Committee will have any interlocking or other relationships with TAP that would call into question his independence as a member of the Compensation Committee. OWNERSHIP OF COMMON STOCK The following table sets forth certain information regarding the beneficial ownership of TAP's Common Stock, at the date hereof and after giving effect to the Equity Offering. As of the date hereof, none of the outstanding Common Stock of TAP is owned by any director or executive officer of TAP. However, certain executive officers of the Company and directors of TAP will have the opportunity to purchase shares of Class A Common Stock in the Equity Offerings pursuant to the Directed Share Program. See "Underwriting." All beneficial owners have sole voting and sole investment power with respect to their shares.
NUMBER OF SHARES PERCENTAGE OF OUTSTANDING COMMON PERCENTAGE OF VOTING POWER OF BENEFICIALLY OWNED STOCK OUTSTANDING COMMON STOCK NAME AND ADDRESS OF ------------------------ --------------------------------- --------------------------------- BENEFICIAL OWNER CLASS A CLASS B BEFORE OFFERING AFTER OFFERING BEFORE OFFERING AFTER OFFERING - ------------------------------- ----------- ----------- --------------- -------------- --------------- -------------- Travelers Group Inc.(1)........ -- 328,020,170 90.85% 82.74% 99.00% 97.96% 388 Greenwich Street New York, NY 10013 Aetna Life and Casualty 12,571,625 -- 3.48 3.17 * * Company........................ 151 Farmington Avenue Hartford, CT 06156 J.P. Morgan Capital 12,571,625 -- 3.48 3.17 * * Corporation.................... 60 Wall Street New York, New York 10260 The Trident Partnership, 4,714,359 -- 1.31 1.19 * * L.P............................ Marsh & McClennan Risk Capital Corp. 80 Field Point Road Greenwich, CT 06830 Fund American Enterprises Holdings, Inc.................. 3,142,906 -- * * * * The 1820 House Main Street Norwich, VT 05055
- ------------ (1) The record owner of these shares is TIGI. Travelers Group indirectly owns 100% of the outstanding capital stock of TIGI. * Less than 1% 107 CERTAIN TRANSACTIONS The following summaries of the Aetna Stock Purchase Agreement, the Intercompany Agreement and the Shareholders Agreement do not purport to be complete and are qualified in their entirety by reference to such agreements, copies of which have been filed as exhibits to the Registration Statement of which this Prospectus is a part. Capitalized terms used but not defined herein have the meanings given to them in such agreements. THE ACQUISITION Pursuant to the Stock Purchase Agreement dated as of November 28, 1995 between TIGI and Aetna (the "Aetna Stock Purchase Agreement"), TIGI agreed to purchase all of the outstanding capital stock of Aetna Casualty and Standard Fire for a purchase price of $4 billion, subject to certain adjustments. TIGI assigned its rights under the Aetna Stock Purchase Agreement to TAP, which purchased Aetna Casualty and Standard Fire on April 2, 1996 for a cash purchase price of approximately $4.16 billion, subject to further adjustments which are not expected to be material. Aetna has agreed that for a period of five years from the closing under the Aetna Stock Purchase Agreement, it will not engage in any business in the United States, Canada or the United Kingdom that competes with any of the Aetna P&C businesses as conducted in such countries as of the closing, with certain limited exceptions. Aetna has entered into a license agreement with Aetna Casualty and Standard Fire that permits those companies and their subsidiaries to use the "Aetna" name in connection with their operations through December 31, 1998. Aetna has also agreed not to license the Aetna name to anyone else for use in a property and casualty insurance business until after December 31, 2001. Pursuant to a separate letter agreement between TAP and Aetna, TAP will be able to use "Aetna" in its corporate name, subject to certain conditions, through December 31, 1997. Following the consummation of the Acquisition, Aetna will not control Aetna P&C and TAP. See "Risk Factors--Discontinuance of Use of 'Aetna' and 'Travelers' Names." Aetna and TAP or their respective subsidiaries have entered into various agreements, as contemplated by the Aetna Stock Purchase Agreement, relating to transitional and other services. These services include data processing and computer support, telecommunications services, payroll and benefit administration, certain reinsurance arrangements relating to property and casualty business written by Aetna and stop loss insurance for group health business written by a subsidiary of Aetna and arrangements for the lease of real and personal property, among other things. In addition, pursuant to the terms of the Aetna Stock Purchase Agreement, the bond portfolio of Aetna P&C has been invested and managed at the direction of TIGI since November 29, 1995. RELATIONSHIPS WITH TIGI AND TRAVELERS GROUP The Company has engaged in certain transactions and is a party to certain arrangements with TIGI and Travelers Group and certain of their affiliates. ELECTION OF THE BOARD OF DIRECTORS Following the Equity Offerings, TIGI will continue to be the controlling stockholder of TAP. Subject to the right of one of the Private Investors pursuant to the Shareholders Agreement to nominate one director to the Board of Directors of TAP and TIGI's agreement to vote its shares of Common Stock in favor of such nominee, so long as TIGI controls a majority of the combined voting power of the outstanding Common Stock, TIGI will continue to have the ability to elect the entire Board of Directors of TAP. See "Certain Transactions--Private Investors." INTERCOMPANY AGREEMENT TAP and Travelers Group have entered into an Intercompany Agreement dated as of April 2, 1996 (the "Intercompany Agreement"), certain provisions of which are summarized below. As used herein, "Travelers Affiliated Group" means Travelers Group collectively with its subsidiaries other than TAP and its subsidiaries. License to Use the Travelers Name and Certain Trademarks. Pursuant to the Intercompany Agreement, certain members of the Travelers Affiliated Group have granted to TAP and certain of its subsidiaries, a non-exclusive, revocable license to use the "Travelers" name and certain trademarks (collectively, the "Trademarks") solely in connection with TAP's property and casualty insurance business and activities related to such property 108 and casualty insurance business. The Intercompany Agreement provides, among other things, that, subject to Travelers Group's ability to revoke the license in the circumstances described below and subject to regulatory approval, within a limited time from the date on which the Travelers Affiliated Group ceases to control more than 20% of the combined voting power of the outstanding Common Stock (the "License Trigger Date"), if TAP's name or any of its subsidiaries' names at such time includes the "Travelers" name, TAP and such subsidiaries will be required to change their names and will be required to discontinue the use of certain related marks. Following the License Trigger Date, TAP and its subsidiaries will continue to have the right to use the "Travelers" name in connection with the identification of property and casualty insurance products for an initial five-year period with an option to renew for an additional five years, for which TAP will pay a nominal annual fee to Travelers Group until such time as TAP and its subsidiaries completely discontinue use of the "Travelers" name. In addition, the Intercompany Agreement provides that TAP and its subsidiaries will not, without the prior written consent of Travelers Group, take any action with respect to (i) any litigation or proceeding involving the Trademarks, (ii) any change in TAP's names, logos and other identifications that might reasonably be expected to affect the Trademarks or (iii) any advertising campaigns or strategies that use the Trademarks or that refer to any member of the Travelers Affiliated Group. Travelers Group has the right to revoke the license under certain circumstances relating to advertising, promotion or use of the Trademarks in a manner contrary to Travelers Group guidelines. In addition, Travelers Group can revoke any of TAP's subsidiaries' use of the license if there is a change of control of any such subsidiary of TAP that is licensed to use the Trademarks. A revocation by Travelers Group of the license to use the Trademarks could have a material adverse effect on TAP's ability to conduct its business. Indemnification. The Intercompany Agreement provides that TAP will indemnify each member of the Travelers Affiliated Group and each of their respective officers, directors, employees and agents (collectively, the "Indemnitees") against losses based on, arising out of or resulting from (i) the use of the Trademarks, (ii) the ownership or the operation of the assets or properties, and the operation or conduct of the business, of TAP or its subsidiaries, (iii) any other activities of TAP or its subsidiaries, (iv) any other acts or omissions arising out of performance of the Intercompany Agreement and certain other agreements, (v) any guaranty, keep well, net worth or financial condition maintenance agreement of or by any member of the Travelers Affiliated Group provided to any parties with respect to any actual or contingent obligation of TAP or its subsidiaries, and (vi) certain other matters. In addition, TAP has agreed to indemnify the Indemnitees against certain civil liabilities, including liabilities under the Securities Act, relating to misstatements in or omissions from the Registration Statement of which this Prospectus forms a part and any other registration statement that TAP files under the Securities Act (other than misstatements or omissions made in reliance on information relating to and furnished by any member of the Travelers Affiliated Group for use in the preparation thereof, against which Travelers Group has agreed to indemnify TAP). Travelers Group has also agreed to indemnify TAP and its subsidiaries and each of their respective officers, directors, employees and agents against losses based on, arising out of or resulting from (i) any breach by Travelers Group of the Intercompany Agreement (ii) the ownership of the operation of the assets or properties, and the operation or conduct of the business, of Travelers Group and its subsidiaries (other than TAP and its subsidiaries), (iii) certain third party claims relating to the Trademarks and (iv) certain other specifically identified matters. Travelers Group Consent to Certain Events. The Intercompany Agreement provides that until members of the Travelers Affiliated Group ceases to control at least 20% of the combined voting power of the outstanding Common Stock or no longer owns at least 20% of the outstanding shares of Common Stock, the prior written consent of Travelers Group will be required for: (i) any consolidation or merger of TAP or any of its subsidiaries with any person (other than certain transactions involving wholly owned subsidiaries); (ii) any sale, lease, exchange or other disposition or any acquisition by TAP or any of its subsidiaries (other than transactions to which TAP and its wholly owned subsidiaries are the only parties), or any series of related dispositions or acquisitions, involving consideration in excess of $20 million; (iii) any change in the authorized capital stock of TAP or the creation of any class or series of capital stock of TAP, (iv) any issuance by TAP or any subsidiary of TAP of any equity securities or equity derivative securities, except (a) up to 4 million shares of Common Stock pursuant to TAP's Capital Accumulation Plan and up to one million shares of Common Stock pursuant to employee and director stock option, profit sharing and other benefit plans of TAP and its subsidiaries (provided that such stock option, profit sharing and other benefit plans contain certain share repurchase provisions), (b) the issuance of shares of capital stock of a wholly owned subsidiary of TAP to TAP or another wholly owned subsidiary of TAP and (c) in the Equity Offerings, pursuant to the Transactions and the financing thereof and in the sale of preferred stock and/or preferred trust securities pursuant to the Debt and Preferred Offerings; (v) the dissolution of TAP; (vi) the amendment of certain provisions of the Charter and By-Laws of TAP; (vii) any change in the Chief 109 Executive Officer of TAP; (viii) the declaration of dividends on any class of the capital stock of TAP except as otherwise described herein; (ix) the creation or incurrence or guaranty by TAP or any of its subsidiaries of indebtedness in excess of $100 million (except (a) pursuant to the Credit Agreement, (b) up to $2.4 billion aggregate principal amount of indebtedness pursuant to the Transactions, the Equity Offering, the Trust Preferred Securities Offerings or the Debt Offerings) and (c) guarantees given to states or insurance regulatory authorities thereof in connection with the licensing of the business of TAP or its subsidiaries in such jurisdictions); (x) any change in the number of directors on the board of directors of TAP, the establishment of any committee of the board, the determination of the members of the board or any committee thereof, and the filling of newly created memberships and vacancies on the board or any committee thereof (except to the extent otherwise provided for in the Shareholders Agreement); and (xi) transactions or series of related transactions with affiliates of the Company (other than members of the Travelers Affiliated Group) involving consideration in excess of $5 million, other than (a) the Transactions, the Equity Offering and any issuance and sale of securities the proceeds of which are used, directly or indirectly, to finance the Acquisition and any and all refinancings, replacements and refundings thereof, (b) transactions on terms substantially the same as or more favorable to TAP than those that would be available from an unaffiliated third party and (c) transactions between or among any of TAP and its wholly owned subsidiaries. Registration Rights. TAP has granted to the Travelers Affiliated Group certain demand and "piggyback" registration rights with respect to shares of Common Stock owned by it. The Travelers Affiliated Group has the right to request up to two demand registrations in each calendar year. The Travelers Affiliated Group also has the right, which it may exercise at any time and from time to time, to include the shares of Common Stock held by it in certain other registrations of common equity securities of TAP initiated by TAP on its own behalf or on behalf of any stockholder of TAP. Such registration rights are transferable by the Travelers Affiliated Group. TAP has agreed to pay all costs and expenses in connection with each such registration, except underwriting discounts and commissions applicable to the shares of Common Stock sold by the Travelers Affiliated Group. The Intercompany Agreement contains customary terms and provisions with respect to, among other things, registration procedures and certain rights to indemnification granted by parties thereunder in connection with the registration of Common Stock on behalf of the Travelers Affiliated Group. Reimbursement Agreements. TAP has agreed to pay all costs and expenses incurred in connection with TAP's formation, the Transactions and all related transactions, except as otherwise described in this Prospectus. Equity Purchase Rights. TAP has agreed that, to the extent permitted by the principal national securities exchange in the United States upon which TAP's Common Stock is listed and so long as Travelers Group controls at least 20% of the combined voting power of the outstanding Common Stock of TAP or at least 50% of the issued and outstanding Common Stock, the Travelers Affiliated Group may purchase its pro rata share (based on its then current percentage equity interest in TAP) of any voting equity security issued by TAP (excluding any such securities offered in connection with the Equity Offering and pursuant to employee stock options or other benefit plans, dividend reinvestment plans and other offerings other than for cash). The exercise of such rights is currently prohibited by the NYSE. Certain Business Relationships. TAP has agreed that all distribution arrangements in effect as of April 2, 1996 pursuant to which members of the Travelers Affiliated Group distribute property and casualty insurance products of TAP or its subsidiaries shall continue until such time as the members of the Travelers Affiliated Group cease to control at least 50% of the combined voting power of the outstanding Common Stock. Until such time, Travelers Group and TAP agree to review and discuss from time to time, with a view towards entering into an arrangement, all reasonable distribution alternatives for TAP's and its subsidiaries' property and casualty insurance products taking into consideration that the members of the Travelers Affiliated Group would be the preferred distribution channel for such products. If, as a result of such review and discussion, Travelers Group and TAP enter into a distribution arrangement, such arrangement shall be mutually exclusive and each party shall use its best efforts to cause such arrangement to remain in effect until the second anniversary of the date upon which the members of Travelers Affiliated Group cease to control at least 50% of the combined voting power of the outstanding Common Stock. TAP has agreed to make its products available for distribution through other members of the Travelers Affiliated Group, such as PFS, and to refrain from using like distribution channels, and Travelers Group has agreed that the members of the Travelers Affiliated Group will refrain from selling property and casualty insurance products of any nonaffiliate, in each case, until such time as the members of the Travelers Affiliated Group, in the aggregate, cease to control at least 50% of the combined voting power of the outstanding 110 Common Stock (the "Trigger Date") and for a period of two years from and after such date unless the parties agree to terminate earlier or to extend such period. The economic and other terms of this arrangement will be reviewed annually thereafter and may be modified as the parties mutually agree. Real Property. The Intercompany Agreement provides that the Travelers Affiliated Group will continue to lease to the Company certain premises currently occupied by it and to sublease certain other properties currently occupied by it on terms consistent with prior cost allocation practices until the Trigger Date and thereafter for succeeding periods of varying lengths on a fair market value basis. Other Provisions. The Intercompany Agreement also provides for: (i) the provision of insurance and allocation and/or reimbursement of costs and premiums thereof; (ii) the provision of data processing services and allocation and/or reimbursement of costs thereof; (iii) cross-licensing of computer software; (iv) the provision of benefits and participation in benefit and retirement plans and reimbursement for the costs thereof; and (v) provisions governing certain other relationships among members of the Travelers Affiliated Group, on the one hand, and TAP and its subsidiaries, on the other hand. TAX SHARING AGREEMENT TAP's items of income, loss, deductions and credits are currently and after the Equity Offering will continue to be included in the consolidated and combined tax returns of Travelers Group for federal income and certain state tax purposes. Travelers Group, TIGI and TAP have entered into an agreement, effective January 1, 1996 (the "Tax Sharing Agreement"), providing for the filing of consolidated and combined federal and certain state income tax and franchise tax returns and for the allocation of income tax liabilities related to such returns. As required by the terms of the Tax Sharing Agreement, in general, TAP will pay TIGI an amount equal to the federal income or state income or franchise taxes that would have been payable by TAP if it filed separate consolidated or combined returns with its own subsidiaries. Travelers Group and its subsidiaries other than TAP and its subsidiaries may benefit from such agreement under limited circumstances to the extent that they have net tax benefits that would not otherwise have been currently usable. In addition, under limited circumstances the actual tax liability of TAP and its subsidiaries may differ from the tax liability that would have been incurred had they filed separate returns. Also, tax benefits related to certain compensation plan deductions will be retained by Travelers Group. Travelers Group will continue to have all the rights of a parent of a consolidated group (and similar rights provided for by applicable state and local law with respect to a parent of a combined, consolidated or unitary group), and as such will be the exclusive agent for the Company in any and all matters relating to the income, franchise and similar tax liabilities of the Company, will have exclusive responsibility for the preparation and filing of consolidated federal and consolidated or combined state and local income tax returns (or amended returns), and will have the power, in its sole discretion, acting in good faith to contest or compromise any asserted tax adjustment or deficiency and to file, litigate or compromise any claim for refund on behalf of the Company. Each member of a consolidated group is jointly and severally liable for the federal income tax liability of each other member of the consolidated group. Accordingly, although the Tax Sharing Agreement allocates tax liabilities between the Company and Travelers Group with respect to periods in which the Company is or has been included in Travelers Group's consolidated group, the Company could be liable in the event that any federal tax liability is incurred, but not discharged, by any other member of Travelers Group's consolidated group. OTHER INTERCOMPANY AGREEMENTS The Company has other intercompany arrangements with Travelers Group and other subsidiaries of Travelers Group. The Company participates with Travelers Group and TIGI in certain limited group purchasing arrangements, the most important of which involves the acquisition of telecommunication services. Pursuant to this arrangement, the Company has committed to acquire for a period ending in 1998 substantially all of its telecommunications service needs from the national vendor of such services to Travelers Group. The Company expects to receive substantial savings in its telecommunications expenses as a result of this arrangement. The Company may participate in other group purchasing arrangements with Travelers Group and/or TIGI from time to time upon mutual agreement. Prior to the Equity Offering, Travelers Group has provided certain corporate staff services, including legal, internal audit and other services, to the Company at cost pursuant to a Service Reimbursement Agreement and 111 may, but will not be obligated to, continue to do so following completion of the Equity Offering. For further information regarding arrangements and transactions between the Company, Travelers Group and TIGI, see "Unaudited Pro Forma Financial Information." TIGI and various of its subsidiaries, including subsidiaries of TAP, are parties to an Expense Allocation Agreement that provides for the allocation among the parties of costs for services provided to or by the parties. Such services include, but are not limited to, financial management, operational management, accounting, payroll, internal audit, human resource management, tax, transportation, risk management, legal, investment management, government relations, record-keeping and data processing services and the acquisition of equipment, software and office space. Charges are allocated at cost, and no party is expected to realize a profit or incur a loss as a result of providing or obtaining services under the agreement. The agreement may be terminated as to any party upon 90 days prior notice to the other parties. PRIVATE INVESTORS Concurrently with the closing of the Acquisition on April 2, 1996, pursuant to separate stock purchase agreements (the "Private Investors Stock Purchase Agreements") between TAP and each of Aetna, J.P. Morgan, Trident and Fund American, the Private Investors purchased shares of Class A Common Stock representing in the aggregate approximately 1.0% of the combined voting power of the Common Stock outstanding and approximately 8.3% of the outstanding Common Stock after giving effect to the Equity Offering. Aetna invested $200 million; J.P. Morgan invested $200 million; Trident invested $75 million; and Fund American invested $50 million. The Private Investors will hold approximately 48.2% of the outstanding shares of Class A Common Stock after giving effect to the Equity Offering. Pursuant to the Shareholders Agreement among TAP, TIGI, J.P. Morgan, Aetna, Trident and Fund American, the Private Investors have certain rights with respect to the ownership of Class A Common Stock and the management of TAP. So long as the Private Investors continue to beneficially own at least 52% of the shares of Class A Common Stock purchased pursuant to the Private Investors Stock Purchase Agreements, then, subject to certain conditions, Mr. Roberto G. Mendoza will be nominated to the Board of Directors of TAP by Trident, and Travelers Affiliated Group has agreed to vote its shares of Common Stock in favor of such nominee. If the conditions required to nominate Mr. Mendoza are not satisfied, Trident will have the right to nominate an alternative director to the Board of Directors of TAP, and if such nominee is found to be reasonably satisfactory to the other members of the Board of TAP and to the members of the Travelers Affiliated Group holding shares of Common Stock at such time, the Travelers Affiliated Group has agreed to vote its shares of Common Stock in favor of such nominee. In addition, for a period of 18 months from the date of the Shareholders Agreement (subject to early termination if the members of the Travelers Affiliated Group, in the aggregate, cease to control at least 50% of the combined voting power of the outstanding Common Stock) (the "Restricted Period"), so long as the Private Investors continue to own, in the aggregate, at least 50% of the shares of Class A Common Stock initially purchased by them pursuant to the Private Investors Stock Purchase Agreements, TAP has agreed that, except in limited circumstances, it will not take the following fundamental corporate actions without the approval of at least 50% of the shares of Class A Common Stock then owned, in the aggregate, by the Private Investors: (i) the liquidation, dissolution or winding up of TAP or any material subsidiary of TAP that is not a direct or indirect wholly owned subsidiary of TAP; (ii) a sale or other disposition of all or substantially all of the assets of TAP or any material subsidiary of TAP, other than to TAP or to a direct or indirect wholly owned subsidiary of TAP; (iii) the merger or consolidation of TAP or any material subsidiary of TAP, except any such merger or consolidation between or among any of TAP and any wholly owned direct or indirect subsidiary of TAP (so long as TAP shall be the surviving corporation); (iv) any action that would result in a fundamental change in the nature of the business conducted by TAP or any material subsidiary of TAP, other than actions compelled by law, rule, regulation, order or decree; (v) the entry by TAP or a material subsidiary of TAP into any material transaction, or series of related transactions with an Affiliate (as defined therein) of TAP or an Affiliate of any material subsidiary of TAP, other than (a) transactions which are on terms substantially the same as or more favorable to TAP than those that would be available from an unaffiliated third party, (b) transactions between or among any of TAP and its direct or indirect subsidiaries, (c) the issuance, sale, repurchase or redemption of any indebtedness or preferred stock of TAP in accordance with the terms of any agreements or instruments governing or relating to such indebtedness or preferred stock, and (d) as specifically set forth or otherwise described in the Shareholders Agreement, the Private Investors Stock Purchase Agreements, the Intercompany Agreement, the Tax Sharing Agreement and certain expense allocation agreements; provided that, in the case of clause (a) above (if such 112 transaction or series of related transactions involves in excess of $20 million) or in the case of clause (c) above (regardless of the valuation of the transaction), the terms of such transaction or series of related transactions shall have been previously disclosed to the Board of Directors of TAP; and provided further, that transactions between TAP or a material subsidiary of TAP with an Affiliate thereof (except for transactions of the type described in clauses (b) or (d) above) that are not material individually shall be on terms that are fair and reasonable to TAP when considered in the aggregate with all other transactions with Affiliates that are not material individually; and (vi) any amendment to the Charter or By-laws of TAP that adversely affects the Private Investors' voting rights pursuant to this provision of the Shareholders Agreement. See "--Relationship with TIGI and Travelers Group-- Intercompany Agreement." Pursuant to the Shareholders Agreement, the Private Investors have the right, from and after the expiration or early termination of the Restricted Period, to require TAP to file a registration statement at TAP's expense with respect to the shares of Class A Common Stock purchased by the Private Investors pursuant to their respective Stock Purchase Agreements. The Private Investors are collectively entitled to a total of four demand registrations. Private Investors owning more than 50% of the shares of Class A Common Stock then owned in the aggregate by the Private Investors are required to demand a registration, and a demand may be made to register no less than a number of shares, the sale of which is reasonably expected to yield gross proceeds of at least $60 million. In addition, TAP has agreed that, from and after the expiration of the Restricted Period, the Private Investors have the right to have their shares included in certain other registrations of securities of TAP initiated by TAP or otherwise demanded by another stockholder of TAP registered on a "piggyback" basis on an unlimited number of occasions. TAP has agreed to indemnify the Private Investors for certain liabilities, including liabilities under the Securities Act, or to contribute to payments the Private Investors may be required to make in respect thereof, in connection with sales by the Private Investors of shares of Class A Common Stock in a registration statement prepared by TAP. Pursuant to the Shareholders Agreement, TAP has agreed to pay all expenses in connection with each such registration, except underwriting discounts and commissions applicable to the shares of Class A Common Stock sold by the Private Investors. In addition, the Shareholders Agreement contains customary terms and provisions with respect to, among other things, registration procedures and certain rights to indemnification granted by parties thereunder in connection the registration of Class A Common Stock on behalf of the Private Investors. Pursuant to the Shareholders Agreement with the Private Investors and TIGI, TIGI has agreed that until the earlier to occur of (i) the date the Private Investors no longer beneficially own at least 50% of the shares of Class A Common Stock originally purchased by them; (ii) Travelers Group and its affiliates (excluding TAP and its subsidiaries), in the aggregate, no longer beneficially own at least 50% of the outstanding Common Stock; and (iii) 30 days following the fifth anniversary of the date of the closing of the Acquisition, the Company will be the primary vehicle through which Travelers Group or any of its affiliates (other than the Company) engages in the property and casualty insurance business in the United States, with certain limited exceptions. In addition, TIGI has agreed that neither TIGI nor any other member of the Travelers Affiliated Group will effect a Tax-Free Spin-Off prior to the third anniversary of the expiration of the Restricted Period. See "Description of Capital Stock-- Class A Common Stock and Class B Common Stock." The Private Investors have also agreed not to sell or otherwise transfer any Class A Common Stock (i) until the expiration of the Restricted Period, except (a) to an affiliate or (b) as otherwise required by regulatory authorities, unless, in the case of (b) the shares proposed to be sold are first offered on substantially the same terms to TAP, and if TAP determines not to purchase all of the shares offered, to TIGI (the "Right of First Offer") and (i) after the expiration of the Restricted Period, (a) to an affiliate or (b) subject to the Right of First Offer, except sales pursuant to a registered public offering or Rule 144 under the Securities Act. Arthur Zankel, a director of TAP, is co-managing partner of First Manhattan Co., which acted as financial advisor to Fund American in connection with its investment in TAP. DESCRIPTION OF CAPITAL STOCK The authorized capital stock of the Company consists of 700,000,000 shares of Class A Common Stock, par value $.01 per share, 700,000,000 shares of Class B Common Stock, par value $.01 per share, and 25,000,000 shares of preferred stock, par value $.10 per share (the "Preferred Stock"). The following summary is qualified in its entirety by the provisions of TAP's Charter and Restated By-laws (the "By-laws"), copies of which have been filed as exhibits to the Registration Statement of which this Prospectus is a part, and to the applicable provisions of the General Corporation Law of the State of Delaware (the "DGCL"). 113 CLASS A COMMON STOCK AND CLASS B COMMON STOCK The Charter provides for two classes of Common Stock. Upon completion of the Equity Offering, TAP will have outstanding 68,436,255 shares of Class A Common Stock (assuming the U.S. Underwriters' over-allotment option is not exercised) and 328,020,170 shares of Class B Common Stock. Immediately following consummation of the Equity Offering, TIGI will own all of the 328,020,170 shares of Class B Common Stock and will control approximately 98.0% of the combined voting power of the Common Stock and beneficially own approximately 82.7% of the outstanding shares of Common Stock (97.9% and 82.0%, respectively, if the U.S. Underwriters' over-allotment option is exercised in full). Therefore, subject to the right of one of the Private Investors as described above under "Certain Transactions--Private Investors," TIGI will have the power to elect all of the members of TAP's Board of Directors and will have the power to control all matters requiring stockholder approval. On all matters submitted to a vote of stockholders, holders of Class A Common Stock are entitled to one vote per share and holders of Class B Common Stock are entitled to ten votes per share. Both classes vote together as a single class on all matters, except that the holders of Class A Common Stock are entitled to vote as a separate class on, and must approve, any change to the Charter modifying the terms of the Class A Common Stock and/or the Class B Common Stock which change would adversely affect the relative rights of the Class A Common Stock as compared to those of the Class B Common Stock and as otherwise required by law. Holders of Class A Common Stock and Class B Common Stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors on the Common Stock out of funds legally available therefor, subject to any preferential dividend rights of any outstanding Preferred Stock. Cash dividends may be declared and paid to the holders of Class A Common Stock only if at such time cash dividends in the same amount per share are declared and paid to the holders of Class B Common Stock, and vice versa. See "Dividend Policy." Upon the liquidation, dissolution or winding up of TAP, the holders of Class A Common Stock and Class B Common Stock are entitled to receive ratably the net assets of TAP available after payment of all debts and other liabilities, subject to the prior rights of any outstanding Preferred Stock. Holders of Class A Common Stock and Class B Common Stock as such have no preemptive, subscription, redemption or, except as provided below, conversion rights, except for the limited equity purchase rights described in "Certain Transactions--Relationships with TIGI and Travelers Group." The outstanding shares of Class A Common Stock and Class B Common Stock are, and the shares of Class A Common Stock offered by TAP in the Equity Offering will be, when issued and paid for, fully paid and non-assessable. Each share of Class B Common Stock is convertible at any time while held by a member of the Travelers Affiliated Group, or the Class B Transferee (as defined below) or any of its subsidiaries, if any, at the option of the holder thereof, into one share of Class A Common Stock. Except as provided below, any shares of Class B Common Stock transferred to, or issued by TAP to, a person other than a member of the Travelers Affiliated Group or the Class B Transferee or any of its subsidiaries will automatically convert into shares of Class A Common Stock upon such transfer on a share-for-share basis. Shares of Class B Common Stock representing more than a 50% economic interest in TAP transferred by Travelers Group or any of its subsidiaries in a single transaction to one unrelated person (the "Class B Transferee") will not automatically convert into shares of Class A Common Stock upon such transfer. Any shares of Class B Common Stock retained by Travelers Group or any of its subsidiaries following any such transfer to the Class B Transferee will automatically convert into shares of Class A Common Stock upon such transfer. Following a disposition of shares of Class B Common Stock beneficially owned by Travelers Group or the Class B Transferee effected in connection with a transfer of such Class B Common Stock to stockholders of Travelers Group or stockholders of the Class B Transferee, as the case may be, as a spin-off, split off or split-up that is intended to be on a tax-free basis under the Internal Revenue Code ("Tax-Free Spin-Off"), shares of Class B Common Stock shall not convert into shares of Class A Common Stock. Following a Tax-Free Spin-Off, shares of Class B Common Stock will be transferable as Class B Common Stock, subject to applicable laws; provided, however, that shares of Class B Common Stock will automatically convert into shares of Class A Common Stock on the fifth anniversary of the Tax-Free Spin-Off, unless prior to such Tax-Free Spin-Off, Travelers Group or the Class B Transferee, as the case may be, delivers to TAP an opinion reasonably satisfactory to TAP to the effect that such conversion would preclude Travelers Group or the Class B Transferee, as the case may be, from obtaining a favorable ruling from the IRS that such transfer of Class B Common Stock would be a Tax-Free Spin-Off. If such 114 an opinion is received, conversion of Class B Common Stock to Class A Common Stock shall not be automatic and approval of such conversion will be submitted to a vote of the holders of the Common Stock as soon as practicable after the fifth anniversary of the Tax-Free Spin-Off unless Travelers Group or the Class B Transferee, as the case may be, delivers to TAP an opinion reasonably satisfactory to TAP prior to such anniversary that such vote would adversely affect the status of the Tax-Free Spin-Off. Approval of such conversion will require the affirmative vote of the holders of a majority of the shares of both the Class A Common Stock and Class B Common Stock present and voting, voting together as a single class, with each share entitled to one vote for such purpose. No assurance can be given that such conversion would be consummated. The requirement to submit such conversion to a vote of the holders of Common Stock is intended to ensure that the tax treatment of the Tax-Free Spin-Off is preserved should the IRS challenge such automatic conversion as violating the 80% vote requirement. Pursuant to the Shareholders Agreement, TIGI has agreed that neither TIGI nor any other member of the Travelers Affiliated Group will effect a Tax-Free Spin-Off prior to the third anniversary of the expiration of the Restricted Period. See "Certain Transactions--Private Investors." PREFERRED STOCK The Board of Directors has the authority to issue Preferred Stock in one or more classes or series and to fix the designations, powers, preferences and rights of the shares of each such class or series, including dividend rates, conversion rights, voting rights, terms of redemption and liquidation preferences and the number of shares constituting each such class or series, without any further vote or action by the stockholders. Series Z Preferred Stock. TAP has issued 2,160 shares of redeemable preferred stock, par value $0.10 per share (the "Series Z Preferred Stock"), pursuant to the authority granted to it by the Charter. As of the date hereof, Travelers Group owns all of the issued and outstanding shares of Series Z Preferred Stock. The Series Z Preferred Stock was purchased by Travelers Group in connection with the financing of the Acquisition. See "Recent History." Dividends on the Series Z Preferred Stock are payable quarterly when, as and if declared by the Board of Directors out of funds legally available therefor at a rate of 7.5% per annum, payable quarterly. Dividends will be cumulative from the date of original issuance of the Series Z Preferred Stock. Unless full cumulative dividends on all outstanding shares of the Series Z Preferred Stock have been paid or declared and set aside for payment for all past dividend periods, no dividend (other than a dividend paid in stock ranking junior to the Series Z Preferred Stock as to dividends or upon liquidation, distribution or winding up of TAP) may be declared on any stock ranking junior to or on a parity with the Series Z Preferred Stock as to dividends, including the Class A Common Stock. Upon the liquidation, dissolution or winding up of TAP (other than by merger or transfer of assets to a successor), holders of Series Z Preferred Stock will be entitled to receive, out of the assets of TAP legally available for distribution to stockholders and before any payment to holders of Common Stock or any other stock of TAP ranking junior to the shares of Series Z Preferred Stock upon liquidation, dissolution or winding up of TAP, a liquidation preference of $250,000 per share (the "Liquidation Preference") plus accumulated and unpaid dividends. If dividends payable on the Series Z Preferred Stock are in arrears for the equivalent of six quarterly dividend periods (whether or not consecutive), the number of directors of TAP will be increased by two, and the holders of the Series Z Preferred Stock will have the right, voting separately as a class with holders of any other series of preferred stock ranking on parity with the Series Z Preferred Stock and upon which like voting rights have been conferred and are exercisable, to vote for the election of two members of TAP's Board of Directors, which directors shall remain in place until all unpaid dividends are paid or set aside for payment. The Series Z Preferred Stock is not redeemable at the option of TAP prior to June 30, 2002. From and after June 30, 2002, the Series Z Preferred Stock will be redeemable at the option of TAP, in whole or in part, at any time upon not less than 30 nor more than 60 days' notice. Other than as described below, the Series Z Preferred Stock is not subject to any mandatory redemption, sinking fund or other obligation of TAP to redeem or retire the Series Z Preferred Stock. The Series Z Preferred Stock is mandatorily redeemable, in whole or in part, upon not less than three nor more than 60 days' notice given to TAP by a holder of Series Z Preferred Stock that is a member of the Travelers Affiliated Group, at a redemption price equal to the aggregate Liquidation Preference of the shares to be 115 redeemed, plus accrued and accumulated but unpaid dividends (whether or not earned or declared) on such shares to but excluding the date fixed for redemption. The aggregate amount of Series Z Preferred Stock required to be redeemed by TAP on any mandatory redemption date will be limited to an "Applicable Amount," which is equal to the aggregate net proceeds (regardless of the actual use of such proceeds) received by TAP or a subsidiary trust of TAP from the date of initial issuance of the Series Z Preferred Stock to and including the applicable mandatory redemption date, from any issuance and sale by TAP or a subsidiary of TAP of shares of its capital stock (or, in the case of a subsidiary trust of TAP, beneficial interests in the trust) (except sales to the Private Investors pursuant to the Private Investors Stock Purchase Agreements and other than issuances pursuant to benefit plans for employees or directors, or non-cash issuances and sales in connection with an acquisition, exchange offer, recapitalization or similar transaction), less the aggregate Liquidation Preference of all shares of Series Z Preferred Stock redeemed by TAP pursuant to this mandatory redemption provision prior to such redemption date. This right to request redemption will automatically terminate with respect to any shares of Series Z Preferred Stock that are transferred to a person other than a member of the Travelers Affiliated Group. Travelers Group has indicated that it will not request TAP to redeem shares of Series Z Preferred Stock in connection with the Equity Offering, but does expect to request redemption of shares in connection with the expected offering of trust preferred securities pursuant to the Trust Preferred Securities Offerings. See "Use of Proceeds" and "Certain Indebtedness." ANTITAKEOVER EFFECTS OF PROVISIONS OF THE CHARTER, BY-LAWS AND CERTAIN OTHER AGREEMENTS Stockholders' rights and related matters are governed by the DGCL, the Charter, the By-Laws, the Shareholders Agreement and the Intercompany Agreement. Certain provisions of the DGCL, the Charter, the By-Laws, the Shareholders Agreement and the Intercompany Agreement, which are summarized below, may discourage or make more difficult a takeover attempt that a stockholder might consider in its best interest. Such provisions may also adversely affect prevailing market prices for the Class A Common Stock. Board of Directors. The Charter provides that the Board will be classified with approximately one-third of the Board elected each year. The number of directors will be fixed from time to time by a majority of the total number of directors which TAP would have if there were no vacancies. The number of directors that will comprise the Board of Directors has been fixed at nine. The directors will be divided into three classes, designated Class I, Class II and Class III. Each class will consist, as nearly as may be possible, of one-third of the total number of directors constituting the entire Board. The initial division of the Board into classes will be made by the decision of a majority of the entire Board. The term of the initial Class I directors will terminate on the date of the 1997 annual meeting of stockholders; the term of the initial Class II directors will terminate on the date of the 1998 annual meeting of stockholders; and the term of the initial Class III directors will terminate on the date of the 1999 annual meeting of stockholders. At each annual meeting of stockholders beginning in 1997, successors to the class of directors whose term expires at that annual meeting will be elected for a three-year term. In addition, subject to certain limited exceptions, if the number of directors is changed, any increase or decrease will be apportioned among the classes so as to maintain the number of directors in each class as nearly equal as possible, and any additional director of any class elected to fill a vacancy resulting from an increase in such class will hold office for a term that will coincide with the remaining term of that class, but in no case will a decrease in the number of directors shorten the term of any incumbent director. Immediately following consummation of the Equity Offering, TIGI will own all of the outstanding shares of Class B Common Stock, representing approximately 98.0% of the combined voting power of the Common Stock and approximately 82.7% of the economic interest in TAP (97.9% and 82.0%, respectively, if the U.S. Underwriters' over-allotment option is exercised in full). Therefore, subject to the rights of one of the Private Investors (as described below), TIGI will have the power to elect all of the members of TAP's Board of Directors and will have the power to control all matters requiring stockholder approval. So long as the Private Investors continue beneficially to own at least 52% of the shares of Class A Common Stock purchased pursuant to the Private Investors Stock Purchase Agreements, then, subject to certain conditions, an individual to be named in the Shareholders Agreement will be nominated to the Board of Directors of TAP, and the Travelers Affiliated Group has agreed to vote its shares of Common Stock in favor of such individual. If the conditions required to nominate such individual are not satisfied, then such Private Investor will have the right to nominate an alternative director to the Board of Directors of TAP, and if such nominee is found to be reasonably satisfactory to the other members of the Board of Directors of TAP and to the members of the Travelers Affiliated Group holding shares of Common Stock at such time, the Travelers Affiliated Group has agreed to vote its shares of Common Stock in favor of such nominee. See "Certain Transactions--Private Investors." 116 No Stockholder Action by Written Consent; Special Meetings. The Charter prohibits stockholders from taking action by written consent in lieu of an annual or special meeting, except in connection with a change in TAP's name from "Travelers/Aetna Property Casualty Corp.", and thus stockholders will only be able to take action at an annual or special meeting called in accordance with the By-Laws. The By-Laws provide that special meetings of stockholders may only be called by (i) the Chairman of the Board, the Vice Chairman of the Board, the Chairman of the Executive Committee, the President or the Secretary of TAP or (ii) any such officer at the request in writing of the Board or of the Executive Committee of the Board. Stockholders will not be able to call special meetings. Advance Notice Requirements for Stockholder Proposals and Director Nominations. The By-Laws contain advance notice procedures with regard to stockholder proposals and the nomination, other than by or at the direction of the Board or a committee thereof, of candidates for election as directors of TAP. These procedures provide that notice of stockholder proposals and stockholder nominations for the election of directors at an annual meeting must be in writing and received by the Secretary of TAP no later than 50 days prior to such annual meeting (or if less than 50 days' notice of a meeting of stockholders is given, stockholder proposals and nominations must be delivered to the Secretary of TAP no later than the close of business on the seventh day following the day notice was mailed). Stockholder proposals and nominations for the election of directors at a special meeting must be in writing and received by the Secretary of TAP no later than the close of business on the tenth day following the day on which notice of the meeting was mailed or public disclosure of the date of the meeting was made, whichever occurs first. The notice of stockholder nominations must set forth certain information with respect to each nominee who is not an incumbent director. ANTITAKEOVER LEGISLATION Section 203 of the DGCL provides that, subject to certain exceptions specified therein, an "interested stockholder" of a Delaware corporation shall not engage in any business combination, including mergers or consolidations or acquisitions of additional shares of the corporation, with the corporation for a three-year period following the date that such stockholder becomes an "interested stockholder" unless (i) prior to such date, the board of directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an "interested stockholder," (ii) upon consummation of the transaction which resulted in the stockholder becoming an "interested stockholder," the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (excluding certain shares), or (iii) on or subsequent to such date, the business combination is approved by the board of directors of the corporation and authorized at an annual or special meeting of stockholders by the affirmative vote of at least 66 2/3% of the outstanding voting stock which is not owned by the "interested stockholder." Except as otherwise specified in Section 203, an "interested stockholder" is defined to include (x) any person that is the owner of 15% or more of the outstanding voting stock of the corporation, or is an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock of the corporation at any time within three years immediately prior to the relevant date and (y) the affiliates and associates of any such person. A Delaware corporation, pursuant to a provision in its certificate of incorporation or by-laws, may choose not to be governed by Section 203, in which case such election becomes effective one year after its adoption. TAP has chosen, pursuant to a provision in its Charter, not to be governed by Section 203 of the DGCL. Such election is expected to become effective on March 29, 1997, one year after such election was made. INSURANCE REGULATIONS CONCERNING CHANGE OF CONTROL Many state insurance regulatory laws intended primarily for the protection of policyholders contain provisions that require advance approval by state agencies of any change in control of an insurance company or insurance holding company that is domiciled (or, in some cases, having such substantial business that it is deemed to be commercially domiciled) in that state. See "Business--Regulation." CHARTER PROVISIONS RELATING TO CORPORATE OPPORTUNITIES AND INTERESTED DIRECTORS For the purpose of the description below of the corporate opportunity and interested director provisions, the terms "TAP" and "Travelers Group" include their subsidiaries and other entities in which they respectively own 50% or more of the voting power or similar interests and, in the case of Travelers Group, all successors by way of merger, consolidation or sale of all or substantially all of its assets. 117 In order to address certain potential conflicts of interest between TAP and Travelers Group, the Charter contains provisions regulating and defining the conduct of certain affairs of TAP as they may involve Travelers Group and their officers and directors, and the powers, rights, duties and liabilities of TAP and its officers, directors and stockholders in connection therewith. In general, these provisions recognize that TAP and Travelers Group may engage in the same or similar business activities and lines of business, have an interest in the same areas of corporate opportunities and that TAP and Travelers Group will continue to have certain contractual and business relations with each other (including service of officers and directors of Travelers Group as directors of TAP). See "Management--Directors and Executive Officers of TAP" and "Certain Transactions." TAP's Charter provides that Travelers Group shall have no duty to refrain from (i) engaging in the same or similar business activities or lines of business as TAP, (ii) doing business with any client or customer of TAP or (iii) employing or otherwise engaging any officer or employee of TAP. Accordingly, neither Travelers Group nor any officer or director of Travelers Group (except as provided in the following paragraph) will be liable to TAP or to its stockholders for breach of any fiduciary duty by reason of any such activities. TAP's Charter provides that Travelers Group is not under any duty to present any corporate opportunity to TAP which may be a corporate opportunity for Travelers Group and TAP and Travelers Group will not be liable to TAP or its stockholders for breach of any fiduciary duty as a stockholder of TAP by reason of the fact that Travelers Group pursues or acquires such corporate opportunity for itself, directs such corporate opportunity to another person or does not present such corporate opportunity to TAP. Where corporate opportunities are offered to persons who are directors or officers of TAP and Travelers Group the Charter provides that such directors or officers of TAP (a) shall have fully satisfied their fiduciary duties to TAP and its stockholders with respect to such corporate opportunity, (b) shall not be liable to TAP or its stockholders for breach of fiduciary duty by reasons of Travelers Group's actions with respect to such corporate opportunity, (c) shall, for purposes of the Charter, be deemed to have acted in good faith and in a manner such officers and directors believed to be in and not opposed to the best interests of TAP and (d) shall, for purpose of the Charter, be deemed not to have breached their duties of loyalty to TAP or its stockholders or to have derived an improper personal benefit therefrom, if such persons act in good faith in a manner consistent with the following policy: (i) a corporate opportunity offered to any person who is an officer of TAP and who is also a director but not an officer of Travelers Group shall belong to TAP, unless such opportunity is expressly offered to such person solely in his capacity as a director of Travelers Group, in which case such opportunity shall belong to Travelers Group; (ii) a corporate opportunity offered to any person who is a director but not an officer of TAP and who is also a director or an officer of Travelers Group shall belong to TAP only if such opportunity is expressly offered to such person solely in his capacity as a director of TAP, and otherwise shall belong to Travelers Group; and (iii) a corporate opportunity offered to any person who is an officer of both TAP and Travelers Group shall belong to Travelers Group, unless (x) such person is an employee of TAP or (y) such opportunity is expressly offered to such person solely in his capacity as an officer of TAP, in either of which case such opportunity shall belong to TAP. For purposes of the Charter, "corporate opportunities" include business opportunities that TAP is financially able to undertake, that are, from their nature, in TAP's line of business, are of practical advantage to it and are ones in which it has an interest or a reasonable expectancy, and in which, by embracing the opportunities, the self-interest of Travelers Group or its officers or directors will be brought into conflict with that of TAP. The Charter also provides that no contract, agreement, arrangement or transaction between TAP and Travelers Group or between TAP and any entity in which a director of TAP has a financial interest (a "Related Entity") or between TAP and any director or officer of TAP, Travelers Group or any Related Entity shall be void or voidable solely for the reason that Travelers Group, a Related Entity or any one or more of the officers or directors of TAP, Travelers Group or any Related Entity are parties thereto, or solely because any such directors or officers are present at, participate in or vote with respect to the authorization of the contract, agreement, arrangement or transaction, and that Travelers Group, any Related Entity and such directors and officers (a) shall have fully satisfied and fulfilled their fiduciary duties to TAP and its stockholders with respect thereto, (b) shall not 118 be liable to TAP or its stockholders for any breach of fiduciary duty by reason of the entering into, performance or consummation of any such contract, agreement, arrangement or transaction, (c) shall, for purposes of the Charter, be deemed to have acted in good faith and in a manner such persons reasonably believed to be in and not opposed to the best interests of TAP and (d) shall, for purposes of the Charter, be deemed not to have breached their duties of loyalty to TAP and its stockholders and not to have derived an improper personal benefit therefrom, if: (i) the material facts as to the contract, agreement, arrangement or transaction are disclosed or are known to TAP's Board of Directors or the committee thereof that authorizes the contract, agreement, arrangement or transaction, and TAP's Board of Directors or such committee in good faith authorizes the contract, agreement, arrangement or transaction by the affirmative vote of a majority of the disinterested directors, even though the disinterested directors be less than a quorum; or (ii) the material facts as to the contract, agreement, arrangement or transaction are disclosed or are known to the holders of the then outstanding Common Stock entitled to vote thereon and the contract, agreement, arrangement or transaction is specifically approved in good faith by vote of the holders of a majority of the voting power of the then outstanding Common Stock not owned by Travelers Group or a Related Entity, as the case may be. Any person purchasing or otherwise acquiring any interest in any shares of capital stock of TAP will be deemed to have consented to such provisions of the Charter. Until the time that Travelers Group ceases to own at least 20% of the combined voting power of the outstanding Common Stock, the affirmative vote of the holders of more than 80% of the combined voting power of the outstanding Common Stock is required to alter, amend or repeal, or adopt any provision inconsistent with the corporate opportunity and interested director provisions described above. Accordingly, until such time, so long as Travelers Group controls at least 20% of such voting power, it can prevent any such alteration, adoption, amendment or repeal. PROVISIONS RELATING TO REGULATORY STATUS The Charter also contains provisions regulating and defining the conduct of certain affairs of TAP as they may affect Travelers Group and its legal and regulatory status. In general, the Charter provides that, without the written consent of Travelers Group, TAP shall not take any action that would result in (a) Travelers Group being required to file any documents with, register with, obtain the authorization of, or otherwise become subject to any rules, regulations or other legal restrictions of any governmental, administrative or regulatory authority or (b) any director of TAP who is also a director or officer of Travelers Group being ineligible to serve or prohibited from serving as a director of TAP under applicable law. The Charter further provides that Travelers Group shall not be liable to TAP or its stockholders for breach of any fiduciary duty by reason of the fact that Travelers Group gives or withholds any such consent for any reason. In addition, any persons purchasing or otherwise acquiring any interest in shares of capital stock of TAP will be deemed to have consented to such provisions of the Charter. Until the time that Travelers Group ceases to own at least 20% of the combined voting power of the outstanding Common Stock, the affirmative vote of the holders of more than 80% of the combined voting power of the Common Stock is required to alter, amend or repeal, or adopt any provision inconsistent with, this provision of the Charter described above; however, the provision relating to legal and regulatory status automatically becomes inoperative six months after Travelers Group ceases to own at least 20% of the voting power of the then outstanding Common Stock. Accordingly, until such time, so long as Travelers Group controls at least 20% of the combined voting power of such Common Stock, it can prevent any alteration, adoption, amendment or repeal of such provision. For the purpose of the above description of the corporate opportunity, interested director and legal and regulatory status provisions, the terms "TAP" and "Travelers Group" include their subsidiaries and other entities in which they respectively own 50% or more of the voting power or similar interests and, in the case of Travelers Group, all successors by way of merger, consolidation or sale of all or substantially all of its assets. 119 The Delaware courts have not conclusively determined the validity or enforceability of provisions similar to the corporate opportunity, interested director and legal and regulatory status provisions that are included in TAP's Charter and could rule that certain liabilities which they purport to eliminate remain in effect. LIMITATION OF LIABILITY OF DIRECTORS AND OFFICERS The Charter provides that a director or officer of TAP will not be personally liable to TAP or its stockholders for monetary damages for breach of fiduciary duty as a director or officer, except for liability (i) for any breach of the director's or officer's duty of loyalty to TAP or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the DGCL which concerns unlawful payment of dividends, stock purchases or redemptions, or (iv) for any transaction from which the director or officer derived an improper personal benefit. While the Charter provides directors and officers with protection from awards for monetary damages for breaches of their duty of care, it does not eliminate such duty. Accordingly, the Charter will have no effect on the availability of equitable remedies such as an injunction or rescission based on a director's or officer's breach of his or her duty of care. CERTAIN INDEBTEDNESS BANK DEBT The following summary of the Credit Agreement does not purport to be complete and is qualified in its entirety by reference to the Credit Agreement, a copy of which has been filed as an exhibit to the Registration Statement of which this Prospectus is a part. Capitalized terms used but not defined herein have the meanings given to them in the Credit Agreement. Pursuant to a credit agreement dated as of March 15, 1996 (the "Credit Agreement"), a syndicate of banks for which Citibank, N.A. is acting as Administrative Agent has agreed to provide TAP with a $2.65 billion five-year unsecured revolving credit facility. On April 2, 1996, TAP borrowed the full $2.65 billion under the Credit Agreement. See "Recent History." During the five-year term of the Credit Agreement, TAP may borrow, repay and reborrow up to a maximum outstanding principal amount of $2.65 billion. Borrowings under the Credit Agreement bear interest at floating rates, the margins of which remain constant during the five-year term of the Credit Agreement but will vary with the ratings assigned to TAP's long-term unsecured senior debt by Standard & Poor's and Moody's. TAP may repay any loans under the Credit Agreement, subject to certain breakage costs if loans are repaid other than at the end of an interest period. TAP may reduce the unused portion of the Credit Agreement at any time or times and may terminate the Credit Agreement upon payment of all amounts owing under the Credit Agreement. Under the Credit Agreement, TAP must maintain Consolidated Stockholders' Equity (as defined in the Credit Agreement) of at least $4.175 billion plus 25% of post-Acquisition consolidated net income, and may not incur consolidated debt of more than 45% of the sum of TAP's consolidated debt and consolidated stockholders' equity, subject in each case to certain adjustments. The Credit Agreement also contains customary representations and warranties, financial and other covenants (including limitations relating to the incurrence of additional liens and additional indebtedness and restrictions relating to transactions with affiliates), events of default (including Travelers Group failing to own and control more than 50% of the voting power of TAP's voting stock) and other provisions typical of facilities of this kind. In addition, any lender may withdraw from the Credit Agreement and have its loans repaid if there is a change of control of Travelers Group involving the acquisition of more than 35% of Travelers Group's voting stock by any person or group (other than employee benefit plans or subsidiaries or senior executive officers or directors of Travelers Group) or a majority of Travelers Group's board of directors ceasing during any 36-month period to be continuing directors (i.e., persons who were directors on the first day of the period or whose election was approved by a majority of continuing directors). 120 INTERCOMPANY LINE OF CREDIT Travelers Group, through a subsidiary, has provided to TAP a line of credit of up to $200 million for working capital and other general corporate purposes. The line of credit is evidenced by an unsecured promissory note, and the interest rate, interest payment dates and maturity date of any borrowings under the note will be as agreed upon by TAP and the lender at the time such borrowings are made. The lender has no obligation to make any loan to TAP under this line of credit at any time. As of the date of this Prospectus, there is no outstanding balance under the note. THE DEBT OFFERINGS TAP has filed a Registration Statement under the Securities Act with respect to $2 billion aggregate principal amount of debt securities that may be issued from time to time by TAP pursuant to separate prospectuses. On or about the date hereof, TAP expects, subject to market conditions, to sell up to $1.5 billion of senior debt securities (the "Debt Securities"). The Company may, subject to market conditions and other factors, issue commercial paper or other short-term instruments in lieu of a portion of the Debt Securities. The applicable interest rates, public offering prices, redemption provisions (if any), maturities and other terms of the Debt Securities and other debt securities registered pursuant to such Registration Statement (collectively, the "Securities") would be determined by negotiation between TAP and the underwriters of such Securities. The Securities will be issued under an Indenture (the "Debt Securities Indenture"), which is expected to provide that securities may be issued from time to time thereunder in series. Any securities issued thereunder would rank on a parity with one another and with all unsecured and unsubordinated indebtedness of TAP. The Debt Securities Indenture is expected to contain certain restrictive covenants, including covenants that, among other things, will limit the ability of TAP and its subsidiaries to incur indebtedness secured by voting stock of its subsidiaries and will limit TAP's ability to engage in mergers, consolidations and sales of substantially all of their assets. The Debt Securities Indenture is also expected to contain certain events of default, the occurrence of which would allow the trustee under such Indenture or the holders of 25% in aggregate principal amount of any series of Securities to declare the principal of and accrued interest on such Securities to be immediately due and payable. Such events of default include failure to pay principal when due, failure for 30 days to pay interest when due, default under any covenant in the Debt Securities Indenture continued for 60 days after notice of such default, failure to pay at maturity or acceleration of maturity of certain indebtedness aggregating $50 million or more, and certain events of bankruptcy, insolvency or reorganization. TAP may determine to create additional restrictive covenants and events of default with respect to any particular series of Debt Securities. The Debt Securities, if issued, will be "Senior Indebtedness" of TAP and the Junior Subordinated Debt Securities will be subordinated to such Debt Securities. DESCRIPTION OF JUNIOR SUBORDINATED DEBT SECURITIES The following description sets forth certain general terms and provisions of the Junior Subordinated Debt Securities to which any Prospectus Supplement may relate. The particular terms of the Junior Subordinated Debt Securities offered by any Prospectus Supplement and the extent, if any, to which such general provisions may apply to the Junior Subordinated Debt Securities so offered will be described in the Prospectus Supplement relating to such Junior Subordinated Debt Securities. The Junior Subordinated Debt Securities may be issued, from time to time, in one or more series, under an Indenture, dated as of April 30, 1996 (the "Indenture"), between TAP and The Chase Manhattan Bank, N.A., as trustee (the "Indenture Trustee"), the form of which is filed as an exhibit to the Registration Statement of which this Prospectus forms a part. The following summary of certain provisions of the Junior Subordinated Debt Securities and the Indenture does not purport to be complete and is subject to, and is qualified in its entirety by express reference to, all of the 121 provisions of the Indenture, including the definitions therein of certain terms. All article and section references appearing herein are to articles and sections of the Indenture, unless otherwise indicated, and capitalized terms which are not otherwise defined in this Prospectus shall have the meanings specified in the Indenture. General. The Junior Subordinated Debt Securities will be direct, unsecured obligations of TAP. The Indenture does not limit the amount of Junior Subordinated Debt Securities which may be issued thereunder, and provides that Junior Subordinated Debt Securities may be issued thereunder in series up to the aggregate principal amount which may be authorized from time to time by the Board of Directors of TAP. (Section 3.1) Reference is made to the Prospectus Supplement which accompanies this Prospectus for the following terms and other information with respect to the Junior Subordinated Debt Securities being offered thereby: (i) the designation, priority, aggregate principal amount and authorized denominations; (ii) the percentage of their principal amount at which such Junior Subordinated Debt Securities will be issued; (iii) the date on which such Junior Subordinated Debt Securities will mature; (iv) the rate per annum at which such Junior Subordinated Debt Securities will bear interest or the method of determination of such rate; (v) the dates on which such interest will be payable; (vi) the rights, if any, to defer payments of interest on the Junior Subordinated Debt Securities by extending the interest payment period, and the maximum duration of such extensions; (vii) the place or places where payments on such Junior Subordinated Debt Securities shall be made; (viii) any redemption terms or sinking fund provisions; (ix) the terms of subordination of Junior Subordinated Debt Securities; (x) whether Debt Securities issued in fully registered form will be represented by either a global security delivered to a depositary and recorded in a book-entry system maintained by such depositary or by a certificate delivered to the Holder; (xi) the restrictions, if any, applicable to the exchange of Junior Subordinated Debt Securities of a series of one form for another of such series and to the offer, sale and delivery of the Junior Subordinated Debt Securities; (xii) whether and under what circumstances TAP will pay additional amounts in the event of certain developments with respect to United States withholding tax or information reporting laws; or (xiii) other specific terms. Unless otherwise specified in the applicable Prospectus Supplement, Junior Subordinated Debt Securities will be issued in fully registered form without coupons, will be exchangeable for other Junior Subordinated Debt Securities of the same series, registered in the same name, for a like aggregate principal amount in authorized denominations, and will be transferable at any time or from time to time at the Corporate Trust Office of the Indenture Trustee or at any other office or agency of TAP maintained for that purpose. No charge will be made to the Holder for any such exchange or transfer except for any tax or governmental charge incidental thereto. Unless otherwise described in the Prospectus Supplement accompanying this Prospectus, there are no covenants or provisions contained in the Indenture which afford the Holders of the Junior Subordinated Debt Securities protection in the event of a highly leveraged transaction involving TAP. Consolidation, Merger and Sale of Assets. The Indenture provides that TAP will not consolidate with or merge into any other corporation or convey, transfer or lease its assets substantially as an entirety unless (a) the successor is a corporation organized in the United States and expressly assumes the due and punctual payment of the principal of (and premium, if any) and interest on all Junior Subordinated Debt Securities issued thereunder and the performance of every other covenant of the Indenture on the part of TAP and (b) immediately thereafter no Event of Default and no event which, after notice or lapse of time, or both, would become an Event of Default, shall have happened and be continuing. Upon any such consolidation, merger, conveyance or transfer, the successor corporation shall succeed to and be substituted for TAP under the Indenture and thereafter the predecessor corporation shall be relieved of all obligations and covenants under the Indenture and the Junior Subordinated Debt Securities. (Article Eight) Events of Default. The Indenture provides that the following are Events of Default thereunder with respect to any series of the Junior Subordinated Debt Securities: (a) default in the payment of the principal of (or premium, if any, on) any Junior Subordinated Debt Security of such series at its maturity; (b) default in making a sinking fund payment, if any, when and as the same shall be due and payable by the terms of the Junior Subordinated Debt Securities of such series; (c) default for 30 days in the payment of any installment of interest on any Junior Subordinated Debt Security of such series; (d) default for 90 days after written notice in the performance of any other covenant in respect of the Junior Subordinated Debt Securities of such series contained in the Indenture; (e) certain events of bankruptcy, insolvency or reorganization, or court appointment of a receiver, liquidator or trustee of TAP; (f) any other Event of Default provided in the applicable resolution of the Board of Directors or supplemental indenture under which the Junior Subordinated Debt Securities are issued; and (g) in the event 122 Junior Subordinated Debt Securities of a series are issued and sold to a TAP Trust or a trustee of such trust in connection with the issuance of Trust Securities by such TAP Trust, such TAP Trust shall have voluntarily or involuntarily dissolved, wound-up its business or otherwise terminated its existence, except in connection with (i) the distribution of Junior Subordinated Debt Securities to holders of Trust Securities in liquidation or redemption of their interests in such TAP Trust upon a Special Event, (ii) the redemption of all of the outstanding Trust Securities of such TAP Trust or (iii) certain mergers, consolidations or amalgamations, each as permitted by the Declaration of such TAP Trust. (Section 5.1) The Indenture Trustee may withhold notice to the Holders of the Junior Subordinated Debt Securities of any default with respect thereto (except in the payment of principal, premium or interest) if it considers such withholding to be in the interests of such Holders. (Section 6.2) If an Event of Default with respect to the Junior Subordinated Debt Securities shall have occurred and be continuing, the Indenture Trustee or the Holders of 25% in aggregate principal amount of the Junior Subordinated Debt Securities may declare the principal of all the Junior Subordinated Debt Securities to be due and payable immediately. (Section 5.2) The Indenture contains a provision entitling the Indenture Trustee to be indemnified by the Holders before proceeding to exercise any right or power under the Indenture at the request of any of the Holders. (Section 6.3). The Indenture provides that the Holders of a majority in principal amount of the outstanding Junior Subordinated Debt Securities may direct the time, method and place of conducting any proceeding for any remedy available to the Indenture Trustee, or exercising any trust or power conferred upon the Indenture Trustee, with respect to the Junior Subordinated Debt Securities. (Section 5.12) The right of a Holder to institute a proceeding with respect to the Indenture is subject to certain conditions precedent including notice and indemnity to the Indenture Trustee, but the Holder has an absolute right to receipt of principal, premium, if any, and interest on the Junior Subordinated Debt Securities at the Stated Maturity (or, in the case of redemption, on the Redemption Date) or to institute suit for the enforcement thereof. (Sections 5.7 and 5.8) The Holders of not less than a majority in principal amount of the Outstanding Junior Subordinated Debt Securities may on behalf of the Holders of all the Junior Subordinated Debt Securities waive any past defaults except (a) a default in payment of the principal of (or premium, if any) or interest on any Junior Subordinated Debt Security and (b) a default in respect of a covenant or provision of the Indenture which cannot be amended or modified without the consent of the Holder of each affected Junior Subordinated Debt Security; provided, however, that if the Junior Subordinated Debt Securities are held by a TAP Trust or a trustee of such trust, such waiver or modification to such waiver shall not be effective until the holders of a majority in liquidation preference of Trust Securities of the applicable TAP Trust shall have consented to such waiver or modification to such waiver; provided further, that if the consent of the Holder of each outstanding Junior Subordinated Debt Security is required, such waiver shall not be effective until each holder of the Trust Securities of the applicable TAP Trust shall have consented to such waiver. (Section 5.13) The Indenture requires TAP to furnish to the Indenture Trustee an annual statement as to defaults, if any, by TAP under the Indenture. (Section 10.4) Modifications and Amendments. Modifications and amendments to the Indenture may be made by TAP and the Indenture Trustee with the consent of the Holders of a majority in principal amount of the Junior Subordinated Debt Securities at the time outstanding of each series which is affected thereby, provided, that no such modification or amendment may, without the consent of the Holder of each Junior Subordinated Debt Security affected thereby: (i) modify the terms of payment of principal, premium, if any, or interest; or (ii) reduce the percentage of Holders of Junior Subordinated Debt Securities necessary to modify or amend the Indenture or waive compliance by TAP with any covenant or past default, provided, further, that if the Junior Subordinated Debt Securities of such series are held by a TAP Trust or a trustee of such trust, such supplemental indenture shall not be effective until the holders of a majority in liquidation preference of Trust Securities of the applicable TAP Trust shall have consented to such supplemental indenture; provided further, that if the consent of the Holder of each outstanding Junior Subordinated Debt Security is required, such supplemental indenture shall not be effective until each holder of the Trust Securities of the applicable TAP Trust shall have consented to such supplemental indenture. (Section 9.2) Discharge and Defeasance. TAP may discharge all of its obligations (except those set forth below) to holders of any series of Junior Subordinated Debt Securities issued under the Indenture, which Junior Subordinated Debt Securities have not already been delivered to the Indenture Trustee for cancellation and which either have become 123 due and payable or are by their terms due and payable within one year (or are to be called for redemption within one year) by depositing with the Indenture Trustee an amount certified to be sufficient to pay when due the principal of and premium, if any, and interest on all outstanding Junior Subordinated Debt Securities of such series and to make any mandatory sinking fund payments thereon when due. (Section 4.1) Unless otherwise specified in the applicable Prospectus Supplement with respect to the Junior Subordinated Debt Securities of a series, TAP, at its option, (i) will be discharged from any and all obligations in respect of the Junior Subordinated Debt Securities of such series (except for certain obligations to pay all expenses of the applicable TAP Trust, to register the transfer or exchange of Junior Subordinated Debt Securities of such series, to replace mutilated, defaced, destroyed, lost or stolen Junior Subordinated Debt Securities of such series, and to maintain Paying Agents and hold monies for payment in trust), or (ii) need not comply with certain covenants specified in the applicable Prospectus Supplement with respect to the Junior Subordinated Debt Securities of that series, and the occurrence of an event described in clause (d) under "Events of Default" above with respect to any defeased covenant and clause (f) of the "Events of Default" above shall no longer be an Event of Default if, in either case, TAP deposits with the Indenture Trustee, in trust, money or U.S. Government Obligations that through the payment of interest thereon and principal thereof in accordance with their terms will provide money in an amount sufficient to pay all the principal of (and premium, if any) and any interest on the Junior Subordinated Debt Securities of such series on the dates such payments are due (which may include one or more redemption dates designated by TAP) in accordance with the terms of such Junior Subordinated Debt Securities. Such a trust may only be established, if, among other things, TAP shall have delivered an Opinion of Counsel, which, in the case of a discharge pursuant to clause (i), must be based upon a ruling or administrative pronouncement of the Internal Revenue Service, to the effect that the Holders of the Junior Subordinated Debt Securities will not recognize gain or loss for federal income tax purposes as a result of such deposit or defeasance and will be subject to federal income tax in the same manner as if such defeasance had not occurred. (Sections 4.2, 4.3 and 4.4) In the event TAP omits to comply with its remaining obligations under the Indenture after a defeasance of the Indenture with respect to the Junior Subordinated Debt Securities of any series as described under clause (ii) above and the Junior Subordinated Debt Securities of such series are declared due and payable because of the occurrence of any undefeased Event of Default, the amount of money and U.S. Government Obligations on deposit with the Indenture Trustee may be insufficient to pay amounts due on the Junior Subordinated Debt Securities of such series at the time of the acceleration resulting from such Event of Default. However, TAP will remain liable in respect of such payments. Concerning the Indenture Trustees. The Indenture Trustee has extended substantial credit facilities (the borrowings under which constitute Senior Indebtedness) to TAP. TAP and certain of its subsidiaries also maintain bank accounts, borrow money and have other customary commercial banking or investment banking relationships with the Indenture Trustee in the ordinary course of business. Global Securities. The Indenture provides that the registered Junior Subordinated Debt Securities of a series may be issued in the form of one or more fully registered Global Securities (a "Registered Global Security") that will be deposited with a depositary (a "Depositary") or with a nominee for a Depositary identified in the Prospectus Supplement relating to such series and registered in the name of the Depositary or a nominee thereof. (Section 3.1) In such case, one or more Registered Global Securities will be issued in a denomination or aggregate denominations equal to the portion of the aggregate principal amount of outstanding registered Junior Subordinated Debt Securities to be represented by such Registered Global Security or Securities. Unless and until it is exchanged in whole for Junior Subordinated Debt Securities in definitive registered form, a Registered Global Security may not be transferred except as a whole by the Depositary for such Registered Global Security to a nominee of such Depositary or by a nominee of such Depositary to such Depositary or another nominee of such Depositary or by such Depositary or any such nominee to a successor of such Depositary or a nominee of such successor. The Depositary currently accepts only debt securities that are payable in U.S. dollars. The specific terms of the depositary arrangement with respect to any portion of a series of Junior Subordinated Debt Securities to be represented by a Registered Global Security will be described in the Prospectus Supplement relating to such series. Ownership of beneficial interests in a Registered Global Security will be limited to persons that have accounts with the Depositary for such Registered Global Security ("participants") or persons that may hold interests through participants. Upon the issuance of a Registered Global Security, the Depositary for such Registered 124 Global Security will credit, on its book-entry registration and transfer system, the participants' accounts with the respective principal amounts of the Debt Securities represented by such Registered Global Security beneficially owned by such participants. The accounts to be credited shall be designated by any dealers, underwriters or agents participating in the distribution of such Junior Subordinated Debt Securities. Ownership of beneficial interests in such Registered Global Security will be shown on, and the transfer of such ownership interests will be effected only through, records maintained by the Depositary for such Registered Global Security (with respect to interests of participants) and on the records of participants (with respect to interests of persons holding through participants). The laws of some states may require that certain purchasers of securities take physical delivery of such securities in definitive form. Such limits and such laws may impair the ability to own, transfer or pledge beneficial interests in Registered Global Securities. So long as the Depositary for a Registered Global Security, or its nominee, is the registered owner of such Registered Global Security, such Depositary or such nominee, as the case may be, will be considered the sole owner or holder of the Junior Subordinated Debt Securities represented by such Registered Global Security for all purposes under the Indenture. Except as set forth below, owners of beneficial interests in a Registered Global Security will not be entitled to have the Junior Subordinated Debt Securities represented by such Registered Global Security registered in their names, will not receive or be entitled to receive physical delivery of such Junior Subordinated Debt Securities in definitive form and will not be considered the owners or holders thereof under the Indenture. Accordingly, each person owning a beneficial interest in a Registered Global Security must rely on the procedures of the Depositary for such Registered Global Security and, if such person is not a participant, on the procedures of the participant through which such person owns its interest, to exercise any rights of a holder under the Indenture. TAP understands that under existing industry practices, if TAP requests any action of holders or if an owner of a beneficial interest in a Registered Global Security desires to give or take any action which a holder is entitled to give or take under the Indenture, the Depositary for such Registered Global Security would authorize the participants holding the relevant beneficial interests to give or take such action, and such participants would authorize beneficial owners owning through such participants to give or take such action or would otherwise act upon the instructions of beneficial owners holding through them. Principal, premium, if any, and interest payments on Junior Subordinated Debt Securities represented by a Registered Global Security registered in the name of a Depositary or its nominee will be made to such Depositary or its nominee, as the case may be, as the registered owner of such Registered Global Security. None of TAP, the Indenture Trustee or any other agent of TAP or agent of the Indenture Trustee will have any responsibility or liability for any aspect of the records relating to or payments made on account of beneficial ownership interests in such Registered Global Security or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests. TAP expects that the Depositary for any Junior Subordinated Debt Securities represented by a Registered Global Security, upon receipt of any payment of principal, premium or interest in respect of such Registered Global Security, will immediately credit participants' accounts with payments in amounts proportionate to their respective beneficial interests in such Registered Global Security as shown on the records of such Depositary. TAP also expects that payments by participants to owners of beneficial interests in such Registered Global Security held through such participants will be governed by standing customer instructions and customary practices, as is now the case with the securities held for the accounts of customers in bearer form or registered in "street name," and will be the responsibility of such participants. If the Depositary for any Junior Subordinated Debt Securities represented by a Registered Global Security is at any time unwilling or unable to continue as Depositary or ceases to be a clearing agency registered under the Exchange Act, and a successor Depositary registered as a clearing agency under the Exchange Act is not appointed by TAP within 90 days, TAP will issue such Junior Subordinated Debt Securities in definitive form in exchange for such Registered Global Security. In addition, TAP may at any time and in its sole discretion determine not to have any of the Junior Subordinated Debt Securities of a series represented by one or more Registered Global Securities and, in such event, will issue Junior Subordinated Debt Securities of such series in definitive form in exchange for all of the Registered Global Security or Securities representing such Junior Subordinated Debt Securities. Any Junior Subordinated Debt Securities issued in definitive form in exchange for a Registered Global Security will be registered in such name or names as the Depositary shall instruct the relevant Trustee. It is expected that such instructions will be based upon directions received by the Depositary from participants with respect to ownership of beneficial interests in such Registered Global Security. 125 The Junior Subordinated Debt Securities of a series may also be issued in the form of one or more bearer global Securities (a "Bearer Global Security") that will be deposited with a common depositary for Euro-clear and Cedel Bank, societe anonyme, or with a nominee for such depositary identified in the Prospectus Supplement relating to such series. The specific terms and procedures, including the specific terms of the depositary arrangement, with respect to any portion of a series of Junior Subordinated Debt Securities to be represented by a Bearer Global Security will be described in the Prospectus Supplement relating to such series. Ranking of Junior Subordinated Debt Securities. The Junior Subordinated Debt Securities will be subordinated and junior in right of payment to certain indebtedness of TAP to the extent set forth in the Prospectus Supplement that will accompany this Prospectus. Certain Provisions Applicable to TAP Trusts. In the event Junior Subordinated Debt Securities of a series are issued and sold to a TAP Trust or a trustee of such trust in connection with the issuance of Trust Securities by such TAP Trust, such Junior Subordinated Debt Securities subsequently may be distributed pro rata to the holders of such Trust Securities in connection with the dissolution of such TAP Trust upon the occurrence of certain events described in the Prospectus Supplement relating to such Trust Securities. Only one series of Junior Subordinated Debt Securities will be issued to a TAP Trust, or a trustee of such trust, in connection with the issuance of Trust Securities by such TAP Trust. If Junior Subordinated Debt Securities are issued to a TAP Trust or a trustee of such trust in connection with the issuance of Trust Securities by such TAP Trust and (i) there shall have occurred and be continuing an Event of Default, (ii) TAP shall be in default with respect to its payment of any obligations under the related Guarantee, or (iii) TAP shall have given notice of its election to defer payments of interest on such Junior Subordinated Debt Securities by extending the interest payment period as provided in the Indenture and such period, or any extension thereof, shall be continuing, then (a) TAP shall not declare or pay any dividend on, make any distributions with respect to, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock or make any guarantee payment with respect thereto (other than (i) repurchases, redemptions or other acquisitions of shares of capital stock of TAP in connection with any employment contract, benefit plan or other similar arrangement with or for the benefit of employees, officers, directors or consultants, (ii) as a result of an exchange or conversion of any class or series of TAP's capital stock for any other class or series of the TAP's capital stock, or (iii) the purchase of fractional interests in shares of TAP's capital stock pursuant to the conversion or exchange provisions of such capital stock or the security being converted or exchanged), and (b) TAP shall not make any payment of interest on or principal of (or premium, if any, on), or repay, repurchase or redeem any debt securities issued by TAP which rank pari passu with or junior to such Junior Subordinated Debt Securities. The foregoing, however, will not apply to any stock dividends paid by TAP where the dividend stock is the same stock as that on which the dividend is being paid. In the event Junior Subordinated Debt Securities are issued to a TAP Trust or a trustee of such trust in connection with the issuance of Trust Securities of such TAP Trust, for so long as such Trust Securities remain outstanding, TAP will covenant (i) to directly or indirectly maintain 100% ownership of the Common Securities of such TAP Trust; provided, however, that any permitted successor of TAP under the Indenture may succeed to TAP's ownership of such Common Securities, (ii) to not voluntarily dissolve, wind-up or terminate such TAP Trust, except in connection with a distribution of Junior Subordinated Debt Securities upon a Special Event and in connection with certain mergers, consolidations or amalgamations permitted by the Declaration of the applicable TAP Trust, (iii) to timely perform its duties as Sponsor of the applicable TAP Trust and (iv) to use its reasonable efforts to cause such TAP Trust (a) to remain a statutory business trust, except in connection with the distribution of Junior Subordinated Debt Securities to the holders of Trust Securities in liquidation of such TAP Trust, the redemption of all of the Trust Securities of such TAP Trust, or certain mergers, consolidations or amalgamations, each as permitted by the Declaration of such TAP Trust, and (b) to otherwise continue to be classified as a grantor trust for United States federal income tax purposes. (Section 10.5) DESCRIPTION OF PREFERRED SECURITIES Each TAP Trust may issue, from time to time, only one series of Preferred Securities having terms described in the Prospectus Supplement relating thereto. The Declaration of each TAP Trust authorizes the Regular Trustees of such TAP Trust to issue on behalf of such TAP Trust one series of Preferred Securities. Each Declaration will be qualified as an indenture under the Trust Indenture Act. The Preferred Securities will have such terms, including distributions, redemption, voting, liquidation rights and such other preferred, deferred or 126 other special rights or such restrictions as shall be set forth in the Declaration of the TAP Trust issuing such Preferred Securities or made part of such Declaration by the Trust Indenture Act. Reference is made to any Prospectus Supplement relating to the Preferred Securities of a TAP Trust for specific terms, including (i) the distinctive designation of such Preferred Securities, (ii) the number of Preferred Securities issued by such TAP Trust, (iii) the annual distribution rate (or method of determining such rate) for Preferred Securities issued by such TAP Trust and the date or dates upon which such distributions shall be payable, (iv) whether distributions on Preferred Securities issued by such TAP Trust shall be cumulative, and, in the case of Preferred Securities having such cumulative distribution rights, the date or dates or method of determining the date or dates from which distributions on Preferred Securities issued by such TAP Trust shall be cumulative, (v) the amount or amounts which shall be paid out of the assets of such TAP Trust to the Holders of Preferred Securities of such TAP Trust upon voluntary or involuntary dissolution, winding-up or termination of such TAP Trust, (vi) the obligation, if any, of such TAP Trust to purchase or redeem Preferred Securities issued by such TAP Trust and the price or prices at which, the period or periods within which and the terms and conditions upon which Preferred Securities issued by such TAP Trust shall be purchased or redeemed, in whole or in part, pursuant to such obligation, (vii) the voting rights, if any, of Preferred Securities issued by such TAP Trust in addition to those required by law, including the number of votes per Preferred Security and any requirement for the approval by the holders of Preferred Securities, or of Preferred Securities issued by one or more TAP Trusts, or of both, as a condition to specified action or amendments to the Declaration of such TAP Trust, and (viii) any other relevant rights, preferences, privileges, limitations or restrictions of Preferred Securities issued by such TAP Trust consistent with the Declaration of such TAP Trust or with applicable law. All Preferred Securities offered hereby will be guaranteed by TAP to the extent set forth below under "Description of Guarantees." Certain United States federal income tax considerations applicable to any offering of Preferred Securities will be described in the Prospectus Supplement relating thereto. In connection with the issuance of Preferred Securities, each TAP Trust will issue one series of Common Securities. The Declaration of each TAP Trust authorizes the Regular Trustees of such trust to issue on behalf of such TAP Trust one series of Common Securities having such terms including distributions, redemption, voting, liquidation rights or such restrictions as shall be set forth therein. The terms of the Common Securities issued by such TAP Trust will be substantially identical to the terms of the Preferred Securities issued by such TAP Trust and the Common Securities will rank pari passu, and payments will be made thereon pro rata with such Preferred Securities except that, upon an Event of Default under the Declaration of such TAP Trust, the rights of the holders of such Common Securities to payment in respect of distributions and payments upon liquidation, redemption and otherwise will be subordinated to the rights of the holders of such Preferred Securities. Except in certain limited circumstances, the Common Securities of a TAP Trust will also carry the right to vote and to appoint, remove or replace any of the TAP Trustees of such TAP Trust. All of the Common Securities of a TAP Trust will be directly or indirectly owned by TAP. If an Event of Default with respect to a Declaration of any TAP Trust occurs and is continuing, then the holders of Preferred Securities of such TAP Trust would rely on the enforcement by the Institutional Trustee of its rights as a holder of the Junior Subordinated Debt Securities against TAP. In addition, the holders of a majority in liquidation amount of such Preferred Securities will have the right to direct the time, method, and place of conducting any proceeding for any remedy available to the Institutional Trustee or to direct the exercise of any trust or power conferred upon the Institutional Trustee under such Declaration, including the right to direct the Institutional Trustee to exercise the remedies available to it as a holder of the Junior Subordinated Debt Securities. If the Institutional Trustee fails to enforce its rights under the Junior Subordinated Debt Securities, any holder of such Preferred Securities may directly institute a legal proceeding against TAP to enforce the Institutional Trustee's rights under the Junior Subordinated Debt Securities without first instituting any legal proceeding against the Institutional Trustee or any other person or entity. If an Event of Default with respect to the Declaration of any TAP Trust has occurred and is continuing and such event is attributable to the failure of TAP to pay interest or principal on the Junior Subordinated Debt Securities on the date such interest or principal is otherwise payable (or in the case of redemption, on the redemption date), then a holder of Preferred Securities of such TAP Trust may also directly institute a proceeding for enforcement of payment to such holder of the principal of or interest on the Junior Subordinated Debt Securities having a principal amount equal to the aggregate liquidation amount of such Preferred Securities of such holder (a "Direct Action") on or after the respective due date specified in the Junior Subordinated Debt Securities without first (i) directing the Institutional Trustee to enforce the terms of the Junior Subordinated Debt Securities or (ii) instituting a legal proceeding against TAP to 127 enforce the Institutional Trustee's Rights under the Junior Subordinated Debt Securities. In connection with such Direct Action, TAP will be subrogated to the rights of such holder of such Preferred Securities under such Declaration to the extent of any payment made by TAP to such holder of such Preferred Securities in such Direct Action. Consequently, TAP will be entitled to payment of amounts that a holder of Preferred Securities receives in respect of an unpaid distribution that resulted in the bringing of a Direct Action to the extent that such holder receives or has already received full payment with respect to such unpaid distribution from TAP Capital. The holders of Preferred Securities of a TAP Trust will not be able to exercise directly any other remedy available to the holders of the Junior Subordinated Debt Securities. DESCRIPTION OF GUARANTEES Set forth below is a summary of information concerning the Guarantees that will be executed and delivered by TAP for the benefit of the holders, from time to time, of Preferred Securities. Each Guarantee will be qualified as an indenture under the Trust Indenture Act. The Chase Manhattan Bank, N.A. will act as indenture trustee under each Guarantee (the "Guarantee Trustee"). The terms of each Guarantee will be those set forth in such Guarantee and those made part of such Guarantee by the Trust Indenture Act. The summary does not purport to be complete and is subject in all respects to the provisions of, and is qualified in its entirety by reference to, the form of Guarantee, which is filed as an exhibit to the Registration Statement of which this Prospectus forms a part, and the Trust Indenture Act. Each Guarantee will be held by the Guarantee Trustee for the benefit of the holders of the Preferred Securities of a TAP Trust. GENERAL Pursuant to and to the extent set forth in each Guarantee, TAP will irrevocably and unconditionally agree to pay in full to the holders of the Preferred Securities issued by a TAP Trust (except to the extent paid by such TAP Trust), as and when due, regardless of any defense, right of set-off or counterclaim which such TAP Trust may have or assert, the following payments (the "Guarantee Payments"), without duplication: (i) any accrued and unpaid distributions that are required to be paid on such Preferred Securities, to the extent such TAP Trust has funds available therefor, and (ii) the redemption price of $25 per Preferred Security, plus all accrued and unpaid distributions (the "Redemption Price"), to the extent such TAP Trust has funds available therefor, with respect to any Preferred Securities called for redemption by such TAP Trust, and (iii) upon a voluntary or involuntary dissolution, winding-up or termination of such TAP Trust (other than in connection with the distribution of Junior Subordinated Debt Securities to the holders of Preferred Securities or the redemption of all of the Preferred Securities) the lesser of (a) the aggregate of the liquidation amount and all accrued and unpaid distributions on such Preferred Securities to the date of payment or (b) the amount of assets of such TAP Trust remaining for distribution to holders of such Preferred Securities in liquidation of such TAP Trust. TAP's obligation to make a Guarantee Payment may be satisfied by direct payment of the required amounts by TAP to the holders of Preferred Securities or by causing such TAP Trust to pay such amounts to such holders. Each Guarantee will be a guarantee on a subordinated basis with respect to the Preferred Securities issued by a TAP Trust from the time of issuance of such Preferred Securities but will not apply to any payment of distributions or Redemption Price, or to payments upon the dissolution, winding-up or termination of such TAP Trust, except to the extent such TAP Trust shall have funds available therefor. If TAP does not make interest payments on the Junior Subordinated Debt Securities purchased by a TAP Trust, such TAP Trust will not pay distributions on the Preferred Securities issued by such TAP Trust and will not have funds available therefor. See "Description of Junior Subordinated Debt Securities." The Guarantee, when taken together with TAP's obligations under the Junior Subordinated Debt Securities, the Indenture and the Declaration of any TAP Trust, including its obligations to pay costs, expenses, debts and liabilities of such TAP Trust (other than with respect to Trust Securities) will provide a full and unconditional guarantee on a subordinated basis by TAP of payments due on the Preferred Securities issued by such TAP Trust. CERTAIN COVENANTS OF TAP In each Guarantee, TAP will covenant that, so long as any Preferred Securities issued by a TAP Trust remain outstanding, if there shall have occurred any event that would constitute an Event of Default under such Guarantee or the Declaration of such TAP Trust, then (a) TAP shall not declare or pay any dividend on, make any 128 distributions with respect to, or redeem, purchase, acquire or make a liquidation payment with respect to, any of its capital stock or make any guarantee payment with respect thereto (other than (i) repurchases, redemptions or other acquisitions of shares of capital stock of TAP in connection with any employment contract, benefit plan or other similar arrangement with or for the benefit of employees, officers, directors or consultants, (ii) as a result of an exchange or conversion of any class or series of TAP's capital stock for any other class or series of TAP's capital stock, or (iii) the purchase of fractional interests in shares of TAP's capital stock pursuant to the conversion or exchange provisions of such capital stock or the security being converted or exchanged) and (b) TAP shall not make any payment of interest on, or principal of (or premium, if any, on), or repay, repurchase or redeem, any debt securities issued by TAP which rank pari passu with or junior to such Junior Subordinated Debt Securities. Each Guarantee, however, will except from the foregoing any stock dividends paid by TAP where the dividend stock is the same stock as that on which the dividend is being paid. MODIFICATION OF THE GUARANTEES; ASSIGNMENT Except with respect to any changes that do not adversely affect the rights of holders of Preferred Securities to which a Guarantee relates (in which case no vote will be required), each Guarantee may be amended only with the prior approval of the holders of not less than a majority in aggregate liquidation amount of the outstanding related Preferred Securities issued by a TAP Trust. The manner of obtaining any such approval of holders of such Preferred Securities will be set forth in an accompanying Prospectus Supplement. All guarantees and agreements contained in a Guarantee shall bind the successors, assignees, receivers, trustees and representatives of TAP and shall inure to the benefit of the holders of the related Preferred Securities of a TAP Trust then outstanding. EVENTS OF DEFAULT An Event of Default under a Guarantee will occur upon the failure of TAP to perform any of its payment or other obligations thereunder. The holders of a majority in aggregate liquidation amount of the Preferred Securities to which a Guarantee relates have the right to direct the time, method and place of conducting any proceeding for any remedy available to the Guarantee Trustee in respect of the Guarantee or to direct the exercise of any trust or power conferred upon the Guarantee Trustee under the Guarantee. If the Guarantee Trustee fails to enforce the Guarantee Trustee's rights under a Guarantee, any holder of related Preferred Securities may directly institute a legal proceeding against TAP to enforce the Guarantee Trustee's rights under such Guarantee without first instituting a legal proceeding against the TAP Trust that issued such Preferred Securities, the Guarantee Trustee or any other person or entity. A holder of Preferred Securities may also directly institute a legal proceeding against TAP to enforce such holder's right to receive payment under such Guarantee without first (i) directing the Guarantee Trustee to enforce the terms of the Guarantee or (ii) instituting a legal proceeding against the TAP Trust that issued such Preferred Securities or any other person or entity. TAP will be required to provide annually to the Guarantee Trustee a statement as to the performance by TAP of certain of its obligations under each of the Guarantees and as to any default in such performance. INFORMATION CONCERNING THE GUARANTEE TRUSTEE The Guarantee Trustee, prior to the occurrence of a default with respect to a Guarantee, undertakes to perform only such duties as are specifically set forth in the Guarantee and, after default with respect to a Guarantee, shall exercise the same degree of care as a prudent individual would exercise in the conduct of his or her own affairs. Subject to such provision, the Guarantee Trustee is under no obligation to exercise any of the powers vested in it by a Guarantee at the request of any holder of Preferred Securities to which such Guarantee relates unless it is offered reasonable indemnity against the costs, expenses and liabilities that might be incurred thereby. TERMINATION OF THE GUARANTEES Each Guarantee will terminate as to the Preferred Securities issued by a TAP Trust upon full payment of the Redemption Price of all Preferred Securities of such TAP Trust, upon distribution of the Junior Subordinated Debt Securities held by such TAP Trust to the holders of the Preferred Securities of such TAP Trust or upon full payment of the amounts payable in accordance with the Declaration of such TAP Trust upon liquidation of such TAP Trust. Each Guarantee will continue to be effective or will be reinstated, as the case may be, if at any time any holder of related Preferred Securities issued by a TAP Trust must restore payment of any sums paid under such Preferred Securities or such Guarantee. 129 STATUS OF THE GUARANTEES Each Guarantee will constitute an unsecured obligation of TAP and will rank (i) subordinate and junior in right of payment to all other liabilities of TAP, (ii) pari passu with the most senior preferred or preference stock now or hereafter issued by TAP and with any guarantee now or hereafter entered into by TAP in respect of any preferred or preference stock of any affiliate of TAP and (iii) senior to TAP's common stock. The terms of the Preferred Securities provide that each holder of Preferred Securities issued by a TAP Trust by acceptance thereof agrees to the subordination provisions and other terms of the applicable Guarantee. Each Guarantee will constitute a guarantee of payment and not of collection (that is, the guaranteed party may institute a legal proceeding directly against the guarantor to enforce its rights under a Guarantee without instituting a legal proceeding against any other person or entity). GOVERNING LAW The Guarantees will be governed by, and construed in accordance with, the internal laws of the State of New York. PLAN OF DISTRIBUTION Any TAP Trust may sell Preferred Securities in one or more of the following ways from time to time: (i) to or through underwriters or dealers, (ii) directly to purchasers, or (iii) through agents. Any such underwriters, dealers or agents may include Smith Barney. The Prospectus Supplement with respect to any Offered Securities will set forth (i) the terms of the offering of the Offered Securities, including the name or names of any underwriters, dealers or agents, (ii) the purchase price of the Offered Securities and the proceeds to TAP or a TAP Trust as the case may be, from such sale, (iii) any underwriting discounts and commissions or agency fees and other items constituting underwriters' or agents' compensation, (iv) any initial public offering prices, (v) any discounts or concessions allowed or reallowed or paid to dealers and (vi) any securities exchange on which such Offered Securities may be listed. Any initial public offering price, discounts or concessions allowed or reallowed or paid to dealers may be changed from time to time. If underwriters are used in the sale, the Offered Securities will be acquired by the underwriters for their own account and may be resold from time to time in one or more transactions, including negotiated transactions, at a fixed public offering price or at varying prices determined at the time of sale. The Offered Securities may be offered to the public either through underwriting syndicates represented by one or more managing underwriters or directly by one or more firms acting as underwriters. The underwriter or underwriters with respect to a particular underwritten offering of Offered Securities will be named in the Prospectus Supplement relating to such offering and, if an underwriting syndicate is used, the managing underwriter or underwriters will be set forth on the cover of such Prospectus Supplement. Unless otherwise set forth in the Prospectus Supplement relating thereto, the obligations of the underwriters to purchase the Offered Securities will be subject to certain conditions precedent, and the underwriters will be obligated to purchase all the Offered Securities if any are purchased. If dealers are utilized in the sale of Offered Securities, TAP or the applicable TAP Trust will sell such Offered Securities to the dealers as principals. The dealers may then resell such Offered Securities to the public at varying prices to be determined by such dealers at the time of resale. The names of the dealers and the terms of the transaction will be set forth in the Prospectus Supplement relating thereto. Any series of Preferred Securities may be sold from time to time either directly by a TAP Trust or by its designated agents. Any agent involved in the offer or sale of the Offered Securities in respect to which this Prospectus is delivered will be named, and any commissions payable by TAP or the applicable TAP Trust to such agent will be set forth in the Prospectus Supplement relating thereto. Unless otherwise indicated in the Prospectus Supplement, any such agent will be acting on a best efforts basis for the period of its appointment. The Preferred Securities may be sold directly by a TAP Trust to institutional investors or others who may be deemed to be underwriters within the meaning of the Securities Act with respect to any resale thereof. The terms of any such sales will be described in the Prospectus Supplement relating thereto. If so indicated in the Prospectus Supplement, TAP or the applicable TAP Trust will authorize agents, underwriters or dealers to solicit offers from certain types of institutions to purchase Offered Securities from TAP or such TAP Trust at the public offering price set forth in the Prospectus Supplement pursuant to delayed delivery 130 contracts (the "Contracts") providing for payment and delivery on a specified date or dates in the future. Such Contracts will not be subject to any conditions except (a) the purchase by an institution of the Offered Securities covered by its Contracts shall not at the time of delivery be prohibited under the laws of any jurisdiction in the United States to which such institution is subject and (b) if the Offered Securities are being sold to underwriters, the Company shall have sold to such underwriters the total principal amount of the Offered Securities less the principal amount thereof covered by the Contracts. The Prospectus Supplement will set forth the commission payable for solicitation of such Contracts. Smith Barney, a member of the National Association of Securities Dealers, Inc. (the "NASD") and an affiliate of TAP and the TAP Trusts, may participate in distributions of the Offered Securities. Accordingly, the offerings of Offered Securities will conform with the requirements set forth in any applicable sections of Schedule E to the By-Laws of the NASD. This Prospectus together with an applicable Prospectus Supplement may also be used by Smith Barney in connection with offers and sales of the Offered Securities (subject to obtaining any necessary approval of the New York Stock Exchange for any such offers and sales) in market-making transactions at negotiated prices related to prevailing market prices at the time of sale. Smith Barney may act as principal or agent in such transactions. Smith Barney has no obligation to make a market in any of the Offered Securities and may discontinue any market-making activities at any time without notice, at its sole discretion. Agents, dealers and underwriters may be entitled, under agreements with TAP or a TAP Trust, to indemnification by TAP or the applicable TAP Trust against certain civil liabilities, including liabilities under the Securities Act, or to contribution with respect to payments that such agents, dealers or underwriters may be required to make in respect thereof. Agents, dealers and underwriters may be customers of, engage in transactions with, or perform services for TAP or a TAP Trust in the ordinary course of business. Each series of Offered Securities will be a new issue of securities and will have no established trading market. Any underwriters to whom Offered Securities are sold for public offering and sale may make a market in such Offered Securities, but such underwriters will not be obligated to do so and may discontinue any market making at any time without notice. The Offered Securities may or may not be listed on a national securities exchange. No assurance can be given that there will be a market for the Offered Securities. LEGAL MATTERS The validity of the Preferred Securities, the Junior Subordinated Debt Securities, the Guarantees and certain matters relating thereto and certain United States federal income tax matters will be passed upon for TAP and the TAP Trusts by Skadden, Arps, Slate, Meagher & Flom, New York, New York. Certain legal matters will be passed upon for the Underwriters by Shearman & Sterling, New York, New York. Kenneth J. Bialkin, a partner of Skadden, Arps, Slate, Meagher & Flom, is a director of Travelers Group and will be a director of TAP and he and other attorneys in such firm beneficially own an aggregate of less than one percent of the common stock of Travelers Group. EXPERTS The consolidated financial statements and financial statement schedules of TAP and its subsidiaries, as of December 31, 1995 and 1994, and for each of the years in the three-year period ended December 31, 1995, included herein and elsewhere in the Registration Statement, have been included herein and in the Registration Statement in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. The report of KPMG Peat Marwick LLP covering the December 31, 1995 consolidated financial statements of TAP and its subsidiaries refers to a change in the method of accounting for certain investments in debt and equity securities in 1994. The combined financial statements of Aetna P&C, as of December 31, 1995 and 1994, and for each of the years in the three-year period ended December 31, 1995, included herein and elsewhere in the Registration Statement, have been included herein and in the Registration Statement in reliance upon the report of KPMG Peat Marwick LLP, independent certified public accountants, appearing elsewhere herein, and upon the authority of said firm as experts in accounting and auditing. The report of KPMG Peat Marwick LLP covering the December 31, 1995 combined financial statements of Aetna P&C refers to changes to the methods of accounting for certain investments in debt and equity securities, workers' compensation life table indemnity reserves and retrospectively rated reinsurance contracts in 1993. 131 GLOSSARY OF SELECTED INSURANCE TERMS Accident year................ The annual accounting period in which loss events occurred, regardless of when the losses are actually reported, booked or paid. Adjusted unassigned surplus...................... Unassigned surplus as of the most recent statutory annual report reduced by twenty-five percent of that year's unrealized appreciation in value or revaluation of assets or unrealized profits on investments, as defined in such report. Admitted insurer............. A company licensed to transact insurance business within a state. Alternative market........... The segment of the insurance market which has developed in response to volatility in cost and availability of traditional commercial insurance coverage and consists of various risk financing mechanisms, including self insurance, captive insurance companies, risk retention groups and residual market business. Assigned risk pools.......... Reinsurance pools which cover risks for those unable to purchase insurance in the voluntary market because the risk is too great or rate adequacy has reduced the supply of insurance. The costs of the risks associated with these pools are charged back to insurance carriers in proportion to their direct writings. Assumed reinsurance.......... Insurance liabilities acquired from a ceding company. Assumption reinsurance....... A transaction whereby the ceding company transfers its entire obligation under the policy to the reinsurer, who becomes directly liable to the policyholder in all respects, including collecting premiums and paying benefits. See "reinsurance." Attachment point............. The amount of losses above which excess of loss reinsurance becomes operative. Broker....................... One who negotiates contracts of insurance or reinsurance on behalf of an insured party, receiving a commission from the insurer or reinsurer for placement and other services rendered. Capacity..................... The percentage of surplus, or the dollar amount of exposure, that an insurer or reinsurer is willing to place at risk. Capacity may apply to a single risk, a program, a line of business or an entire book of business. Capacity may be constrained by legal restrictions, corporate restrictions or indirect restrictions. Captive company.............. An insurance company formed to insure the risks of its parent entity or entities. Case reserves................ Loss reserves established with respect to specific, individual reported claims. Casualty insurance........... Insurance which is primarily concerned with the losses caused by injuries to third persons (i.e., not the insured) and the legal liability imposed on the insured resulting therefrom. It includes, but is not limited to, employers' liability, workers' compensation, public liability, automobile liability, personal liability and aviation liability insurance. It excludes certain types of losses that by law or custom are considered as being exclusively within the scope of other types of insurance, such as fire or marine. Catastrophe.................. A severe loss, usually involving risks such as fire, earthquake, windstorm, explosion and other similar events. Catastrophe loss............. Loss and directly identified loss adjustment expenses from catastrophes. Catastrophe reinsurance...... A form of excess of loss property reinsurance which, subject to a specified limit, indemnifies the ceding company for the amount of loss in excess of a specified retention with respect to an accumulation of losses resulting from a catastrophic event. The actual reinsurance document is called a "catastrophe cover." Cede; ceding company......... When an insurer reinsures its liability with another insurer (a "cession"), it "cedes" business and is referred to as the "ceding company."
G-1 Claim........................ Request by an insured for indemnification by an insurance company for loss incurred from an insured peril. Claim adjustment expense..... See "Loss adjustment expense." Claims and claim adjustment expense...................... See "Loss and loss adjustment expenses." Claims and claim adjustment expense reserves............. See "Loss reserves." Clash cover.................. A casualty excess of loss agreement with a retention higher than the limits on any one reinsured policy. The agreement is thus only exposed to loss when two or more casualty policies (perhaps from different lines of business) are involved in a common occurrence in an amount greater than the clash cover retention. Also known as contingency cover. Combined ratio............... The sum of the loss and LAE ratio, the underwriting expense ratio and, where applicable, the ratio of dividends to policyholders to net premiums earned. A combined ratio under 100% generally indicates an underwriting profit. A combined ratio over 100% generally indicates an underwriting loss. Commercial lines............. The various kinds of insurance which are written for businesses. Deductible................... The amount of loss that an insured retains. Deferred acquisition costs... Commissions and premium taxes, which vary with and are primarily related to the production of new business, are deferred and amortized to achieve a matching of revenues and expenses when reported in financial statements prepared in accordance with GAAP. Direct written premiums...... The amounts charged by a primary insurer to insureds in exchange for coverages provided in accordance with the terms of an insurance contract. Earned premiums or premiums earned....................... That portion of property-liability premiums written that applies to the expired portion of the policy term. Earned premiums are recognized as revenues under both SAP and GAAP. Excess liability............. Additional casualty coverage above the first layer. Excess of loss reinsurance... Reinsurance that indemnifies the reinsured against all or a specified portion of losses under reinsured policies in excess of a specified dollar amount or "retention." Expense ratio................ See "Underwriting expense ratio." Extra contractual obligations losses....................... Losses incurred by an insurer, beyond those that would have been incurred as specified in the insurance agreement with an insured, due to monetary awards required by a court of law against the insurer for its negligence to its insured. Facultative reinsurance...... The reinsurance of all or a portion of the insurance provided by a single policy. Each policy reinsured is separately negotiated. Fidelity and surety programs..................... Insurance which guarantees performance of an obligation or indemnifies for loss due to embezzlement or wrongful abstraction of money, securities or other property. Gross premiums written....... Total premiums for insurance written and reinsurance assumed during a given period. Guaranteed cost products..... An insurance policy where the premiums charged will not be adjusted for actual loss experience during the covered period. Guaranty fund................ State-regulated mechanism which is financed by assessing insurers doing business in those states. Should insolvencies occur, these funds are available to meet some or all of the insolvent insurer's obligations to policyholders.
G-2 High or large deductible policy....................... An insurance policy where the customer assumes at least $25,000 or more of each loss. Incurred but not reported ("IBNR") reserves............ Reserves for estimated losses and LAE which have been incurred but not yet reported to the insurer. Indemnity reinsurance........ A transaction whereby the reinsurer agrees to indemnify the ceding company against all or part of the loss that the latter may sustain under the policies it issued that are being reinsured. The ceding company remains primarily liable as the direct insurer on all risks ceded. See "reinsurance." Inland marine................ A broad type of insurance generally covering articles that may be transported from one place to another, as well as bridges, tunnels and other instrumentalities of transportation. It includes goods in transit (generally other than transoceanic) and may include policies for movable objects such as personal effects, personal property, jewelry, furs, fine arts and others. IRIS ratios.................. Financial ratios calculated by the NAIC to assist state insurance departments in monitoring the financial condition of insurance companies. Loss......................... An occurrence that is the basis for submission and/or payment of a claim. Losses may be covered, limited or excluded from coverage, depending on the terms of the policy. Loss adjustment expense ("LAE")...................... The expenses of settling claims, including legal and other fees and the portion of general expenses allocated to claim settlement costs. Loss and LAE ratio........... The ratio of incurred losses and loss adjustment expenses to net premiums earned. Loss reserves................ Liabilities established by insurers and reinsurers to reflect the estimated cost of claims incurred that the insurer or reinsurer will ultimately be required to pay in respect of insurance or reinsurance it has written. Reserves are established for losses and for LAE, and consist of case reserves and IBNR reserves. Losses and loss adjustment expenses..................... The sum of losses incurred and loss adjustment expenses. Losses incurred.............. The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses includes a provision for IBNR. Multiple peril policies...... Refers to policies which cover both property and third party liability exposures. National Association of Insurance Commissioners ("NAIC")..................... An organization of the insurance commissioners or directors of all 50 states and the District of Columbia organized to promote consistency of regulatory practice and statutory accounting standards throughout the United States. Net written premiums......... Gross premiums written less premiums ceded to reinsurers. Non-admitted coverage........ Insurance coverage written in a given state by an insurer not licensed in that state. Personal lines............... Types of insurance written for individuals or families, rather than for businesses. Pool......................... An organization of insurers or reinsurers through which particular types of risks are underwritten with premiums, losses and expenses being shared in agreed percentages.
G-3 Premium equivalents.......... Premium equivalents represent estimates of premiums that customers would have been charged under a fully insured arrangement, based on expected losses associated with non-risk-bearing components of each account, as determined in the pricing process. Premium equivalents are indicative of the volume of business handled by an insurer in servicing relationships. Premium equivalents do not represent actual premium revenues. Premiums..................... The amount charged during the year on policies and contracts issued, renewed or reinsured by an insurance company. Producer..................... Contractual entity which directs insureds to the insurer for coverage. See "broker." Property insurance........... Insurance that provides coverage to a person with an insurable interest in tangible property for that person's property loss, damage or loss of use. Quota share reinsurance...... Reinsurance wherein the insurer cedes an agreed fixed percentage of liabilities, premiums and losses for each policy covered on a pro rata basis. Rate of renewal/retention ratio...................... Current period renewal accounts or policies as a percentage of expired accounts or policies. Rates........................ Amounts charged per unit of insurance. Reinsurance.................. The practice whereby one insurer, called the reinsurer, in consideration of a premium paid to such insurer, agrees to indemnify another insurer, called the ceding company, for part or all of the liability assumed by the ceding company under one or more policies or contracts of insurance which it has issued. Reinsurance agreement........ A contract specifying the terms of a reinsurance transaction. Residual market (involuntary business).................... Insurance market which provides coverage for risks unable to purchase insurance in the voluntary market either because the risk is too great or rate inadequacy has reduced the supply of insurance. Residual markets are frequently created by state legislation either because of lack of available coverage such as property coverage in a windstorm prone area or protection of the accident victim as in the case of workers' compensation. The costs of the residual market are usually charged back to the direct insurance carriers in proportion to the carriers' voluntary market shares for the type of coverage involved. Retention.................... The amount of exposure an insurance company retains on any one risk or group of risks. Retrospective premiums....... Premiums related to retrospectively rated policies. Retrospective rating......... A plan or method whch permits adjustment of the final premium or commission on the basis of actual loss experience, subject to certain minimum and maximum limits. Risk-based capital ("RBC")... A measure adopted by the NAIC for assessing the minimum statutory capital requirements of insurers. Risk retention............... The amount or portion of a risk an insurer retains for its own account after ceded reinsurance. Losses above the stated retention level are collectible from the reinsurer. The retention level may be stated as a percentage or dollar amount. Salvage...................... The amount of money an insurer recovers through the sale of property transferred to the insurer as a result of a loss payment.
G-4 Second injury fund........... The purpose of a second injury fund is to encourage employers to hire and retain workers who have pre-existing physical impairments and to provide economic relief to such employers should a second injury occur. The cost is shared by the insurance industry, funded through assessments to insurance companies based on either premiums or losses. Self-insured retentions...... That portion of the risk retained by a person for its own account. Servicing carrier............ An insurance company that provides, for a fee, various services including policy issuance, claims adjusting and customer service for insureds in a reinsurance pool. Standard policy forms........ Self-contained pre-printed policy language used when a large number of insureds face similar loss exposures. Statutory accounting practices ("SAP").......... The rules and procedures prescribed or permitted by United States state insurance regulatory authorities for recording transactions and preparing financial statements. Statutory accounting practices generally reflect a modified going concern basis of accounting. Statutory surplus............ As determined under SAP, the amount remaining after all liabilities, including loss reserves, are subtracted from all admitted assets. Admitted assets are assets of an insurer prescribed or permitted by a state to be taken into account in determining the insurer's financial condition for statutory purposes. Statutory surplus is also referred to as "surplus" or "surplus as regards policyholders" for statutory accounting purposes. Structured settlements....... Periodic payments to an injured person or survivor for a determined number of years or for life, typically in settlement of a claim under a liability policy. Subrogation.................. A principle of law incorporated in insurance policies, which enables an insurance company, after paying a loss to its insured, to recover the amount of the loss from another who is legally liable for it. Third party liability........ A liability owed to a claimant (or "third party") who is not one of the two parties to the insurance contract. Insured liability claims are referred to as third party claims. Treaty reinsurance........... The reinsurance of a specified type or category of risks defined in a reinsurance agreement (a "treaty") between a primary insurer or other reinsured and a reinsurer. Typically, in treaty reinsurance, the primary insurer or reinsured is obligated to offer and the reinsurer is obligated to accept a specified portion of all such type or category of risks originally written by the primary insurer or reinsured. Umbrella coverage............ A form of insurance protection against losses in excess of amounts covered by other liability insurance policies or amounts not covered by the usual liability policies. Unassigned funds (surplus)... The undistributed and unappropriated amount of statutory surplus. Underwriter.................. An employee of an insurance company who examines, accepts or rejects risks and classifies accepted risks in order to charge an appropriate premium for each accepted risk. The underwriter is expected to select business that will produce an average risk of loss no greater than that anticipated for the class of business. Underwriting................. The insurer's or reinsurer's process of reviewing applications for insurance coverage, and the decision whether to accept all or part of the coverage and determination of the applicable premiums; also refers to the acceptance of such coverage. Underwriting expense ratio... The ratio of underwriting expenses incurred to net premiums written.
G-5 Underwriting profit or underwriting loss............ The pre-tax profit or loss experienced by a property and casualty insurance company after deducting loss and loss adjustment expenses and operating expenses from net earned premiums. This profit or loss calculation includes reinsurance assumed and ceded but excludes investment income. Unearned premium............. The portion of premiums written that is allocable to the unexpired portion of the policy term. Voluntary market............. The market in which a person seeking insurance obtains coverage without the assistance of residual market mechanisms. Wholesale broker............. An independent or exclusive agent that represents both admitted and non-admitted insurers in market areas which include standard, non-standard, specialty and excess and surplus lines of insurance. The wholesaler does not deal directly with the insurance consumer. The wholesaler deals with the retail agent or broker. Workers' compensation........ A system (established under state laws) under which employers provide insurance for benefit payments to their employees for work-related injuries, deaths and diseases, regardless of fault.
G-6 INDEX TO FINANCIAL STATEMENTS
PAGE ---- TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES--AUDITED Independent Auditors' Report................................................................... F-2 Consolidated Financial Statements: Consolidated Statement of Operations--Years ended December 31, 1995, 1994 and 1993........... F-3 Consolidated Balance Sheet--December 31, 1995 and 1994....................................... F-4 Consolidated Statement of Changes in Stockholder's Equity--Years ended December 31, 1995, 1994 and 1993.............................................................................. F-5 Consolidated Statement of Cash Flows--Years ended December 31, 1995, 1994 and 1993........... F-6 Notes to Consolidated Financial Statements................................................... F-7 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES--AUDITED Independent Auditors' Report................................................................... F-27 Combined Financial Statements: Combined Statements of Income--Years ended December 31, 1995, 1994 and 1993.................. F-28 Combined Balance Sheets--December 31, 1995 and 1994.......................................... F-29 Combined Statements of Shareholder's Equity--Years ended December 31, 1995, 1994 and 1993.... F-30 Combined Statements of Cash Flows--Years ended December 31, 1995, 1994 and 1993.............. F-31 Notes to Combined Financial Statements....................................................... F-32
F-1 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholder of Travelers/Aetna Property Casualty Corp.: We have audited the accompanying consolidated balance sheets of Travelers/Aetna Property Casualty Corp. and Subsidiaries as of December 31, 1995 and 1994, and the related consolidated statements of operations, changes in stockholder's equity, and cash flows for each of the years in the three-year period ended December 31, 1995. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Travelers/Aetna Property Casualty Corp. and Subsidiaries as of December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. As discussed in Note 4 to the consolidated financial statements, the Company changed its method of accounting for certain investments in debt and equity securities in 1994. KPMG PEAT MARWICK LLP Hartford, Connecticut January 16, 1996 F-2 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF OPERATIONS (FOR THE YEAR ENDED DECEMBER 31, IN MILLIONS)
1995 1994 1993 ------ ------ ------ REVENUES Premiums.................................................................... $3,315 $3,178 $3,378 Net investment income....................................................... 710 573 657 Fee income.................................................................. 456 496 470 Realized investment gains (losses).......................................... 71 (132) 192 Other, including gain on disposition in 1994................................ 17 53 18 ------ ------ ------ 4,569 4,168 4,715 ------ ------ ------ BENEFITS AND EXPENSES Claims and claim adjustment expenses........................................ 2,817 2,819 3,245 Amortization of deferred acquisition costs.................................. 512 473 475 General and administrative expenses......................................... 689 666 825 ------ ------ ------ 4,018 3,958 4,545 ------ ------ ------ Income before federal income taxes.......................................... 551 210 170 ------ ------ ------ Federal income taxes: Current................................................................... 160 (6) 15 Deferred.................................................................. (28) 28 (12) ------ ------ ------ 132 22 3 ------ ------ ------ Net income.................................................................. $ 419 $ 188 $ 167 ------ ------ ------ ------ ------ ------
See notes to consolidated financial statements. F-3 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET (AT DECEMBER 31, IN MILLIONS, EXCEPT SHARES)
1995 1994 ------- ------- ASSETS Fixed maturities, available for sale at market (cost, $10,534; $9,531)............ $10,908 $ 8,866 Equity securities, at market (cost, $565; $337)................................... 603 320 Mortgage loans.................................................................... 213 236 Real estate held for sale......................................................... 23 30 Short-term securities............................................................. 786 575 Other investments................................................................. 287 298 ------- ------- Total investments............................................................... 12,820 10,325 ------- ------- Cash.............................................................................. 51 32 Investment income accrued......................................................... 165 152 Premium balances receivable....................................................... 2,213 2,600 Reinsurance recoverables.......................................................... 5,407 5,676 Deferred acquisition costs........................................................ 202 221 Deferred federal income taxes..................................................... 650 997 Contractholder receivables........................................................ 1,713 1,594 Other assets...................................................................... 1,400 1,540 ------- ------- Total assets.................................................................... $24,621 $23,137 ------- ------- ------- ------- LIABILITIES Claims and claim adjustment expense reserves...................................... $15,460 $15,299 Unearned premium reserves......................................................... 1,695 1,778 Contractholder payables........................................................... 1,713 1,594 Other liabilities................................................................. 2,152 1,885 ------- ------- Total liabilities............................................................... 21,020 20,556 ------- ------- STOCKHOLDER'S EQUITY Common stock, par value $100; 150,000 shares authorized, 100,000 shares issued and outstanding....................................................................... 10 10 Additional paid-in capital........................................................ 2,889 2,911 Retained earnings................................................................. 422 103 Unrealized investment gains (losses), net of taxes................................ 280 (443) ------- ------- Total stockholder's equity...................................................... 3,601 2,581 ------- ------- Total liabilities and stockholder's equity...................................... $24,621 $23,137 ------- ------- ------- -------
See notes to consolidated financial statements. F-4 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDER'S EQUITY (FOR THE YEAR ENDED DECEMBER 31, IN MILLIONS, EXCEPT SHARES)
SHARES ----------------------------- 1995 1994 1993 1995 1994 1993 ------ ------ ------ ------- ------- ------- COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL Balance, beginning of year.................... $2,921 $2,965 $1,621 100,000 100,000 100,000 Allocation of purchase price.................. -- (41) 264 Acquisition adjustments....................... -- -- 978 Capital contribution.......................... -- -- 100 Other......................................... (22) (3) 2 ------ ------ ------ ------- ------- ------- Balance, end of year.......................... 2,899 2,921 2,965 100,000 100,000 100,000 ------ ------ ------ ------- ------- ------- RETAINED EARNINGS Balance, beginning of year.................... 103 -- 934 Acquisition adjustments....................... -- -- (978) Net income.................................... 419 188 167 Dividends to parent........................... (100) (85) (125) Other......................................... -- -- 2 ------ ------ ------ Balance, end of year.......................... 422 103 -- ------ ------ ------ UNREALIZED INVESTMENT GAINS (LOSSES) Balance, beginning of year.................... (443) 12 44 Net change in unrealized gains and losses on investment securities, net of taxes........... 723 (455) (32) ------ ------ ------ Balance, end of year.......................... 280 (443) 12 ------ ------ ------ ------- ------- ------- Total stockholder's equity.................... $3,601 $2,581 $2,977 100,000 100,000 100,000 ------ ------ ------ ------- ------- ------- ------ ------ ------ ------- ------- -------
See notes to consolidated financial statements. F-5 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF CASH FLOWS INCREASE (DECREASE) IN CASH (FOR THE YEAR ENDED DECEMBER 31, IN MILLIONS)
1995 1994 1993 ------- ------- ------- CASH FLOWS FROM OPERATING ACTIVITIES Net income............................................................ $ 419 $ 188 $ 167 Reconciling adjustments Realized (gains) losses............................................. (71) 132 (192) Depreciation and amortization....................................... 15 5 8 Deferred federal income taxes....................................... (28) 28 (12) Amortization of deferred policy acquisition costs................... 512 473 475 Deferred policy acquisition costs................................... (493) (474) (452) Investment income accrued........................................... (13) (5) (4) Premium balances receivable......................................... 387 367 172 Reinsurance recoverables............................................ 364 (8) (523) Insurance reserves.................................................. (18) 295 606 Trading account investments, (purchases) sales, net................. -- -- 364 Other............................................................... 420 (327) (486) ------- ------- ------- Net cash provided by operating activities........................... 1,494 674 123 ------- ------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Investment repayments Fixed maturities.................................................... 684 638 1,099 Mortgage loans...................................................... 15 33 108 Proceeds from sales of investments, including real estate held for sale Fixed maturities.................................................... 4,871 1,806 897 Equity securities................................................... 157 121 76 Mortgage loans...................................................... 36 32 127 Real estate held for sale........................................... 22 69 53 Investments in Fixed maturities.................................................... (6,497) (3,191) (2,553) Equity securities................................................... (472) (141) (104) Mortgage loans...................................................... (40) (1) (7) Real estate held for sale........................................... (1) (7) (27) Short-term securities, (purchases) sales, net......................... (211) 78 172 Other investments, net................................................ 17 174 24 Securities transactions in course of settlement....................... 44 (178) 19 Business acquisitions................................................. -- (150) -- Business divestments.................................................. -- 135 -- ------- ------- ------- Net cash used in investing activities............................... (1,375) (582) (116) ------- ------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Dividends to parent................................................... (100) (85) (118) Contribution from parent.............................................. -- -- 100 Other................................................................. -- -- 2 ------- ------- ------- Net cash used in financing activities............................... (100) (85) (16) ------- ------- ------- Net increase (decrease) in cash......................................... 19 7 (9) Cash at beginning of year............................................... 32 25 34 ------- ------- ------- Cash at end of year................................................... $ 51 $ 32 $ 25 ------- ------- ------- ------- ------- ------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION Income taxes paid (refunded).......................................... $ (28) $ (30) $ 12 ------- ------- ------- ------- ------- -------
See notes to consolidated financial statements. F-6 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. PENDING ACQUISITION On November 28, 1995, The Travelers Insurance Group Inc. (TIGI) agreed to acquire the domestic property and casualty insurance subsidiaries of Aetna Life and Casualty Company. TIGI, an indirect wholly owned subsidiary of Travelers Group Inc., will contribute the Travelers Indemnity Company and its subsidiaries (Travelers P&C) to a wholly owned subsidiary called Travelers/Aetna Property Casualty Corp. (TAP). TAP will purchase all of the outstanding capital stock of The Aetna Casualty and Surety Company and The Standard Fire Insurance Company for a purchase price of approximately $4 billion, subject to certain adjustments. The acquisition is subject to regulatory approval and is expected to be completed in March 1996. These consolidated financial statements include the accounts of TAP and Travelers P&C on a combined basis, referred to herein as "the Company." 2. NATURE OF OPERATIONS The Company is comprised of two major business segments: Commercial Lines and Personal Lines. Commercial Lines ("Commercial Lines") is divided into four marketing groups that are designed to focus on a particular client base or industry segment to provide products and services that specifically address customers' needs: National accounts ("National Accounts"), Commercial accounts ("Commercial Accounts"), Select accounts ("Select Accounts"), and Specialty accounts ("Specialty Accounts"). Protection is afforded to customers of Commercial Lines for the risks of property loss such as fire and windstorm, financial loss such as business interruption, liability claims arising from operations and workers' compensation benefits through insurance products where risk is transferred from the customer to Commercial Lines. Such coverages include workers' compensation, general liability, multiple peril, commercial automobile, property, fidelity and surety and several miscellaneous coverages. National Accounts serves large companies, as well as employee groups, associations and franchises, and includes the Company's alternative market business. National Accounts also provides claims settlement, loss control and risk management through service agreements, and participates in state assigned risk pools. The primary product serviced under these agreements is workers' compensation. Commercial Accounts serves medium-sized businesses. Commercial Accounts sells a broad range of property and casualty insurance products through a large network of independent agents and brokers. Retrospectively rated or large deductible programs are also available to these customers. Select Accounts serves individuals with commercial exposures and small businesses. Select Accounts products are generally guaranteed cost policies, often a packaged product covering property and general liability exposures. The products are sold through independent agents. Specialty Accounts markets products to national, mid-size and small customers. The principal products of Specialty Accounts include professional liability insurance, product liability, fidelity bonds, commercial umbrella and excess insurance, excess property insurance and coverages relating to the entertainment and transportation industries. Personal Lines ("Personal Lines") writes virtually all types of property and casualty insurance covering personal risks. The primary coverages in Personal Lines are personal automobile and homeowners insurance sold to individuals, which accounted for 97% of net written premiums generated by Personal Lines in 1995. Personal automobile policies provide coverage for liability to others for both bodily injury and property damage, and for physical damage to an insured's own vehicle from collision and various other perils. In addition, many states require policies to provide first-party personal injury protection, frequently referred to as no-fault coverage. Homeowners policies are available for dwellings, condominiums, mobile homes and rental property contents. Protection against losses to dwellings and contents from a wide variety of perils is included in these policies, as well as coverage for liability arising from ownership or occupancy. F-7 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 2. NATURE OF OPERATIONS--(CONTINUED) The Company has a geographic exposure to catastrophic losses in certain North Atlantic states and in South Florida. Catastrophes can be caused by various events including hurricanes, windstorms, earthquakes, hail, explosions, severe winter weather and fires, and the incidence and severity of catastrophes are inherently unpredictable. The extent of losses from a catastrophe is a function of both the total amount of insured exposure in the area affected by the event and the severity of the event. Most catastrophes are restricted to small geographic areas; however, hurricanes and earthquakes may produce significant damage in large, heavily populated areas. The Company generally seeks to reduce its exposure to catastrophe through individual risk selection and the purchase of catastrophe reinsurance. 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Significant accounting policies used in the preparation of the accompanying financial statements follow. Basis of presentation The consolidated financial statements include the accounts of TAP and The Travelers Indemnity Company and its insurance and noninsurance subsidiaries on a combined basis. Significant intercompany transactions and balances have been eliminated. In December 1992, Primerica Corporation ("Primerica") acquired approximately 27% of the common stock of TIGI's then parent, The Travelers Corporation (the "27% Acquisition"). The 27% Acquisition was accounted for as a purchase. In connection with the 27% Acquisition, Primerica transferred 50% of the parent of Gulf Insurance Company ("Gulf") (a wholly owned subsidiary of Primerica) to The Travelers Corporation, which contributed it to the Company at a value of $150 million. Effective December 31, 1993, Primerica acquired the approximately 73% of The Travelers Corporation common stock which it did not already own, and The Travelers Corporation was merged into Primerica, which was ultimately renamed Travelers Group Inc. This was effected through the exchange of .80423 shares of Travelers Group Inc. common stock for each share of The Travelers Corporation common stock (the "Merger"). All subsidiaries of The Travelers Corporation were contributed to TIGI. The 27% Acquisition and the Merger were accounted for as a "step acquisition", and the purchase accounting adjustments were "pushed down" as of December 31, 1993 to the subsidiaries of TIGI, including The Travelers Indemnity Company, and reflect adjustments of assets and liabilities of the Company to their fair values determined at each acquisition date (i.e., 27% of the values at December 31, 1992 as carried forward and 73% of the values at December 31, 1993). These assets and liabilities were recorded at December 31, 1993 based upon management's then best estimate of their fair values at the respective dates. Evaluation and appraisal of assets and liabilities, including investments, reinsurance recoverables, other insurance assets and liabilities and related deferred federal income taxes, were completed during 1994. The excess of the purchase price of the common stock of TIGI over the fair value of the 73% of net assets acquired at December 31, 1993, which was allocated to the Company through "pushdown" accounting, was approximately $443 million and is being amortized over 40 years on a straight-line basis. No goodwill was allocated to the Company in connection with the 27% acquisition. The consolidated statements of operations, of changes in stockholder's equity and of cash flows and the related accompanying notes for the years ended December 31, 1995 and 1994, which are presented on a purchase accounting basis, are separated from the corresponding 1993 information, which is presented on a historical accounting basis, to indicate the difference in valuation bases. On December 31, 1994, the Company acquired the remaining 50% of Gulf which it did not already own for approximately $150 million. The effects of this transaction were not material. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and F-8 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and benefits and expenses during the reporting period. Actual results could differ from those estimates. Investments Fixed maturities include bonds, notes and redeemable preferred stocks. Fixed maturities are valued based upon quoted market prices, or if quoted market prices are not available, discounted expected cash flows using market rates commensurate with the credit quality and maturity of the investment. Fixed maturities are classified as "available for sale" and are reported at fair value, with unrealized investment gains and losses, net of income taxes, charged or credited directly to stockholder's equity. Equity securities, which include common and nonredeemable preferred stocks, are available for sale and carried at fair value based primarily on quoted market prices. Changes in fair values of equity securities are charged or credited directly to stockholder's equity, net of income taxes. Mortgage loans are carried at amortized cost. For mortgage loans that are determined to be impaired, a reserve is established for the difference between the amortized cost and fair market value of the underlying collateral. Impaired loans were insignificant at December 31, 1995. Real estate held for sale is carried at the lower of cost or fair value less estimated costs to sell. Fair value was established at time of foreclosure by appraisers, either internal or external, using discounted cash flow analyses and other acceptable techniques. Thereafter, an allowance for losses on real estate held for sale is established if the carrying value of the property exceeds its current fair value less estimated costs to sell. There was no such allowance at December 31, 1995. Accrual of income is suspended on fixed maturities or mortgage loans that are in default, or on which it is likely that future payments will not be made as scheduled. Interest income on investments in default is recognized only as payment is received. Gains or losses arising from financial futures contracts used to hedge investments are treated as basis adjustments and are recognized in income over the life of the hedged investments. Investment Gains and Losses Realized investment gains and losses are included as a component of pretax revenues based upon specific identification of the investments sold on the trade date and, prior to the Merger, included adjustments to investment valuation reserves. These adjustments reflected changes considered to be other than temporary in the net realizable value of investments. Also included are gains and losses arising from the remeasurement of the local currency value of foreign investments to U.S. dollars, the functional currency of the Company. The foreign exchange effects of Canadian operations are included in unrealized gains and losses. Deferred Acquisition Costs Commissions and premium taxes, which vary with and are primarily related to the production of new business, are deferred and amortized pro rata over the contract periods in which the related premiums are earned. Future investment income attributable to related premiums is taken into account in measuring the recoverability of the carrying value of this asset. All other acquisition expenses are charged to operations as incurred. Contractholder Receivables and Payables Under certain insurance contracts with deductible features, the Company is obligated to pay the claimant for the full amount of the claim. The Company is subsequently reimbursed by the policyholder for the deductible amount. These amounts are included on a gross basis in the consolidated balance sheet in contractholder payables and contractholder receivables, respectively. F-9 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) Claims and Claim Adjustment Expense Reserves Claims and claim adjustment expense reserves represent estimated provisions for both reported and unreported claims incurred and related expenses. The reserves are adjusted regularly based on experience. Included in the claims and claim adjustment expense reserves in the consolidated balance sheet at December 31, 1995 and 1994 are $778 million and $744 million, respectively, of reserves related to workers' compensation that have been discounted using an interest rate of 5%. In determining claims and claim adjustment expense reserves, the Company carries on a continuing review of its overall position, its reserving techniques and its reinsurance. These reserves represent the estimated ultimate unpaid cost of all incurred claims and claim adjustment expenses. Since the reserves are based on estimates, the ultimate liability may be more or less than such reserves. The effects of changes in such estimated reserves are included in the results of operations in the period in which the estimates are changed. Such changes may be material to the results of operations and could occur in a future period. Operating Lease Obligations At December 31, 1993, operating lease obligations were recorded at the value assigned at the acquisition dates and included in the consolidated balance sheet as a component of other liabilities. This liability is being amortized over the respective lease periods. Permitted Statutory Accounting Practices The Company's insurance subsidiaries, domiciled principally in Connecticut, prepare statutory financial statements in accordance with the accounting practices prescribed or permitted by the insurance departments of the states of domicile. Prescribed statutory accounting practices include certain publications of the National Association of Insurance Commissioners as well as state laws, regulations, and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The impact of any permitted accounting practices on statutory surplus of the Company is not material. Premiums and Unearned Premium Reserves Premiums are recognized as revenues pro rata over the policy period. Unearned premium reserves represent the unexpired portion of policy premiums. Accrued retrospective premiums are included in premium balances receivable. Fee Income Fee income includes servicing fees, revenue from large deductible policies and premium installment charges. Other Revenues Other revenues include gains and losses on dispositions of assets and operations other than realized investment gains and losses, revenues of noninsurance subsidiaries other than fee income and the pretax operating results of real estate joint ventures. Federal Income Taxes The provision for federal income taxes is comprised of two components, current income taxes and deferred income taxes. Deferred federal income taxes arise from changes during the year in cumulative temporary differences between the tax basis and book basis of assets and liabilities. Accounting Standards not yet Adopted Statement of Financial Accounting Standards No. 121, "Accounting for Long-Lived Assets and for Long-Lived Assets to be Disposed Of" establishes accounting standards for the impairment of long-lived assets, certain F-10 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) identifiable intangibles, and goodwill related to those assets to be held and used and for long-lived assets and certain identifiable intangibles to be disposed of. This statement requires the write down to fair value when long- lived assets to be held and used are impaired. It also requires long-lived assets to be disposed of (e.g., real estate held for sale) to be carried at the lower of cost or fair value less cost to sell and does not allow such assets to be depreciated. The adoption of this statement, effective January 1, 1996, will not have a material effect on the Company's results of operations, financial condition or liquidity. In October 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123). This statement addresses alternative accounting treatments for stock-based compensation, such as stock options and restricted stock. FAS 123 permits either expensing the value of stock-based compensation over the period earned or disclosing in the financial statement footnotes the pro-forma impact to net income as if the value of stock-based compensation awards had been expensed. The value of awards would be measured at the grant date based upon estimated fair value, using option pricing models. The requirements of this statement will be effective for 1996 financial statements, although earlier adoption is permissible if an entity elects to expense the cost of stock-based compensation. The Company, along with affiliated companies, participates in stock option and incentive plans sponsored by Travelers Group Inc. The Company is currently evaluating the disclosure requirements and expense recognition alternatives addressed by this statement. 4. CHANGES IN ACCOUNTING PRINCIPLES Accounting by Creditors for Impairment of a Loan Effective January 1, 1995, the Company adopted Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan," and Statement of Financial Accounting Standards No. 118, "Accounting by Creditors for Impairment of a Loan--Income Recognition and Disclosures," which describe how impaired loans should be measured when determining the amount of a loan loss accrual. These statements amended existing guidance on the measurement of restructured loans in a troubled debt restructuring involving a modification of terms. Their adoption did not have a material impact on the Company's financial condition, results of operations or liquidity. Accounting for Certain Debt and Equity Securities Effective January 1, 1994, the Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (FAS 115), which addresses accounting and reporting for investments in equity securities that have a readily determinable fair value and for all debt securities. Investment securities have been classified as "available for sale" and are reported at fair value, with unrealized gains and losses, net of income taxes, charged or credited directly to stockholder's equity. Previously, securities classified as available for sale were carried at the lower of aggregate cost or market value. Initial adoption of this standard resulted in an increase of approximately $36 million (net of taxes) to net unrealized gains which is included in stockholder's equity. 5. SALE OF SUBSIDIARY In October 1994, the Company sold Bankers and Shippers Insurance Company (Bankers and Shippers) and received cash proceeds of $142 million. Consolidated assets and liabilities were reduced as a result of this disposition. Bankers and Shippers' assets, consisting primarily of cash and investments of $208 million and premium balances receivable of $66 million, were $370 million at the date of the sale. Liabilities, consisting primarily of claims and claim adjustment expense reserves and unearned premium reserves of $237 million, were $267 million at the date of the sale. The $30 million pretax gain on the sale is included in other revenues. F-11 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 5. SALE OF SUBSIDIARY--(CONTINUED) The revenues, income before federal income taxes and net income of Bankers and Shippers were as follows:
1994* 1993 ----- ---- (IN MILLIONS) Revenues............................................................... $178 $175 Income before federal income taxes..................................... 14 19 Net income............................................................. 9 12
- ------------ * Through the date of the sale 6. REINSURANCE The Company participates in reinsurance in order to limit losses, minimize exposure to large risks, provide additional capacity for future growth and to effect business-sharing arrangements. Reinsurance is placed on both a quota-share and excess basis. In addition, the Company assumes 100% of the workers' compensation premiums written by the Accident Department of its affiliate, The Travelers Insurance Company (TIC). The Company also participates as a servicing carrier for, and a member of, several pools and associations. Reinsurance ceded arrangements do not discharge the Company as the primary insurer. Effective January 1, 1995, the Company terminated a reinsurance agreement with TIGI whereby TIGI assumed 8% of the Company's business written prior to 1991. Also, effective January 1, 1995, the Company terminated certain agreements with TIGI whereby TIGI had assumed certain casualty reserves subject to a stop loss arrangement. As a result of the termination of these agreements, TIGI transferred $520 million of invested assets and of insurance liabilities to the Company. In 1993, TIC terminated certain reinsurance agreements with the Company whereby the Company had assumed the long-term disability and individual accident and health business written by TIC. In addition, the Company ceded most of the group long-term disability business written by the Company to TIC. As a result, the Company transferred $365 million of invested assets and insurance liabilities to TIC. F-12 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 6. REINSURANCE--(CONTINUED) A summary of reinsurance financial data reflected within the consolidated statement of operations is presented below:
1995 1994 1993 ------- ------- ------- (IN MILLIONS) Written Premiums: Direct............................................... $ 4,261 $ 4,036 $ 4,155 Assumed from: Affiliated companies............................... 374 373 459 Non-affiliated companies........................... 301 371 369 Ceded to: Affiliated companies............................... (48) (61) (39) Non-affiliated companies........................... (1,267) (1,159) (1,463) ------- ------- ------- Total net written premiums....................... $ 3,621 $ 3,560 $ 3,481 ------- ------- ------- ------- ------- ------- Earned Premiums: Direct............................................... $ 4,007 $ 3,738 $ 4,009 Assumed from: Affiliated companies............................... 284 399 466 Non-affiliated companies........................... 346 332 383 Ceded to: Affiliated companies............................... (48) (61) (25) Non-affiliated companies........................... (1,274) (1,230) (1,455) ------- ------- ------- Total net earned premiums........................ $ 3,315 $ 3,178 $ 3,378 ------- ------- ------- ------- ------- ------- Percentage of amount assumed to net earned............. 19.0% 23.0% 25.1% ------- ------- ------- ------- ------- ------- Ceded claims incurred.................................. $ 1,245 $ 724 $ 1,012 ------- ------- ------- ------- ------- -------
Reinsurance recoverables, net of valuation allowance, at December 31 include amounts recoverable on unpaid and paid losses and were as follows:
1995 1994 ------ ------ (IN MILLIONS) Reinsurance Recoverables: Property-casualty business: Pools and associations.......................................... $2,775 $2,524 Non-affiliated companies........................................ 1,713 1,575 Affiliated companies............................................ 675 1,294 Accident and health business: Affiliated companies............................................ 244 283 ------ ------ Total reinsurance recoverables................................ $5,407 $5,676 ------ ------ ------ ------
Amounts of reinsurance ceded losses, loss adjustment expenses and unearned premiums recoverable from unaffiliated insurers at December 31, 1995 and 1994 included $289 million and $302 million, respectively, recoverable from Lloyd's of London (Lloyd's). Lloyd's is currently undergoing a restructuring to solidify its capital base and to segregate claims for years before 1993. The Company is in arbitration with underwriters at Lloyd's in New York State to enforce reinsurance contracts with respect to recoveries for certain asbestos claims. The dispute involves the ability of the Company to aggregate asbestos claims under a market agreement between Lloyd's and the Company or under the applicable reinsurance treaties. The outcomes of the restructuring of Lloyd's and the arbitration referred to above are uncertain and the impact, if any, on collectibility of amounts recoverable by the Company from Lloyd's cannot be quantified at this F-13 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 6. REINSURANCE--(CONTINUED) time. The Company believes that it is possible that an unfavorable resolution of these matters could have a material adverse effect on the Company's operating results in a future period. However, the Company believes that it is not likely that the outcome of these matters could have a material adverse effect on the Company's financial condition or liquidity. The Company carries an allowance for uncollectible reinsurance which is not allocated to any specific proceedings or disputes, whether for financial impairments or coverage defenses. The Company believes that such allowance properly states the net receivable from reinsurance contracts. 7. INSURANCE CLAIMS RESERVES
1995 1994 ------- ------- (IN MILLIONS) Claims and claim adjustment expense reserves: Property-casualty............................................... $15,213 $15,013 Accident and health............................................. 247 286 ------- ------- Total........................................................... $15,460 $15,299 ------- ------- ------- -------
The table below is a reconciliation of beginning and ending property-casualty reserve balances for claims and claim adjustment expenses for the years ended December 31, 1995, 1994 and 1993.
1995 1994 1993 ------- ------- ------- (IN MILLIONS) Claims and claim adjustment expense reserves at beginning of year..................................... $15,013 $14,638 $14,289 Less reinsurance recoverables on unpaid losses........ 5,301 5,319 5,335 ------- ------- ------- Net balance at beginning of year........................ 9,712 9,319 8,954 ------- ------- ------- Provision for claims and claim adjustment expenses for claims arising in the current year...................... 2,903 3,041 2,949 Estimated claims and claim adjustment expenses for claims arising in prior years......................... (226) (255) 106 Reserves for environmental claims, litigation and reduction of ceded reinsurance balances recorded as a purchase accounting adjustment........................ -- -- 225 Acquisition of Gulf..................................... -- 289 -- Termination of reinsurance agreements with TIGI......... 520 -- -- Other................................................... -- (36) (27) ------- ------- ------- Total increases................................... 3,197 3,039 3,253 ------- ------- ------- Claims and claim adjustment expense payments for claims arising in: Current year.......................................... 886 930 884 Prior years........................................... 1,933 1,716 2,004 ------- ------- ------- Total payments.................................... 2,819 2,646 2,888 ------- ------- ------- Net balances at end of year............................. 10,090 9,712 9,319 Plus reinsurance recoverables on unpaid losses........ 5,123 5,301 5,319 ------- ------- ------- Claims and claim adjustment expense reserves at end of year.................................................... $15,213 $15,013 $14,638 ------- ------- ------- ------- ------- -------
In 1995, the Company terminated certain agreements with TIGI. As a result of the termination of these agreements, TIGI transferred $520 million of insurance claims reserves and invested assets to the Company (see note 6). F-14 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 7. INSURANCE CLAIMS RESERVES--(CONTINUED) In 1995, estimated claims and claim adjustment expenses for claims arising in prior years included favorable loss development in certain workers' compensation, general liability and commercial auto lines of approximately $150 million. For retrospectively rated policies, premiums are determined based on actual loss experience. Ultimate expected losses are included in overall claim and claim adjustment expense reserves. However, there is a corresponding and equal asset for the related future premium. Reductions in loss estimates, reflected as favorable loss development, result in a corresponding reduction of the related asset. There is no net impact on results of operations. In addition, in 1995 estimated claims and claim adjustment expense for claims arising in prior years included favorable loss development in Personal Lines automobile coverage of approximately $60 million. In 1994, estimated claims and claim adjustment expenses arising in prior years included favorable loss development in Personal Lines automobile and homeowners coverage of $100 million, offset by unfavorable development of $100 million for Commercial Lines asbestos and environmental claims from 1985 and prior. In addition, in 1994 Commercial Lines experienced favorable prior year loss development in workers' compensation, other liability and commercial automobile product lines in its National Accounts business for post-1985 accident years. This favorable development amounted to $261 million, however, since the business to which it relates is subject to premium adjustments on retrospectively rated policies, the net impact on results of operations is minimal. In the third quarter of 1993, the Company added $299 million to its reserves primarily for asbestos and environmental liabilities. This addition to reserves resulted in an after-tax charge of $194 million. Several developments contributed to the decision to add to reserves. The insurance industry has witnessed a growth in claims brought by outside workers who allege exposure to asbestos while working on site at various companies, and there was an increase in the incidence of this type of claim during 1993. The Company also experienced a growth in environmental claims, primarily from smaller companies with lower coverage limits, and was named as a defendant in coverage cases brought by other insurers against their policyholders and the policyholders' other carriers. The purchase accounting adjustment of $225 million reflects appellate court decisions that resolved issues concerning obligations of insurers for environmental claims under liability policies in certain jurisdictions, and the measurement of amounts recoverable for asbestos claims from reinsurers based upon commutation of reinsurers' liabilities at a discount. The claims and claim adjustment expense reserves included $806 million and $777 million for asbestos and environmental related claims net of reinsurance at December 31, 1995 and 1994, respectively. The Company carries on a continuing review of its overall position, its reserving techniques and its reinsurance recoverables. However, the industry does not have a standard method of calculating claim activity for environmental and asbestos losses. In each of these areas of exposure, the Company has endeavored to litigate individual cases and settle claims on favorable terms. Given the vagaries of court coverage decisions, plaintiffs' expanded theories of liability, the risks inherent in major litigation and other uncertainties, it is not presently possible to quantify the ultimate exposure or range of exposure represented by these claims to the Company's financial condition, results of operations or liquidity. The Company believes that it is reasonably possible that the outcome of the uncertainties regarding environmental and asbestos claims could result in a liability exceeding the reserves by an amount that would be material to the Company's operating results in a future period. However, the Company believes that it is not likely that these claims will have a material adverse effect on the Company's financial condition or liquidity. 8. STOCKHOLDER'S EQUITY AND DIVIDEND AVAILABILITY Statutory net income of the Company's insurance subsidiaries was $313 million, $67 million and $163 million for the years ended December 31, 1995, 1994 and 1993, respectively. Statutory capital and surplus of the Company's insurance subsidiaries was $2.4 billion and $2.1 billion at December 31, 1995 and 1994, respectively. F-15 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 8. STOCKHOLDER'S EQUITY AND DIVIDEND AVAILABILITY--(CONTINUED) The Company's insurance subsidiaries are currently subject to various regulatory restrictions that limit the maximum amount of dividends available to be paid to their parent without prior approval of insurance regulatory authorities. Dividend payments to TAP from its insurance subsidiaries are limited to $299 million in 1996 without prior approval of the Connecticut Insurance Department. 9. SEGMENT INFORMATION
CORPORATE COMMERCIAL PERSONAL AND OTHER LINES LINES OPERATIONS CONSOLIDATED ---------- -------- --------- ------------ (IN MILLIONS) 1995 Revenues Premiums.................................................. $ 2,017 $1,284 $ 14 $ 3,315 Net investment income..................................... 548 161 1 710 Fee income................................................ 435 21 -- 456 Realized investment gains................................. 62 9 -- 71 Other..................................................... 8 6 3 17 ---------- -------- --------- ------------ Total................................................. $ 3,070 $1,481 $ 18 $ 4,569 ---------- -------- --------- ------------ Income (loss) before federal income taxes................... $ 424 $ 146 $ (19) $ 551 Net income (loss)........................................... 329 107 (17) 419 Total assets................................................ 20,727 3,617 277 24,621 1994 Revenues Premiums.................................................. $ 1,810 $1,353 $ 15 $ 3,178 Net investment income..................................... 444 128 1 573 Fee income................................................ 468 27 1 496 Realized investment gains (losses)........................ (109) (27) 4 (132) Other, including gain on disposition...................... 13 38 2 53 ---------- -------- --------- ------------ Total................................................. $ 2,626 $1,519 $ 23 $ 4,168 ---------- -------- --------- ------------ Income (loss) before federal income taxes................... $ 83 $ 135 $ (8) $ 210 Net income (loss)........................................... 93 97 (2) 188 Total assets................................................ 19,794 3,029 314 23,137 - ------------------------------------------------------------------------------------------------------------------ 1993 Revenues Premiums.................................................. $ 1,916 $1,386 $ 76 $ 3,378 Net investment income..................................... 481 148 28 657 Fee income................................................ 439 27 4 470 Realized investment gains................................. 141 46 5 192 Other..................................................... 11 7 -- 18 ---------- -------- --------- ------------ Total................................................. $ 2,988 $1,614 $ 113 $ 4,715 ---------- -------- --------- ------------ Income before federal income taxes.......................... $ 6 $ 162 $ 2 $ 170 Net income.................................................. 42 121 4 167 Total assets................................................ 17,539 3,446 431 21,416
10. DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS The Company uses derivative financial instruments, including financial futures contracts, forward contracts and interest rate swaps, as a means of hedging exposure to foreign currency and/or interest rate risk on anticipated F-16 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 10. DERIVATIVE FINANCIAL INSTRUMENTS AND FAIR VALUE OF FINANCIAL INSTRUMENTS-- (CONTINUED) investment purchases or existing assets and liabilities. Also, in the normal course of business, the Company has fixed and variable rate loan commitments and unfunded commitments to partnerships. The Company does not hold or issue derivative instruments for trading purposes. The Company uses exchange-traded financial futures contracts to manage the exposure to changes in interest rates on anticipated transactions. The Company is subject to reinvestment risk from investments that mature, are called or sold. To hedge against adverse changes in interest rates, the Company enters long positions in financial futures contracts which offset asset price changes resulting from changes in market interest rates until a fixed maturity investment is purchased. Gains and losses on futures contracts adjust the basis of the hedged investments and are recognized in investment income over the life of the investments. As of December 31, 1995 the Company held financial futures contracts with a notional amount of approximately $220 million and deferred gains of $3 million. Total gains from financial futures of $32 million are deferred at December 31, 1995 relating to anticipated investment purchases which will substantially occur by the end of the second quarter of 1996. These deferred gains are reported in other liabilities. The Company did not hold any financial futures contracts at December 31, 1994. Futures contracts have little credit risk since organized exchanges are the counterparties. Margin payments are required to enter a futures contract and contract gains or losses are settled daily in cash. The notional amount of futures contracts represents the extent of the Company's involvement, but not future cash requirements, as open positions are typically closed out prior to the delivery date of the contract. At December 31, 1995, the Company's futures contracts have no fair value because these contracts are marked to market and settled in cash. The off-balance-sheet risks of forward contracts, interest rate swaps, fixed and variable rate loan commitments and unfunded commitments to partnerships were not significant at December 31, 1995 and 1994. Financial guarantees are described in note 11. Fair Value of Certain Financial Instruments The Company uses various financial instruments in the normal course of its business. Fair values of financial instruments which are considered insurance contracts are not required to be disclosed and are not included in the amounts discussed. At December 31, 1995 and 1994, investments in fixed maturities had a fair value of $10.9 billion and $8.9 billion, respectively. See note 16. The carrying value of $747 million and $808 million of financial instruments classified as other assets approximated their fair values at December 31, 1995 and 1994, respectively. The carrying value of $1.4 billion and $1.3 billion of financial instruments classified as other liabilities at December 31, 1995 and 1994, respectively, also approximated their fair values. Fair value is determined using various methods including discounted cash flows, as appropriate for the various financial instruments. The carrying values of cash, short-term securities, mortgage loans and investment income accrued approximate their fair values. 11. COMMITMENTS AND CONTINGENCIES Financial Instruments with Off-Balance-Sheet Risk See note 10 and Guarantees of the Securities of Other Issuers below for a discussion of financial instruments with off-balance-sheet risk. F-17 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 11. COMMITMENTS AND CONTINGENCIES--(CONTINUED) Guarantees of the Securities of Other Issuers The Company underwrote insurance guaranteeing a small number of the securities of other issuers, primarily corporate and industrial revenue bond issuers. The Company does not consider these obligations to carry a high degree of risk. The aggregate net amount of guarantees of principal and interest for such securities was approximately $127 million ($1.7 billion gross of reinsurance) and $150 million ($2.2 billion gross of reinsurance) at December 31, 1995 and 1994, respectively. The scheduled maturities for these guarantees are $100 million, $2 million, $2 million, $2 million and $21 million for 1996, 1997, 1998, 1999 and 2000 and thereafter, respectively. Premiums are earned pro rata over the policy term. The unearned premium reserve and reserve for possible losses were not significant at December 31, 1995 and 1994. It is not practicable to estimate a fair value for the Company's financial guarantees because the Company no longer writes such guarantees, there is no quoted market price for such contracts, and it is not practicable to reliably estimate the timing and amount of all future cash flows due to the unique nature of each of these contracts. Included in the gross amounts are financial guarantees representing the Company's participation in the Municipal Bond Insurance Association's guarantee of municipal bond obligations of $1.6 billion and $2.1 billion at December 31, 1995 and 1994, respectively. The bonds are generally rated A or above, and the Company's participation has been reinsured. Environmental and Asbestos Claims With respect to environmental and asbestos claims and related reinsurance recoverables, see notes 6 and 7. Litigation The Company is a defendant or codefendant in various litigation matters other than environmental and asbestos claims. Although there can be no assurances, as of December 31, 1995, the Company believes, based on information currently available, that the ultimate resolution of these legal proceedings would not be likely to have a material adverse effect on its results of operations, financial condition or liquidity. 12. BENEFIT PLANS Pension Plans The Company participates in qualified and nonqualified, noncontributory defined benefit pension plans sponsored by an affiliate covering the majority of the Company's U.S. employees. Benefits for the qualified plan are based on an account balance formula. Under this formula, each employee's accrued benefit can be expressed as an account that is credited with amounts based upon the employee's pay, length of service and a specified interest rate, all subject to a minimum benefit level. This plan is funded in accordance with the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. For the nonqualified plan, contributions are based on benefits paid. Certain subsidiaries of Gulf participate in a noncontributory defined benefit plan sponsored by their ultimate parent, Travelers Group Inc. The Company's share of net pension expense was $4 million, $7 million and $8 million for 1995, 1994 and 1993, respectively. Other Benefit Plans In addition to pension benefits, the Company provides certain health care and life insurance benefits for retired employees through a plan sponsored by TIGI. Covered employees may become eligible for these benefits if they reach retirement age while working for the Company. These retirees may elect certain prepaid health care F-18 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 12. BENEFIT PLANS--(CONTINUED) benefit plans. Life insurance benefits generally are set at a fixed amount. The cost recognized by the Company for these benefits represents its allocated share of the total costs of the plan, net of employee contributions. The Company's pretax share of the total cost of the plan for 1995, 1994 and 1993 was $14 million, $16 million and $17 million, respectively. The Merger resulted in a change in control of The Travelers Corporation as defined in the applicable plans, and provisions of some employee benefit plans secured existing compensation and benefit entitlements earned prior to the change in control, and provided a salary and benefit continuation floor for employees whose employment was affected. These merger-related costs were assumed by TIGI. Savings, Investment and Stock Ownership Plan Under the savings, investment and stock ownership plan available to substantially all employees of TIGI, the Company matches a portion of employee contributions. Effective April 1, 1993, the match decreased from 100% to 50% of an employee's first 5% contribution and a variable match based on the profitability of TIGI and its subsidiaries was added. The Company's matching obligations were $7 million, $8 million and $10 million in 1995, 1994 and 1993, respectively. 13. RELATED PARTY TRANSACTIONS The principal banking functions, including payment of salaries and expenses, for certain subsidiaries and affiliates of TIGI, including the Company, are handled by TIC. Settlements for these functions between the Company and its affiliates are made regularly. TIC provides various insurance coverages, principally life and health, to employees of certain subsidiaries of TIGI. The premiums for these coverages are charged in accordance with cost allocation procedures based upon salaries or census. In addition, investment advisory and management services and data processing services are provided by affiliated companies. Charges for these services are shared by the companies on cost allocation methods based generally on estimated usage by department. TIGI and its subsidiaries maintain a short-term investment pool in which the Company participates. The positions of each company participating in the pool are calculated and adjusted daily. At December 31, 1995 and 1994, the pool totaled approximately $2.2 billion and $1.5 billion, respectively. The Company's share of the pool amounted to $722 million and $394 million at December 31, 1995 and 1994, respectively, and is included in short-term securities in the consolidated balance sheet. Most leasing functions for TIGI and its subsidiaries are handled by TIC. Leasing expenses are shared by the companies on a cost allocation method based generally on estimated usage by department. The Company's rent expense was $61 million, $70 million and $92 million in 1995, 1994 and 1993, respectively. The Company leases new furniture and equipment from a noninsurance subsidiary of TIGI. The rental expense charged to the Company for this furniture and equipment was $39 million, $26 million and $27 million in 1995, 1994 and 1993, respectively. At December 31, 1995 and 1994, the Company has an investment of $34 million and $18 million, respectively, in bonds of its affiliate, Commercial Credit Company. This is included in fixed maturities in the consolidated balance sheet. The Company participates in reinsurance agreements with TIGI and TIC. See note 6 for further discussion. The Company purchases annuities from affiliates to settle certain claims. Reinsurance recoverables at December 31, 1995 and 1994 included $672 million and $691 million, respectively, related to these annuities. F-19 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 14. FEDERAL INCOME TAXES
1995 1994 1993 ---- ---- ---- (IN MILLIONS) EFFECTIVE TAX RATE Income before federal income taxes............................ $551 $210 $170 Statutory tax rate............................................ 35% 35% 35% ---- ---- ---- Expected federal income taxes................................. $193 $ 74 $ 60 Tax effect of: Nontaxable investment income................................ (68) (62) (42) Adjustment to deferred tax asset for enacted change in tax rates from 34% to 35%......................................... -- -- (17) Goodwill.................................................... 4 4 -- "Fresh Start" tax adjustment................................ -- -- (14) Other, net.................................................. 3 6 16 ---- ---- ---- Federal income taxes.......................................... $132 $ 22 $ 3 ---- ---- ---- ---- ---- ---- Effective tax rate............................................ 24% 10% 2% ---- ---- ---- COMPOSITION OF FEDERAL INCOME TAXES Current: United States............................................... $155 $(11) $ 13 Foreign..................................................... 5 5 2 ---- ---- ---- Total................................................... 160 (6) 15 ---- ---- ---- Deferred: United States............................................... (28) 28 (12) Foreign..................................................... -- -- -- ---- ---- ---- Total................................................... (28) 28 (12) ---- ---- ---- Federal income taxes.......................................... $132 $ 22 $ 3 ---- ---- ---- ---- ---- ----
The net deferred tax assets at December 31, 1995 and 1994 were comprised of the tax effects of temporary differences related to the following assets and liabilities:
1995 1994 ---- ------ (IN MILLIONS) Deferred tax assets: Claims and claim adjustment expense and other reserves............. $737 $ 721 Investments........................................................ -- 249 Employee benefits.................................................. 95 94 Other.............................................................. 65 39 ---- ------ Total.......................................................... 897 1,103 ---- ------ Deferred tax liabilities: Deferred acquisition costs......................................... 70 77 Investments........................................................ 139 -- Other.............................................................. 38 29 ---- ------ Total.......................................................... 247 106 ---- ------ Net deferred tax asset............................................... $650 $ 997 ---- ------ ---- ------
F-20 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 14. FEDERAL INCOME TAXES--(CONTINUED) The Company is a member of a subgroup of companies comprised of TIGI and its non-life insurance subsidiaries. This subgroup is included in the consolidated federal income tax return filed by Travelers Group Inc. TIGI allocates federal income taxes to its subsidiaries on a separate return basis adjusted for credits and other amounts required by the consolidation process. Any resulting liability is paid currently to TIGI. Any credits for losses will be paid by TIGI currently to the extent that such credits are for tax benefits that have been utilized in the consolidated federal income tax return. TIGI will reimburse the Company for any remaining receivable at the end of the federal statutory carryforward period. In the event that the consolidated return develops an alternative minimum tax (AMT), each company with an AMT on a separate company basis will be allocated a portion of the consolidated AMT. Settlement of the AMT will be made in the same manner and timing as the regular tax. If the AMT is available as a credit against the regular tax, each subsidiary remitting the AMT may establish a receivable from TIGI. The receivable will be paid as the credit is utilized on the consolidated return or at the end of the federal statutory carryforward period for operating losses. The Company has a net deferred tax asset which relates to temporary differences that are expected to reverse as net ordinary deductions. The Company will have to generate approximately $1.8 billion of taxable income, before reversal of these temporary differences, primarily over the next 10 to 15 years, to realize the deferred tax asset. Management expects to realize the deferred tax asset based upon its expectation of future positive taxable income, after the reversal of these deductible temporary differences, in the consolidated federal income tax return of Travelers Group Inc. The taxable income of the consolidated return of Travelers Group Inc., after reversal of the deductible temporary differences, is expected to be at least $1 billion annually. At December 31, 1995, the Company has no ordinary or capital loss carryforwards. Starting in 1990, the Omnibus Budget Reconciliation Act of 1990 requires property-casualty insurance companies to accrue estimated salvage and subrogation recoverable. Companies are, however, allowed a "fresh start" adjustment equal to 87% of the discounted opening 1990 reserve. For the Company, this amount was spread over a four-year period beginning in 1990. "Fresh Start" adjustments relating to salvage and subrogation reduced 1993 taxes by $14 million. 15. NET INVESTMENT INCOME
1995 1994 1993 ---- ---- ---- (FOR THE YEAR ENDED DECEMBER 31, IN MILLIONS) GROSS INVESTMENT INCOME Fixed maturities......................................... $586 $528 $601 Short-term securities.................................... 73 17 12 Mortgage loans........................................... 21 27 43 Other.................................................... 49 26 43 ---- ---- ---- 729 598 699 Investment expenses...................................... 19 25 42 ---- ---- ---- Net investment income.................................... $710 $573 $657 ---- ---- ---- ---- ---- ----
F-21 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 16. INVESTMENTS AND INVESTMENT GAINS (LOSSES) Realized investment gains (losses) for the periods were as follows:
1995 1994 1993 ------- ----- ---- (FOR THE YEAR ENDED DECEMBER 31, IN MILLIONS) REALIZED Fixed maturities...................................... $ (40) $(147) $145 Equity securities..................................... 25 12 24 Real estate........................................... 1 -- (10) Other................................................. 85 3 33 ------- ----- ---- Realized investment gains (losses).................... $ 71 $(132) $192 ------- ----- ---- ------- ----- ----
Changes in net unrealized investment gains (losses) that are included as a separate component of stockholder's equity were as follows:
1995 1994 1993 ------- ----- ---- (FOR THE YEAR ENDED DECEMBER 31, IN MILLIONS) UNREALIZED Fixed maturities...................................... $ 1,039 $(637) $(62) Equity securities..................................... 55 (25) (5) Other................................................. 20 (41) 23 ------- ----- ---- 1,114 (703) (44) Related taxes......................................... 391 (248) (12) ------- ----- ---- Change in unrealized investment gains (losses)........ 723 (455) (32) Balance beginning of year............................. (443) 12 44 ------- ----- ---- Balance end of year................................... $ 280 $(443) $ 12 ------- ----- ---- ------- ----- ----
The initial adoption of FAS 115 resulted in an increase of approximately $36 million (net of taxes) to net unrealized gains in 1994. Fixed Maturities Proceeds from sales of fixed maturities classified as available for sale were $4.9 billion and $1.8 billion in 1995 and 1994, respectively. Gross gains of $65 million and $12 million and gross losses of $90 million and $67 million, respectively, were realized on those sales. Prior to December 31, 1993, fixed maturities that were intended to be held to maturity were recorded at amortized cost and classified as held for investment. Sales from the amortized cost portfolios have been made periodically. Such sales were $897 million in 1993, resulting in gross realized gains of $29 million and gross realized losses of $3 million. Prior to December 31, 1993, the carrying values of the trading portfolio fixed maturities were adjusted to market value as it was likely they would be sold prior to maturity. Sales of trading portfolio fixed maturities were $5.2 billion in 1993, resulting in gross realized gains of $132 million and gross realized losses of $4 million. F-22 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 16. INVESTMENTS AND INVESTMENT GAINS (LOSSES)--(CONTINUED) The amortized cost and market value of investments in fixed maturities were as follows: DECEMBER 31, 1995
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE --------- ---------- ---------- ------- (IN MILLIONS) Available for sale: Mortgage-backed securities--CMOs and pass through securities..... $ 1,518 $ 59 $ 3 $ 1,574 U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities................................ 1,183 65 -- 1,248 Obligations of states, municipalities and political subdivisions....................................................... 3,855 109 11 3,953 Debt securities issued by foreign governments.................... 97 3 -- 100 All other corporate bonds........................................ 3,792 164 12 3,944 Redeemable preferred stock....................................... 89 -- -- 89 --------- ----- ----- ------- Total............................................................ $10,534 $400 $ 26 $10,908 --------- ----- ----- ------- --------- ----- ----- -------
DECEMBER 31, 1994
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE --------- ---------- ---------- ------- (IN MILLIONS) Available for sale: Mortgage-backed securities--CMOs and pass through securities..... $ 1,121 $ 1 $ 72 $ 1,050 U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities................................ 1,231 1 88 1,144 Obligations of states, municipalities and political subdivisions....................................................... 3,918 4 351 3,571 Debt securities issued by foreign governments.................... 141 -- 5 136 All other corporate bonds........................................ 3,082 5 159 2,928 Redeemable preferred stock....................................... 38 -- 1 37 --------- ----- ----- ------- Total............................................................ $ 9,531 $ 11 $676 $ 8,866 --------- ----- ----- ------- --------- ----- ----- -------
The amortized cost and market value of fixed maturities at December 31, 1995, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
AMORTIZED MARKET MATURITY COST VALUE - ----------------------------------------------------------------- --------- ------- (IN MILLIONS) Due in one year or less.......................................... $ 399 $ 400 Due after 1 year through 5 years................................. 2,072 2,121 Due after 5 years through 10 years............................... 2,595 2,713 Due after 10 years............................................... 3,950 4,100 --------- ------- 9,016 9,334 Mortgage-backed securities....................................... 1,518 1,574 --------- ------- Total...................................................... $10,534 $10,908 --------- ------- --------- -------
The Company makes significant investments in collateralized mortgage obligations (CMOs). CMOs typically have high credit quality, offer good liquidity, and provide a significant advantage in yield and total return compared to U.S. Treasury securities. The Company's investment strategy is to purchase CMO tranches which are protected against prepayment risk, primarily planned amortization class (PAC) tranches. Prepayment protected tranches are preferred because they provide stable cash flows in a variety of scenarios. The Company does invest in F-23 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 16. INVESTMENTS AND INVESTMENT GAINS (LOSSES)--(CONTINUED) other types of CMO tranches if a careful assessment indicates a favorable risk/return tradeoff. The Company does not purchase residual interests in CMOs. At December 31, 1995 and 1994, the Company held CMOs classified as available for sale with a fair value of $956 million and $655 million, respectively. Approximately 90% and 89% of the Company's CMO holdings are fully collateralized by GNMA, FNMA or FHLMC securities at December 31, 1995 and 1994, respectively. In addition, the Company held $618 million and $395 million of GNMA, FNMA or FHLMC mortgage-backed securities at December 31, 1995 and 1994, respectively. Virtually all of these securities are rated AAA. Equity Securities The cost and market values of investments in equity securities were as follows:
GROSS GROSS UNREALIZED UNREALIZED MARKET COST GAINS LOSSES VALUE ---- ---------- ---------- ------ (IN MILLIONS) DECEMBER 31, 1995 Common stocks...................................................... $171 $ 38 $ 6 $203 Nonredeemable preferred stocks..................................... 394 11 5 400 ---- --- --- ------ Total........................................................ $565 $ 49 $ 11 $603 ---- --- --- ------ ---- --- --- ------
DECEMBER 31, 1994 Common stocks...................................................... $107 $ 13 $ 10 $110 Nonredeemable preferred stocks..................................... 230 1 21 210 ---- --- --- ------ Total........................................................ $337 $ 14 $ 31 $320 ---- --- --- ------ ---- --- --- ------
Proceeds from sales of equity securities were $157 million and $121 million in 1995 and 1994, respectively, resulting in gross realized gains of $28 million and $19 million and gross realized losses of $6 million and $1 million, respectively. Mortgage loans and real estate Underperforming assets include delinquent mortgage loans, loans in the process of foreclosure, foreclosed loans and loans modified at interest rates below market. The Company continues its strategy, adopted in conjunction with the Merger, to dispose of these real estate assets and some of the mortgage loans and to reinvest the proceeds to obtain current market yields. At December 31, 1995 and 1994, the Company's mortgage loan and real estate held for sale portfolios consisted of the following:
1995 1994 ---- ---- (IN MILLIONS) Current mortgage loans................................................. $201 $196 Underperforming mortgage loans......................................... 12 40 ---- ---- Total mortgage loans............................................. 213 236 ---- ---- Real estate held for sale.............................................. 23 30 ---- ---- Total mortgage loans and real estate held for sale............... $236 $266 ---- ---- ---- ----
F-24 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 16. INVESTMENTS AND INVESTMENT GAINS (LOSSES)--(CONTINUED) Aggregate annual maturities on mortgage loans at December 31, 1995 are as follows:
(IN MILLIONS) Past maturity............................................................. $ 20 1996...................................................................... 8 1997...................................................................... 34 1998...................................................................... 54 1999...................................................................... 18 2000...................................................................... 20 Thereafter................................................................ 59 ----- Total............................................................... $ 213 ----- -----
Concentrations At December 31, 1995 and 1994, the Company had concentrations of credit risk in tax exempt investments of the State of Texas of $602 million and $585 million, respectively. The Company participates in a short-term investment pool maintained by TIGI and its subsidiaries. This pool is discussed in note 13. Included in fixed maturities are below investment grade assets totaling $402 million and $482 million at December 31, 1995 and 1994, respectively. The Company defines its below investment grade assets as those securities rated "Ba1" or below by external rating agencies, or the equivalent by the internal analysts when a public rating does not exist. Such assets include publicly traded below investment grade bonds and certain other privately issued bonds that are classified as below investment grade loans. The Company also has significant concentrations of investments in the following industries:
1995 1994 ---- ---- (IN MILLIONS) Financing.............................................................. $599 $312 Banking................................................................ 575 270 Transportation......................................................... 533 318 Electric utilities..................................................... 513 315 Oil and gas............................................................ 454 271
Below investment grade assets included in the totals above, are as follows:
1995 1994 ---- ---- (IN MILLIONS) Financing................................................................ $15 $ 8 Banking.................................................................. 1 4 Transportation........................................................... 28 36 Electric utilities....................................................... 21 31 Oil and gas.............................................................. 55 27
The Company monitors creditworthiness of counterparties to all financial instruments by using controls that include credit approvals, limits and other monitoring procedures. Collateral for fixed maturities often includes pledges of assets, including stock and other assets, guarantees and letters of credit. F-25 TRAVELERS/AETNA PROPERTY CASUALTY CORP. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 16. INVESTMENTS AND INVESTMENT GAINS (LOSSES)--(CONTINUED) Investment Valuation Reserves There were no investment valuation reserves at December 31, 1995 and 1994. Total investment valuation reserves, which are deducted from the applicable investment carrying values in the consolidated balance sheet, were as follows in 1994 and 1993:
1994 1993 ----- ---- (IN MILLIONS) Beginning of year..................................................... $ 10 $ 80 Increase.............................................................. -- 20 Impairments, net of gains/recoveries.................................. -- (36) FAS 115/Purchase accounting adjustment................................ (10) (54) ----- ---- End of year........................................................... $-- $ 10 ----- ---- ----- ----
Nonincome Producing Investments included in the consolidated balance sheets that were nonincome producing for the preceding 12 months were not significant. 17. NONCASH INVESTING AND FINANCING ACTIVITIES Significant noncash investing and financing activities include: a) the conversion of $23 million of convertible bonds for $23 million of common stock in 1995; b) the conversion of $31 million of convertible preferred stock for $31 million of convertible bonds in 1995; c) the receipt of $28 million of shares of common stock distributed by a venture capital limited partnership in 1994; d) the acquisition of real estate through foreclosures of mortgage loans amounting to $13 million, $24 million and $25 million in 1995, 1994 and 1993, respectively; and e) increases in investment valuation reserves in 1993 for securities, mortgage loans and/or investment real estate (see note 16). 18. QUARTERLY FINANCIAL DATA (UNAUDITED)
1995 ---------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- (IN MILLIONS) Premiums............................................................. $ 866 $ 878 $ 846 $ 725 Net investment income................................................ 168 175 180 187 Fee income........................................................... 124 120 109 103 Realized investment gains (losses)................................... (6) 6 35 36 Other revenues....................................................... 10 (1) 3 5 Federal income taxes................................................. 15 28 34 55 Net income........................................................... 75 99 110 135
1994 ---------------------------------------- FIRST SECOND THIRD FOURTH QUARTER QUARTER QUARTER QUARTER ------- ------- ------- ------- (IN MILLIONS) Premiums............................................................. $ 886 $ 897 $ 882 $ 513 Net investment income................................................ 137 137 148 151 Fee income........................................................... 110 122 130 134 Realized investment gains (losses)................................... 1 (8) (7) (118) Other revenues, including gain on disposition in fourth quarter...... 10 5 2 36 Federal income taxes (benefits)...................................... 6 16 17 (17) Net income........................................................... 45 66 72 5
F-26 INDEPENDENT AUDITORS' REPORT The Board of Directors Aetna Life and Casualty Company: We have audited the accompanying combined balance sheets of The Aetna Casualty and Surety Company and The Standard Fire Insurance Company and their subsidiaries (the "Companies") as of December 31, 1995 and 1994, and the related combined statements of income, shareholder's equity, and cash flows for each of the years in the three-year period ended December 31, 1995. These combined financial statements are the responsibility of the Companies' management. Our responsibility is to express an opinion on these combined financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the combined financial statements referred to above present fairly, in all material respects, the combined financial position of The Aetna Casualty and Surety Company and The Standard Fire Insurance Company and their subsidiaries as of December 31, 1995 and 1994, and the combined results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1995, in conformity with generally accepted accounting principles. As discussed in Note 1 to the combined financial statements, in 1993 the Companies changed their methods of accounting for certain investments in debt and equity securities, workers' compensation life table indemnity reserves and retrospectively rated reinsurance contracts. KPMG PEAT MARWICK LLP Hartford, Connecticut February 28, 1996 F-27 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES COMBINED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, (MILLIONS)
1995 1994 1993 -------- -------- -------- Revenue: Premiums............................................................... $4,117.7 $4,354.8 $4,609.8 Net investment income.................................................. 902.1 824.3 963.8 Fees and other income.................................................. 82.0 115.8 154.3 Net realized capital gains............................................. 199.0 5.9 144.0 -------- -------- -------- Total revenue.......................................................... 5,300.8 5,300.8 5,871.9 -------- -------- -------- Claims and Expenses: Claims and claim adjustment expenses................................... 4,232.0 3,747.1 4,191.1 Operating expenses..................................................... 851.8 1,011.2 1,093.1 Amortization of deferred policy acquisition costs...................... 622.7 633.7 646.2 Severance and facilities charge........................................ -- -- 155.0 -------- -------- -------- Total claims and expenses.............................................. 5,706.5 5,392.0 6,085.4 -------- -------- -------- Loss from continuing operations before income tax benefits and cumulative effect adjustments........................................ (405.7) (91.2) (213.5) Income tax benefits.................................................... (162.8) (53.9) (159.0) -------- -------- -------- Loss from continuing operations before cumulative effect adjustments... (242.9) (37.3) (54.5) Discontinued Operations, net of tax.................................... -- -- 27.0 -------- -------- -------- Loss before cumulative effect adjustments for continuing operations.... (242.9) (37.3) (27.5) Cumulative effect adjustments for continuing operations, net of tax.... -- -- 266.5 -------- -------- -------- Net income (loss)...................................................... $ (242.9) $ (37.3) $ 239.0 -------- -------- -------- -------- -------- --------
See Notes to Combined Financial Statements. F-28 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES COMBINED BALANCE SHEETS (AS OF DECEMBER 31, MILLIONS, EXCEPT SHARE DATA)
1995 1994 --------- --------- ASSETS Investments: Debt securities: Available for sale, at fair value (amortized cost $11,182.3 and $9,696.4)................................................................ $11,598.3 $ 9,096.8 Held for investment, at amortized cost (fair value $407.1)................. -- 413.5 Equity securities, at fair value (cost $289.5 and $779.5).................... 499.9 1,017.9 Short-term investments....................................................... 137.2 106.0 Mortgage loans............................................................... 1,061.7 1,453.7 Real estate.................................................................. 264.7 262.0 Other........................................................................ 291.1 301.2 --------- --------- Total investments.............................................................. 13,852.9 12,651.1 --------- --------- Cash and cash equivalents.................................................... 1,136.5 676.3 Reinsurance recoverables and receivables..................................... 5,276.6 4,903.2 Accrued investment income.................................................... 184.5 178.0 Premiums due and other receivables........................................... 1,002.1 1,063.5 Federal and foreign income taxes: Current.................................................................... 12.6 20.1 Deferred................................................................... 633.7 862.5 Deferred policy acquisition costs............................................ 305.8 316.0 Other assets................................................................... 994.3 1,000.4 --------- --------- Total assets................................................................. $23,399.0 $21,671.1 --------- --------- --------- --------- LIABILITIES Unpaid claims and claim adjustment expenses.................................. $16,558.5 $15,977.2 Unearned premiums............................................................ 1,398.4 1,423.8 Policyholders' funds left with the companies................................. 39.2 46.7 --------- --------- Total insurance liabilities.................................................... 17,996.1 17,447.7 Short-term debt.............................................................. -- 9.1 Long-term debt............................................................... 35.2 35.5 Other liabilities............................................................ 1,486.3 1,057.9 --------- --------- Total liabilities.............................................................. 19,517.6 18,550.2 --------- --------- Commitments and Contingent Liabilities (Notes 12, 13 and 14) SHAREHOLDER'S EQUITY Common capital stock (1,000 share authorized, issued and outstanding with a par value of $25,000 and 20,000 shares authorized, issued and outstanding with a par value of $250).................................................. 30.0 30.0 Paid in capital.............................................................. 1,477.5 1,174.5 Net unrealized capital gains (losses)........................................ 312.8 (387.9) Retained earnings............................................................ 2,061.1 2,304.3 --------- --------- Total shareholder's equity..................................................... 3,881.4 3,120.9 --------- --------- Total liabilities and shareholder's equity................................... $23,399.0 $21,671.1 --------- --------- --------- ---------
See Notes to Combined Financial Statements. F-29 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES COMBINED STATEMENTS OF SHAREHOLDER'S EQUITY FOR THE YEARS ENDED DECEMBER 31,
1995 1994 1993 -------- -------- -------- (MILLIONS) Shareholder's equity, beginning of year................................ $3,120.9 $3,858.3 $3,507.2 Capital Contribution................................................... 303.0 -- -- Dividends to shareholder............................................... (.3) -- -- Net change in unrealized capital gains and losses...................... 700.7 (700.1) 112.1 Net income (loss)...................................................... (242.9) (37.3) 239.0 -------- -------- -------- Shareholder's equity, end of year...................................... $3,881.4 $3,120.9 $3,858.3 -------- -------- -------- -------- -------- --------
See Notes to Combined Financial Statements. F-30 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES COMBINED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31,
1995 1994 1993 --------- --------- --------- (MILLIONS) CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss)..................................................... $ (242.9) $ (37.3) $ 239.0 Adjustments to reconcile net income (loss) to net cash provided by (used for) operating activities: Cumulative effect adjustments....................................... -- -- (266.5) (Increase) Decrease in accrued investment income.................... (6.6) 25.4 (13.3) Decrease (Increase) in premiums due and other receivables........... 154.0 (232.8) 148.3 Increase in reinsurance recoverables and receivables................ (373.4) (191.9) (70.3) Decrease (Increase) in deferred policy acquisition costs............ 10.2 13.5 (.8) Depreciation and amortization....................................... 8.6 15.0 19.3 (Decrease) Increase in federal and foreign income taxes............. 239.3 (205.1) 65.3 Net decrease (increase) in other assets and other liabilities....... 413.1 (513.1) 569.3 Increase (Decrease) in insurance liabilities........................ 555.5 423.9 (349.8) Net purchases of debt trading securities............................ -- -- (1,209.0) Gain on sale of subsidiaries........................................ -- -- (27.0) Net realized capital gains.......................................... (199.0) (5.9) (144.0) Amortization of net investment discounts............................ 3.2 55.0 21.3 Other, net.......................................................... 0.9 70.0 (58.8) --------- --------- --------- Net cash provided by (used for) operating activities.............. 562.9 (583.3) (1,077.0) --------- --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from sales of: Debt securities available for sale.................................. 3,845.9 4,173.2 -- Debt securities prior to adoption of FAS No. 115.................... -- -- 2,174.9 Equity securities................................................... 1,041.4 550.0 746.2 Mortgage loans...................................................... 29.0 33.1 17.5 Real estate......................................................... 94.9 69.5 52.3 Short-term investments.............................................. 9,917.5 7,361.3 9,892.1 Investment maturities and repayments of: Debt securities available for sale.................................. 1,526.4 914.7 -- Debt securities held for investment................................. -- 279.9 -- Debt securities prior to adoption of FAS No. 115.................... -- -- 1,341.4 Mortgage loans...................................................... 319.2 258.4 169.7 Cost of investment purchases in: Debt securities available for sale.................................. (6,508.1) (4,751.4) -- Debt securities prior to adoption of FAS No. 115.................... -- -- (3,328.6) Equity securities................................................... (317.3) (420.4) (772.3) Mortgage loans...................................................... .3 (9.9) (7.3) Real estate......................................................... (18.0) -- -- Short-term investments.............................................. (9,955.7) (7,331.4) (9,627.2) Decrease (increase) in property and equipment......................... 1.9 1.3 (8.9) Other, net............................................................ (373.0) 135.3 (67.1) --------- --------- --------- Net cash (used for) provided by investing activities................ (395.6) 1,263.6 582.7 --------- --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid to shareholder....................................... (.3) -- -- Capital contribution from shareholder............................... 303.0 -- -- Issuance of long-term debt.......................................... -- -- (.3) Repayment of long-term debt......................................... (.3) (12.3) (6.5) Net increase (decrease) in short-term debt.......................... (9.1) 9.1 -- --------- --------- --------- Net cash provided by (used for) financing activities.............. 293.3 (3.2) (6.8) --------- --------- --------- Effect of exchange rate changes on cash and cash equivalents.......... (.4) (.3) (1.3) --------- --------- --------- Net increase (decrease) in cash and cash equivalents.................. 460.2 676.8 (502.4) Cash and cash equivalents, beginning of year.......................... 676.3 (.5) 501.9 --------- --------- --------- Cash and cash equivalents, end of year................................ $ 1,136.5 $ 676.3 $ (.5) --------- --------- --------- --------- --------- ---------
See Notes to Combined Financial Statements. F-31 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES DESCRIPTION OF ENTITY AND PRINCIPLES OF COMBINATION The combined financial statements include The Aetna Casualty and Surety Company and The Standard Fire Insurance Company and their subsidiaries (collectively, the 'Companies') which are wholly-owned subsidiaries of Aetna Life and Casualty Company ('Aetna'). Aetna entered into a definitive agreement, dated November 28, 1995, to sell the Companies to The Travelers Insurance Group Inc. ('Travelers'). The sale is subject to state regulatory approval and other customary conditions and is expected to be completed no later than midyear 1996. The Companies' commercial insurance operations provide most types of commercial property-casualty insurance (primarily workers' compensation, auto, liability and other specialty products), bonds, and insurance-related services for businesses, government units and associations. The personal insurance operations underwrite private-passenger auto and homeowner insurance, which is sold to individuals through independent agents, with a significant market in the Northeastern states. Due to the related business activities, common management control, common ownership and the interdependence of the affiliated entities, combined financial statements have been prepared in accordance with generally accepted accounting principles. Intercompany transactions between the Companies have been eliminated. Certain reclassifications have been made to 1994 and 1993 financial information to conform to 1995 presentation. ACCOUNTING CHANGES Accounting by Creditors for Impairment of a Loan As of January 1, 1995, the Companies adopted Financial Accounting Standard ('FAS') No. 114, Accounting by Creditors for Impairment of a Loan and FAS No. 118, Accounting by Creditors for Impairment of a Loan-- Income Recognition and Disclosures. In accordance with these standards, a loan is considered impaired when it is probable that the Companies will be unable to collect amounts due according to the contractual terms of the loan agreement. For impaired loans, a specific impairment reserve is established for the difference between the recorded investment in the mortgage loan and the fair value of the collateral. General reserves are established for losses management believes are likely to arise from the overall portfolio but cannot be attributed to specific loans. Prior to the adoption of FAS Nos. 114 and 118, the Companies included the reserve for estimated losses on potential problem loans which management believed were likely to become classified as problem or restructured in the next 12 months or so in the general reserve. Adoption of these standards had no impact on 1995 net income. Accounting for Certain Investments in Debt and Equity Securities On December 31, 1993, the Companies adopted FAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, which requires the classification of debt securities into three categories and equity securities into two categories. (Please refer to Note 3.) Initial adoption of this standard in 1993 resulted in a net increase of $107.6 million, net of taxes of $57.9 million, to net unrealized capital gains in shareholder's equity as of December 31, 1993. Discounting of Workers' Compensation Life Table Indemnity Reserves In 1993, the Companies elected to change, retroactive to January 1, 1993, the accounting policy for reporting reserves for current and expected workers' compensation life table indemnity claims to a discounted basis. These reserves are discounted at 5% for voluntary business and 3.5% for involuntary business. A cumulative effect benefit of $250.0 million, net of taxes of $134.7 million, was reported in the 1993 Combined Statement of Income. The effect of the change for the year ended December 31, 1993 was an increase to results from continuing operations before cumulative effect adjustments of $78.0 million, net of taxes of $42.0 million. F-32 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) Accounting for Retrospectively Rated Reinsurance Contracts In 1993, the Companies changed their method of accounting for retrospectively rated reinsurance contracts to conform to the consensus reached by the Emerging Issues Task Force of the Financial Accounting Standards Board ('FASB'). Accordingly, the Companies reported a cumulative effect adjustment, retroactive to January 1, 1993, to recognize an asset for the amounts due from reinsurers related to the experience through January 1, 1993 under retrospectively rated reinsurance contracts. The Companies reported a cumulative effect benefit related to this accounting change of $16.5 million, net of taxes of $8.6 million, in the 1993 Combined Statement of Income. The effect of the change for the year ended December 31, 1993 was an increase to results from continuing operations before cumulative effect adjustments of $3.3 million, net of taxes of $1.8 million. FUTURE APPLICATION OF ACCOUNTING STANDARDS Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of In March 1995, the FASB issued FAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. This statement requires write-down to fair value when long-lived assets to be held and used are impaired. The statement also requires long-lived assets to be disposed of (e.g., real estate held for sale) to be carried at the lower of cost or fair value less estimated selling costs and does not allow such assets to be depreciated. The Companies will adopt this statement in 1996 and the impact on earnings is not expected to be material. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from reported results using those estimates. CASH AND CASH EQUIVALENTS Cash and cash equivalents include cash on hand, money market instruments and other debt issues with a maturity of 90 days or less when purchased. INVESTMENTS Debt securities which may be sold prior to maturity are classified as available for sale and carried at fair value. Available for sale debt securities are written down (as realized losses) for other than temporary declines in value. Unrealized gains and losses related to available for sale investments, net of related taxes, are reflected in shareholder's equity. Debt securities which the Companies have the positive intent and ability to hold to maturity are classified as held for investment and are carried at amortized cost, net of write-downs for other than temporary declines in value. The Companies had no held for investment securities at December 31, 1995. In December 1995, in accordance with guidance published by the FASB, the Companies reassessed the classifications of all debt securities. As a result of this review, debt securities with an amortized cost of $403.1 million (fair value of $400.8 million) were reclassified from the held for investment category to the available for sale category. Debt securities which are held with the objective of trading to generate profits on short-term differences in price ("trading securities") are carried at fair value. Changes in fair value related to the trading portfolio are F-33 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) reflected in net realized capital gains or losses in the Combined Statements of Income. The Companies had no trading securities at December 31, 1995 or 1994. Equity securities are classified as available for sale and carried at fair value. Equity securities are written down (as realized losses) for other than temporary declines in value. Unrealized gains and losses related to such securities, net of related taxes, are reflected in shareholder's equity. Fair values for debt and equity securities are based on quoted market prices or dealer quotations. Where quoted market prices or dealer quotations are not available, fair values are measured utilizing quoted market prices for similar securities or by using discounted cash flow methods. Cost for mortgage-backed securities is adjusted for unamortized premiums and discounts, which are amortized using the interest method over the estimated remaining term of the securities, adjusted for anticipated prepayments. Purchases and sales of debt and equity securities are recorded on the trade date. Purchases and sales of mortgage loans are recorded on the closing date. Mortgage loans are carried at unpaid principal balances, net of impairment reserves, and are generally secured. A mortgage loan is considered impaired when it is probable that the Companies will be unable to collect amounts due according to the contractual terms of the loan agreement. For impaired loans, a specific impairment reserve is established for the difference between the recorded investment in the mortgage loan and the fair value of the collateral. A general reserve is established for losses management believes are likely to arise from the overall portfolio but cannot be attributed to specific loans. Investment real estate, which the Companies have the intent to hold for the production of income, is carried at depreciated costs including capital additions, net of write-downs for other than temporary declines in fair value. Properties held for sale (primarily acquired through foreclosure) are carried at the lower of depreciated cost (fair value at foreclosure plus capital additions less accumulated depreciation) or fair value less estimated selling costs. Adjustments to the carrying value of properties held for sale are recorded in a valuation reserve when the fair value less estimated selling costs is below depreciated cost. Short-term investments, consisting primarily of money market instruments and other debt issues purchased with a maturity of 91 days to one year, are considered available for sale and are carried at fair value, which approximates amortized cost. Other invested assets consist primarily of partnerships, equity subsidiaries and agency loans. Partnerships and equity subsidiaries are carried on an equity basis and agency loans are carried at the unpaid principal balance. The Companies utilize foreign exchange forward contracts and swap agreements for other than trading purposes in order to manage investment returns and align maturities, interest rates, currency rates and funds availability with its obligations. (Please refer to Note 13.) Foreign exchange forward contracts which are designated at inception and effective as hedges of foreign translation exposures and foreign transaction exposures related to investments classified as available for sale are accounted for using the deferral method. Under the deferral method, realized and unrealized gains and losses from these forward contracts are deferred on the balance sheet, net of tax, in net unrealized capital gains or losses. Upon disposal of the hedged item, deferred gains and losses are recognized in net realized capital gains or losses in the Combined Statements of Income. Excess realized or unrealized gain or loss, if any, from the foreign exchange forward contract compared to the foreign investment being hedged, is reported as a net realized gain or loss in the Combined Statements of Income. Swap agreements which are designated as interest rate or foreign exchange rate risk management instruments at inception are accounted for using the accrual method. Under the accrual method, the difference between F-34 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) amounts paid and received on such agreements is reported in net investment income in the Combined Statements of Income; there is no recognition in the Combined Balance Sheets for changes in the fair value of the agreement. DEFERRED POLICY ACQUISITION COSTS Certain costs of acquiring insurance business are deferred. These costs, all of which vary with and are primarily related to the production of new and renewal business, consist principally of commissions, certain expenses of underwriting and issuing contracts and certain agency expenses. Acquisition costs are amortized over the life of the insurance contract. Deferred policy acquisition costs would be written off to the extent that it is determined that future policy premiums and investment income would not be adequate to cover related losses and expenses. OTHER ASSETS Property and equipment are reported at depreciated cost using the straight-line method based upon the estimated useful lives of the assets. The carrying value of property and equipment at December 31, 1995 and 1994 was $12.1 million and $20.9 million, respectively, and was net of accumulated depreciation of $92.8 million and $92.9 million, respectively. INSURANCE LIABILITIES Liabilities for unpaid claims and claim adjustment expenses include, to the extent reasonably estimable, provisions for payments to be made on reported claims, and claims incurred but not reported and for associated claim adjustment expenses. (Please refer to Note 12.) Workers' compensation life table indemnity reserves are discounted at 5% for voluntary business and 3.5% for involuntary business. Workers' compensation life table indemnity reserves, net of the related discount, totaled $863 million and $821 million at December 31, 1995 and 1994, respectively, which were 26% and 24% of the Companies' total workers' compensation reserves for unpaid claims and claim adjustment expenses at December 31, 1995 and 1994, respectively. Certain other reserves with fixed or determinable payment patterns over periods of up to seven years, including reserves related to certain environmental and asbestos-related claim settlements, have also been discounted. The rates used in discounting such reserves range from 4% to 7%, and the amount of such discounted reserves, net of reinsurance was approximately $190 million at December 31, 1995. The Companies' insurance reserve liabilities are reported net of estimated amounts of salvage and subrogation. Unearned premiums are calculated on a pro rata basis. Additional premiums under retrospectively-rated policies are excluded from unearned premiums and classified as premiums due. PREMIUMS, CLAIMS AND EXPENSES Premiums are generally recognized as revenue on a pro rata basis over the policy term. Certain policies allow the Companies to charge additional premiums as a result of recognizing additional claim and expense costs under the policies. Such premiums are recognized when the related losses are provided. Claims and expenses, including acquisition costs such as commissions, certain premium taxes and certain other items, are charged to current operations as incurred. Claims are reported net of salvage and subrogation received and anticipated. Premiums, claims and expenses are also reported net of deductions for reinsurance ceded. F-35 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED) STRUCTURED SETTLEMENTS In cases where the Company has obtained a structured settlement with a qualified assignment, i.e., the structured settlement annuity is owned by a party other than the Company, the cost of the annuity is recognized as a paid loss and gains, if any, are recognized in income. For cases where no qualified assignment is obtained, the related loss amount and the annuity cost plus accrued interest are included in loss reserves and reinsurance recoverables, respectively. FEDERAL AND FOREIGN INCOME TAXES The Companies are included in the consolidated federal income tax return of Aetna. The Companies are taxed at regular corporate rates after adjusting income/(loss) reported for financial statement purposes for certain items. Foreign subsidiaries and U.S. subsidiaries operating outside of the United States are taxed under applicable foreign statutes. Deferred income tax expenses/benefits result from changes during the year in cumulative temporary differences between the tax basis and book basis of assets and liabilities. DISCONTINUED OPERATIONS On September 30, 1992, The Aetna Casualty and Surety Company ("AC&S") completed the sale of American Re-Insurance Company ("Am Re"), formerly a wholly owned subsidiary. As part of the sale, AC&S received 70,000 shares of American Re Corporation's (the new holding company) Preferred Stock which were redeemed in 1993 resulting in an after-tax gain of $27.0 million. 2. SEVERANCE AND FACILITIES CHARGE The Companies recorded a $101 million after-tax ($155 million pretax) severance and facilities charge in the fourth quarter of 1993. The planned actions included the elimination of approximately 2,000 positions. The severance and facilities charge included costs related to vacating excess leased office space and costs related to vacating and selling a property owned by Aetna in Hartford, Connecticut. During 1995 and 1994, the Companies charged costs of $12.6 million and $142.4 million (pretax), respectively, to the 1993 severance and facilities reserve related to the cost reduction actions. 3. INVESTMENTS Debt securities at December 31, 1995 were as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- --------- (MILLIONS) Available for Sale: U.S. Treasury securities and obligations of U.S. government agencies and corporations................... $ 3,048.2 $122.3 $ 8.1 $ 3,162.4 Obligations of states and political subdivisions......... 628.5 10.9 7.6 631.8 Utilities................................................ 735.3 37.6 2.5 770.4 Financial................................................ 1,304.7 83.9 1.2 1,387.4 Transportation/Capital Goods............................. 649.8 27.1 4.9 672.0 Other corporate securities............................... 366.4 12.0 2.0 376.4 Mortgage-backed securities............................... 1,655.5 46.2 4.3 1,697.4 Other loan-backed securities............................. 708.5 12.5 1.4 719.6 Foreign governments...................................... 1,125.7 64.6 6.5 1,183.8 Other.................................................... 959.7 39.4 2.0 997.1 --------- ---------- ---------- --------- Total Available for Sale............................... $11,182.3 $456.5 $ 40.5 $11,598.3 --------- ---------- ---------- --------- --------- ---------- ---------- ---------
F-36 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 3. INVESTMENTS--(CONTINUED) Debt securities at December 31, 1994 were as follows:
GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE --------- ---------- ---------- --------- (MILLIONS) Available for Sale: U.S. Treasury securities and obligations of U.S. government agencies and corporations................... $ 3,680.2 $ 1.2 $254.9 $ 3,426.5 Obligations of states and political subdivisions......... 1,048.0 3.9 46.6 1,005.3 Utilities................................................ 519.7 1.4 22.8 498.3 Financial................................................ 530.2 .1 17.5 512.8 Transportation/Capital Goods............................. 625.6 2.9 26.2 602.3 Other corporate securities............................... 274.0 .6 21.1 253.5 Mortgage-backed securities............................... 1,370.4 3.5 102.3 1,271.6 Other loan-backed securities............................. 332.2 -- 14.7 317.5 Foreign governments...................................... 759.4 1.8 74.0 687.2 Other.................................................... 556.7 1.2 36.1 521.8 --------- ---------- ---------- --------- Total Available for Sale............................... $ 9,696.4 $ 16.6 $616.2 $ 9,096.8 --------- ---------- ---------- --------- --------- ---------- ---------- --------- Held for Investment: Obligations of states and political subdivisions......... $ 246.1 $ 1.1 $ 8.0 $ 239.2 Utilities................................................ 37.7 .1 .6 37.2 Financial................................................ 42.8 .2 .3 42.7 Transportation/Capital Goods............................. 13.8 .5 .2 14.1 Other corporate securities............................... 3.7 .1 .3 3.5 Foreign governments...................................... 23.3 .1 .3 23.1 Other.................................................... 46.1 1.8 .6 47.3 --------- ---------- ---------- --------- Total Held for Investment.............................. $ 413.5 $ 3.9 $ 10.3 $ 407.1 --------- ---------- ---------- --------- --------- ---------- ---------- ---------
The carrying and fair value of debt securities are shown below by contractual maturity. Actual maturities may differ from contractual maturities because securities may be restructured, called or prepaid.
1995 ---------------------- AMORTIZED FAIR COST VALUE --------- --------- (MILLIONS) Available for Sale: Due to mature: One year or less............................................................. $ 793.7 $ 837.2 After one year through five years............................................ 3,812.9 3,864.4 After five years through ten years........................................... 2,494.6 2,610.3 After ten years.............................................................. 1,717.1 1,869.4 Mortgage-backed securities................................................... 1,655.5 1,697.4 Other loan-backed securities................................................. 708.5 719.6 --------- --------- Total Available for Sale................................................... $11,182.3 $11,598.3 --------- --------- --------- ---------
The Companies engage in securities lending whereby certain securities from its portfolio are loaned to other institutions for short periods of time. Cash collateral, which is in excess of the market value of the loaned securities, F-37 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 3. INVESTMENTS--(CONTINUED) is deposited by the borrower with a lending agent, and retained and invested by the lending agent to generate additional income for the Companies. The market value of the loaned securities is monitored on a daily basis with additional collateral obtained or refunded as the market value fluctuates. At December 31, 1995, the Companies had loaned securities (which are reflected as invested assets on the Combined Balance Sheets) with a market value of approximately $.9 billion. Investments in equity securities were as follows:
GROSS GROSS UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ------ ---------- ---------- -------- (MILLIONS) 1995 Equity securities............................................ $289.5 $287.0 $ 76.6 $ 499.9 1994 Equity securities............................................ $779.5 $335.8 $ 97.4 $1,017.9
Real estate holdings at December 31 were as follows:
1995 1994 ------ ------ (MILLIONS) Properties held for sale.................................................................... $173.0 $ 98.6 Investment real estate...................................................................... 106.8 197.7 ------ ------ 279.8 296.3 Valuation reserve........................................................................... 15.1 34.3 ------ ------ Net carrying value........................................................................ $264.7 $262.0 ------ ------ ------ ------
The accumulated depreciation for real estate was $29.0 million and $19.1 million at December 31, 1995 and 1994, respectively. Total real estate write-downs included in the net carrying value of the Companies' real estate holdings on the Combined Balance Sheets at December 31, 1995 and 1994 were $116.4 million and $83.3 million, respectively. At December 31, 1995, the total recorded investment in mortgage loans that are considered to be impaired (which include problem loans, restructured loans and potential problem loans) under FAS No. 114 and related specific reserves are $164.4 million and $21.3 million, respectively. Included in the total recorded investment are impaired loans of $61.0 million for which no specific reserves are considered necessary. The activity in the mortgage loan impairment reserves for the twelve months ended December 31, 1995 is summarized below:
(MILLIONS) Balance at December 31, 1994............................................... $136.6 Charged to net realized capital loss....................................... 6.4 Principal write-offs....................................................... (77.3) ---------- Balance at December 31, 1995(1)............................................ $ 65.7 ---------- ----------
- ------------ (1) Total reserves at December 31, 1995 included $21.3 million of specific reserves and $44.4 million of general reserves. F-38 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 3. INVESTMENTS--(CONTINUED) The Companies accrue interest income on impaired loans to the extent it is deemed collectible and the loan continues to perform under its original or restructured contractual terms. Interest income on problem loans is generally recognized on a cash basis. Cash payments on loans in the process of foreclosure are generally treated as a return of principal. Income earned (pretax) and received were each $12.2 million on the average recorded investment in impaired loans of $227.0 million for the twelve months ended December 31, 1995. The carrying values of investments that were nonincome producing for the twelve months preceding the balance sheet date were as follows:
1995 1994 ----- ----- (MILLIONS) Debt securities........................................................................ $ .6 $ 2.4 Equity securities...................................................................... 12.6 9.3 Mortgage loans......................................................................... .3 14.9 Real estate............................................................................ 71.4 47.9 ----- ----- Total nonincome producing investments................................................ $84.9 $74.5 ----- ----- ----- -----
Significant noncash investing activities include acquisition of real estate through foreclosures (including in-substance foreclosures) of mortgage loans amounting to $40 million in 1995, $59 million in 1994 and $17 million in 1993. 4. CAPITAL GAINS AND LOSSES ON INVESTMENT OPERATIONS Realized capital gains or losses are the difference between the carrying value and sale proceeds of specific investments sold. Provisions for impairments and changes in the fair value of real estate subsequent to foreclosure are also included in net realized capital gains. Unrealized capital gains and losses on available for sale investments, net of related taxes, are reflected in shareholder's equity. Net realized capital gains (losses) on investments were as follows:
1995 1994 1993 ------ ----- ------ (MILLIONS) Debt securities............................................................... $(38.0) $ 9.7 $230.5 Equity securities............................................................. 239.5 30.7 75.9 Mortgage loans................................................................ (5.5) (52.8) (107.5) Real estate................................................................... 28.7 12.2 (51.9) Sales of subsidiaries......................................................... -- 20.8 -- Other......................................................................... (25.7) (14.7) (3.0) ------ ----- ------ Pretax realized capital gains............................................... $199.0 $ 5.9 $144.0 ------ ----- ------ ------ ----- ------ After tax realized capital gains............................................ $128.6 $ 3.8 $ 96.8 ------ ----- ------ ------ ----- ------
Proceeds from the sale of investments in debt securities available for sale during 1995 were $3.8 billion. Gross gains of $56.5 million and gross losses of $94.5 million were realized on those sales. Proceeds from sales of investments in held for investment, available for sale and trading debt securities during 1994 and 1993 were $4.2 billion and $2.2 billion, respectively. Gross gains of $66.5 million and $257.8 million, and gross losses of $57.9 million and $20.9 million were realized on those sales. F-39 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 4. CAPITAL GAINS AND LOSSES ON INVESTMENT OPERATIONS--(CONTINUED) Net realized capital gains in 1994 included a $14 million after tax gain resulting from the sale of a portion of an unconsolidated subsidiary. Changes in shareholder's equity included changes in unrealized capital gains (losses), for the periods as follows:
1995 1994 1993 -------- ------- ------ (MILLIONS) Equity securities......................................................... $ (28.0) $(132.9) $ 72.0 Debt trading securities................................................... -- -- (99.3) Debt securities available for sale........................................ 1,015.6 (808.1) 208.5 Foreign exchange and other, net........................................... (33.0) 35.2 (3.5) -------- ------- ------ 954.6 (905.8) 177.7 Increase (Decrease) in deferred federal income taxes...................... 253.9 (205.7) 65.6 -------- ------- ------ Net changes in unrealized capital gains (losses)........................ $ 700.7 $(700.1) $112.1 -------- ------- ------ -------- ------- ------
Changes in unrealized capital gains (losses) for the periods exclude pretax changes in debt securities carried at amortized cost. The unrecorded appreciation (depreciation) for debt securities carried at amortized cost is the difference between estimated market and carrying values, and amounted to $(6.4) million and $20.6 million at December 31, 1994 and 1993, respectively. The change in unrecorded appreciation (depreciation) was $6.4 million, $(27.0) million and $(202.6) million in 1995, 1994 and 1993, respectively. Shareholder's equity included the following unrealized capital gains (losses) at December 31:
1995 1994 1993 ------ ------- ------ (MILLIONS) Equity securities: Gross unrealized capital gains........................................... $287.0 $ 335.8 $400.2 Gross unrealized capital losses.......................................... (76.6) (97.4) (28.9) ------ ------- ------ 210.4 238.4 371.3 Debt securities available for sale: Gross unrealized capital gains........................................... 456.5 16.6 251.1 Gross unrealized capital losses.......................................... (40.5) (616.2) (42.6) ------ ------- ------ 416.0 (599.6) 208.5 Foreign exchange and other, net............................................ (96.7) (63.7) (98.9) Deferred federal income taxes (benefits)................................... 216.9 (37.0) 168.7 ------ ------- ------ Net unrealized capital gains (losses).................................... $312.8 $(387.9) $312.2 ------ ------- ------ ------ ------- ------
At December 31, 1994, approximately $290 million of net unrealized capital losses, primarily on available for sale debt and equity securities, were reflected in shareholder's equity without deferred tax benefits. (Please refer to Note 8 for a discussion of the tax treatment for unrealized capital losses on available for sale debt and equity securities.) F-40 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 5. NET INVESTMENT INCOME Sources of net investment income were as follows:
1995 1994 1993 ------ ------ ------- (MILLIONS) Debt securities............................................................. $683.2 $626.5 $ 721.2 Equity securities........................................................... 31.3 27.0 11.2 Short-term investments...................................................... .8 -- 13.4 Mortgage loans.............................................................. 121.8 154.4 189.1 Real estate................................................................. 56.6 59.2 70.1 Other....................................................................... 23.0 8.8 31.6 Cash equivalents............................................................ 48.3 25.6 11.6 ------ ------ ------- Gross investment income..................................................... 965.0 901.5 1,048.2 Less investment expenses.................................................... 62.9 77.2 84.4 ------ ------ ------- Net investment income..................................................... $902.1 $824.3 $ 963.8 ------ ------ ------- ------ ------ -------
6. DIVIDEND RESTRICTIONS AND SHAREHOLDER'S EQUITY The amount of dividends that may be paid to Aetna by AC&S and The Standard Fire Insurance Company in 1996, without prior approval by the Insurance Commissioner of the State of Connecticut (the "Department") is $216.6 million (the sale agreement with Travelers prohibits the payment of dividends from the Companies). Dividends of $.3 million were paid by AC&S to Aetna in 1995. No dividends have been paid by The Standard Fire Insurance Company during 1995. Dividend payments by the domestic insurance subsidiaries of AC&S and The Standard Fire Insurance Company are subject to similar restrictions in Connecticut and other states, and are limited in 1996 to approximately $164.4 million in the aggregate. Dividends of $5.0 million were paid to AC&S by the domestic insurance subsidiaries during 1995. The Department recognizes as net income and shareholder's equity those amounts determined in conformity with statutory accounting practices prescribed or permitted by the Department, which differ in certain respects from generally accepted accounting principles. Statutory net income (loss) was $(196.2) million, $(170.1) million and $7.8 million for the years ended December 31, 1995, 1994 and 1993, respectively. Statutory shareholder's equity was $2,793.4 million and $2,525.7 million as of December 31, 1995 and 1994, respectively. In recent years, state insurance regulators have been considering changes in statutory accounting practices and other initiatives to strengthen solvency regulation. Under the risk-based capital ("RBC") standards for property-casualty insurers adopted by the NAIC, each of the Companies applies the RBC formula which compares adjusted surplus to required surplus and reflects the risk profile of the company (RBC ratio). The RBC ratio at December 31, 1995 for each of the Companies is above the levels which would require regulatory action. As of December 31, 1995, the Companies do not utilize any statutory accounting practices which are not prescribed by insurance regulators that, individually or in the aggregate, materially affect statutory shareholder's equity. 7. LONG-TERM DEBT
1995 1994 ----- ----- (MILLIONS) Long-term debt: Mortgage Notes and Other Notes, 6.9%-11% due in varying amounts to 2018.............. $35.2 $35.5 ----- ----- ----- -----
Aggregate maturities of long-term debt and sinking fund requirements for 1996 through 2000 are $.3 million, $.2 million, $29.5 million, $.1 million, $.1 million, respectively, and $5.0 million thereafter. F-41 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 8. FEDERAL AND FOREIGN INCOME TAXES The Companies are included in the consolidated federal income tax return of Aetna. Aetna allocates to each member an amount approximating the tax it would have incurred were it not a member of the consolidated group, and credits the member for the use of its tax saving attributes in the consolidated return. In August 1993, the Omnibus Budget Reconciliation Act of 1993 ("OBRA") was enacted which resulted in an increase in the federal corporate tax rate from 34% to 35% retroactive to January 1, 1993. The enactment of OBRA resulted in an increase in the deferred tax asset of $26.0 million at date of enactment, which is included in the 1993 deferred tax benefit. Components of income tax benefits were as follows:
1995 1994 1993 ------- ------ ------- (MILLIONS) Current taxes (benefits): Income (Loss)--from operations........................................... $(179.7) $ 4.2 $(169.3) Income--foreign taxes.................................................... .9 -- -- Realized capital gains (losses).......................................... 65.6 (47.4) 71.1 ------- ------ ------- (113.2) (43.2) (98.2) Deferred taxes (benefits): Loss--from operations.................................................... (54.3) (60.2) (36.9) Income--foreign taxes.................................................... (.1) -- -- Realized capital gains (losses).......................................... 4.8 49.5 (23.9) ------- ------ ------- (49.6) (10.7) (60.8) ------- ------ ------- Total...................................................................... $(162.8) $(53.9) $(159.0) ------- ------ ------- ------- ------ -------
Income tax benefits on loss from continuing operations were different from the amount computed by applying the federal income tax rate to loss from continuing operations before income tax benefits for the following reasons:
1995 1994 1993 ------- ------ ------- (MILLIONS) Loss before income tax benefits............................................ $(405.7) $(91.2) $(213.5) Tax rate................................................................... 35% 35% 35% ------- ------ ------- Application of the tax rate................................................ (142.0) (31.9) (74.7) Tax effect of: Tax-exempt interest...................................................... (16.2) (31.1) (42.0) Foreign operations....................................................... .8 6.9 0.7 Excludable dividends..................................................... (6.2) (8.1) (12.0) Tax rate change on deferred assets and liabilities....................... -- -- (24.7) Other, net............................................................... .8 10.3 (6.3) ------- ------ ------- Income tax benefits........................................................ $(162.8) $(53.9) $(159.0) ------- ------ ------- ------- ------ -------
F-42 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 8. FEDERAL AND FOREIGN INCOME TAXES--(CONTINUED) The tax effects of temporary differences that give rise to deferred tax assets and deferred tax liabilities at December 31 are presented below:
1995 1994 ------ ------- (MILLIONS) Deferred tax assets: Insurance reserves................................................................ $814.4 $ 756.6 Reserve for severance and facilities expense...................................... 5.6 26.3 Impairment reserves............................................................... 1.8 49.5 Net unrealized capital losses..................................................... -- 139.5 Net operating loss carryforward................................................... 122.2 113.2 Other............................................................................. 27.4 9.4 ------ ------- Total gross assets.................................................................. 971.4 1,094.5 Less valuation allowance............................................................ -- 102.1 ------ ------- Assets net of valuation............................................................. 971.4 992.4 Deferred tax liabilities: Deferred policy acquisition costs................................................. 107.0 110.5 Market discount................................................................... 11.2 17.1 Net unrealized capital gains...................................................... 216.9 -- Other............................................................................. 2.6 2.3 ------ ------- Total gross liabilities............................................................. 337.7 129.9 ------ ------- Net deferred tax asset............................................................ $633.7 $ 862.5 ------ ------- ------ -------
Net unrealized capital gains and losses are presented in shareholder's equity net of deferred taxes. During the twelve months ended December 31, 1995, the Companies moved from a net unrealized capital loss position of $(387.9) million at December 31, 1994, to a net unrealized capital gain position of $312.8 million at December 31, 1995, primarily due to decreases in interest rates. As a result, the $102.1 million of valuation allowances previously established in 1994 related to deferred tax assets were reversed, which had no impact on net income in 1995. Management believes that it is more likely than not that the Companies will realize the benefit of the net deferred tax asset of $633.7 million. Aetna's election of special estimated tax payments in years 1989 through 1994 assures realizability of a substantial portion of deferred tax assets arising from the discounting of property-casualty reserves. The Companies have more than 15 years to generate sufficient taxable income to cover the reversal of its temporary differences due to the long-term reversal patterns of these differences. Because of Aetna's long-term history of taxable income, which is projected to continue, and the availability of significant tax planning strategies, such as converting tax-exempt bonds to taxable bonds, the Companies expect sufficient taxable income in the future to realize the net deferred tax asset. The net deferred tax asset includes $122.2 million related to the Companies' expected utilization of its current U.S. net operating loss carryforward of $349.2 million, $111.2 million of which expires in the year 2008, $226.3 million of which expires in the year 2009 and $11.7 million of which expires in the year 2010. The Internal Revenue Service (the "Service") has completed examination of the consolidated federal income tax returns of Aetna through 1986. Discussions are being held with the Service with respect to proposed adjustments. The Service has commenced its examination for the years 1987 through 1990. However, management believes there are adequate defenses against, or sufficient reserves recorded by Aetna to provide for, such challenges. F-43 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 8. FEDERAL AND FOREIGN INCOME TAXES--(CONTINUED) The Companies received net federal income tax refunds for continuing operations of $148.4 million, $60.8 million and $141.2 million in 1995, 1994 and 1993, respectively. 9. BENEFIT PLANS Pension Plans--The Companies, in conjunction with Aetna, have noncontributory defined benefit plans covering substantially all employees and certain agents. The plans provide pension benefits based on years of service and average annual compensation (measured over 60 consecutive months of highest earnings in a 120-month period). Contributions are determined by using the Projected Unit Credit Method and, for qualified plans subject to ERISA requirements, are limited to the amounts that are currently deductible for tax reporting purposes. The accumulated benefit obligations and plan assets are recorded by Aetna. Data on a separate company basis regarding the proportionate share of the accumulated benefit obligation and plan assets is not available. The accumulated plan assets exceed accumulated benefits. Pretax charges to operations for the pension plan (based on the Companies' total salary cost as a percentage of Aetna's total salary cost) were $22.3 million, $12.0 million and $6.4 million in 1995, 1994 and 1993, respectively. There has been no funding to the plan in 1995, 1994 or 1993. Postretirement Benefits--In addition to providing pension benefits, Aetna also provides certain health care and life insurance benefits for retired employees. A comprehensive medical and dental plan is offered to all full-time employees retiring at age 50 with 15 years of service or at age 65 with 10 years of service. Retirees are generally required to contribute to the plans based on their years of service with Aetna. In January 1994, Aetna announced a modification of its postretirement benefit plan to cap the portion of the cost paid by Aetna relating to medical and dental benefits for individuals retiring after March 1, 1994. The accumulated benefit obligations and plan assets are recorded by Aetna. Data on a separate company basis regarding the proportionate share of employee costs is not available. An allocation, based on headcount, of Aetna's total cash costs for retirees was approximately $5.0 million (pretax) in 1995, 1994 and 1993, respectively, and is reflected in the Combined Statements of Income. Incentive Saving Plan--Substantially all employees are eligible to participate in a savings plan under which designated contributions, which may be invested in common stock of Aetna or certain other investments, are matched, up to 5% of compensation, by Aetna. Pretax charges to operations for the incentive savings plan were $21.5 million, $24.3 million, and $25.4 million in 1995, 1994 and 1993, respectively. 1994 Stock Incentive Plan--Certain employees participate in Aetna's 1994 stock incentive plan (which replaced the 1984 stock option plan). The 1994 plan provides for stock options (see (1) Stock Option Plans), and deferred contingent common stock or cash awards (see (2) Incentive Units) to certain key employees. The Companies' pretax charges to operations for the Stock Incentive Plan were $12.7 million in 1995. There was an immaterial impact to the results of operations in 1994. (1) Stock Option Plans--Executive and middle management employees may be granted options to purchase common stock of Aetna at the market price on the date of grant. Certain options granted prior to 1992 contain stock appreciation rights permitting the employee to exercise those rights and receive the excess of fair market value at the date of exercise over the grant date fair market value in cash and/or stock. (2) Incentive Units--Executive and middle management employees may be granted incentive units under the Aetna 1994 Stock Incentive Plan, which are rights to receive Aetna common stock or cash at the end of a vesting period (currently 1996 and 1998) conditioned upon the employee's continued employment during that period and achievement of Aetna performance goals. The incentive unit holders are not entitled to dividends during the vesting period. F-44 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 10. RELATED PARTY TRANSACTIONS A substantial portion of the administrative and support functions of the Companies are provided by Aetna and its affiliates. The financial statements reflect allocated charges for these services based upon measures which management considers reasonable and appropriate for the type and nature of service provided. The Companies have agreements and contracts with certain Aetna affiliates to provide administrative and technical services. The types of services provided by Aetna and its affiliates to the Companies related to such functions include, but are not limited to, general ledger processing, including subsidiary expense ledgers, use of the corporate conference center, office services, purchasing, security, facilities management, payroll and other human resources services, bank administration and other treasury services. The Companies are also allocated charges for certain corporate staff area costs which include, but are not limited to, salaries, certain employee benefit and incentive plans, legal fees, travel and taxes (including payroll and personal property). Hartford-area home office properties occupied by the Companies are owned by Aetna affiliates. The Companies are charged rent based on their proportionate share (based on square footage occupied) of the total occupancy cost (including depreciation) of Aetna's Hartford-area properties. Certain other facilities owned by the Companies, either directly or through partnerships, are leased by Aetna and its affiliates. In addition, the Combined Balance Sheets reflect certain mortgage and real estate investments that are held jointly by Companies and Aetna affiliates. The Companies, by virtue of their participation in the consolidated operations of Aetna, benefit from certain costs which are incurred in other Aetna legal entities and not subsequently allocated back to the Companies. Such costs include, but are not limited to, advertising, interest expense, charitable contributions, certain postretirement benefits other than pensions, certain postemployment benefits and certain other employee benefit plans. The Companies utilize intercompany receivable/payable accounts to settle allocated charges primarily related to general and administrative expenses of Aetna and its affiliates. Such expenses are paid by the parent company, Aetna Life and Casualty Company which acts as a clearinghouse in allocating such expenses to each of the parent company's subsidiaries. Settlements generally take place within 45 days after the end of each month. AC&S had entered into a stop-loss agreement with an affiliate, Aetna Re-Insurance Company (U.K.) Ltd., a wholly-owned subsidiary of Aetna. Such agreement covered all policies-in-force, written, renewed or accepted during 1992 and prior years. AC&S had a 100% participation, capped at a maximum of $58.0 million, in net losses in excess of the retention limits which result from adverse development on known losses valued as of December 31, 1992 and/or reported subsequent to December 31, 1992. Effective December 31, 1995, AC&S entered into an agreement with Aetna whereby Aetna was substituted as primary obligor under the stop-loss agreement for a payment equal to the held reserves for such coverage of $35.7 million. 11. REINSURANCE The Companies utilize reinsurance agreements to reduce their exposure to large losses in all aspects of their insurance business. Reinsurance permits recovery of a portion of losses from reinsurers, although it does not discharge the primary liability of the Companies as direct insurers of the risks reinsured. The Companies evaluate the financial strength of potential reinsurers and continually monitor the financial condition of present reinsurers. Only those reinsurance recoverables deemed probable of recovery are reflected as assets on the Combined Balance Sheets. F-45 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 11. REINSURANCE--(CONTINUED) Prepaid reinsurance premiums were $.4 billion for the year ended December 31, 1995 and $.3 billion for both the years ended December 31, 1994 and 1993. A summary of earned premiums for the years ended December 31 was as follows:
1995 1994 1993 -------- -------- -------- (MILLIONS) Direct Amount.......................................................... $5,006.4 $5,093.4 $5,488.2 Ceded to Other Companies(1)............................................ 1,307.0 1,177.7 1,232.3 Assumed from Other Companies(2)........................................ 418.3 439.1 353.9 -------- -------- -------- Net Amount........................................................... $4,117.7 $4,354.8 $4,609.8 -------- -------- -------- -------- -------- -------- Percentage of Amount Assumed to Net.................................. 10.2% 10.1% 7.7%
- ------------ (1) Includes $165.4 million, $184.7 million, and $215.5 million in 1995, 1994 and 1993, respectively, of premiums ceded to Aetna affiliates. (2) Includes $115.3 million, $130.8 million, and $160.9 million in 1995, 1994 and 1993, respectively, of premiums assumed from Aetna affiliates. There is not a material difference in premiums on a written versus an earned basis. Ceded claims and claim adjustment expenses were $.8 billion for the year ended December 31, 1995 and $1.2 billion for the year ended December 31, 1994 and $1.1 billion for the year ended December 31, 1993. Certain subsidiaries of the Companies act as servicing carriers for several involuntary pools. This business is ceded completely to the pools, and the Companies have no direct underwriting risk associated with it. Reinsurance recoverables for this business were approximately $1.7 billion and $1.8 billion as of December 31, 1995 and 1994, respectively. The Companies also participate as members in a number of the involuntary pools, and as a result assume their share of premiums and losses associated with these pools. The Companies also utilize a variety of reinsurance agreements, primarily with nonaffiliated insurers, to control their exposure to large property-casualty losses. These agreements, most of which are renegotiated annually as to coverage, limits and price, are structured either on a treaty basis (where all risks meeting prescribed criteria are automatically covered) or on a facultative basis (where the circumstances of specific individual insurance risks are reflected). The amount of risk retained by the Companies depends on the underwriter's evaluation of the specific risk, subject to maximum limits based on risk characteristics and the type of coverage. The principal catastrophe reinsurance agreement currently in force covers approximately 90% of specified property losses between $150 million and $325 million. The Companies also have in place an aggregate excess of loss arrangement with respect to all of its property-casualty lines for accident year 1995, providing up to approximately $250 million of additional net protection. Unpaid claims and claim adjustment expenses and reinsurance recoverables on the Combined Balance Sheets are reported net of amounts ceded to and assumed from certain affiliates. The total amount of unpaid claims and claim adjustment expenses and reinsurance recoverables related to these reinsurance agreements was $658.8 million and $642.0 million at December 31, 1995 and 1994, respectively, of which $657.1 million and $639.9 million, respectively, relates to an arrangement which terminated effective January 1, 1996. There was no impact to the Combined Statements of Income in 1995, 1994 or 1993 as a result of these agreements. F-46 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 12. RESERVES The following represents changes in aggregate reserves for unpaid claims and claim adjustment expenses:
1995 1994 1993 ------- ------- ------- (MILLIONS) Net unpaid claims and claim adjustment expenses at beginning of year..... $11,022 $11,259 $11,581 Incurred claims and claim adjustment expenses: Provision for insured events of the current year....................... 3,095 3,484 3,526 Increases in provision for insured events of prior years(1)(2)......... 1,137 263 51 ------- ------- ------- Total incurred claims and claim adjustment expenses.................. 4,232 3,747 3,577 ------- ------- ------- Payments: Claim and claim adjustment expenses attributable to insured events of the current year............................................. 1,118 1,275 1,041 Claim and claim adjustment expenses attributable to insured events of prior years............................................................ 2,563 2,709 2,858 ------- ------- ------- Total payments....................................................... 3,681 3,984 3,899 ------- ------- ------- Net unpaid claims and claim adjustment expenses at end of the year....... 11,573 11,022 11,259 Plus: Reinsurance recoverables........................................... 4,573 4,603 4,407 Deductible amounts recoverable from policyholders........................ 412 352 -- ------- ------- ------- Gross unpaid claims and claim adjustment expenses at end of the year..... $16,558 $15,977 $15,666 ------- ------- ------- ------- ------- -------
- ------------ (1) 1995 includes increases in provision for insured events of prior years of $399 million related to asbestos-related claims and $778 million related to environmental-related claims. (2) 1993 includes increases in provision for insured events of prior years of $665 million, offset by the cumulative effect adjustment related to the change in accounting to report workers' compensation life table indemnity claims on a discounted basis of $(514) million and the current year effect of this change in accounting of $(100) million related to the provision for insured events of prior years. Environmental and Asbestos-Related Claims The Companies added $778 million ($505.7 million, after tax) to environmental-related claims reserves in 1995. In the opinion of management, the Companies' reserves for environmental-related claims at December 31, 1995 represent the Companies' best estimate of their ultimate environmental-related liability, based on currently known facts, current law (including Superfund), current technology, and assumptions considered reasonable where facts are not known. Due to the significant uncertainties and related management judgment involved in estimating the Companies' environmental liability, no assurances can be given that the environmental reserve represents the amount that will ultimately be paid by the Companies for all environmental-related losses. The amount ultimately paid could differ materially from the Companies' currently recorded reserve as legal and factual issues are clarified, but any difference cannot be reasonably estimated at this time. As a result of this addition to the environmental-related claims reserves, Aetna contributed $303 million of additional capital to the Companies in the fourth quarter of 1995 in order to restore capital levels (including risk-based capital), to appropriate levels for regulatory and other purposes. In conjunction with the reserve addition for environmental-related claims, the Companies purchased reinsurance which provided aggregate protection of $335 million for the adverse loss development beyond reserves held (net of existing reinsurance). Under this arrangement, approximately $165 million of the existing reserves for such losses were ceded at the time the contract was entered into. As a result of the asbestos-related reserve addition (see below) and other reserve developments, substantially all of, the available statutory surplus protection was utilized during 1995. There was an immaterial benefit to the results of operations under this arrangement. F-47 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 12. RESERVES--(CONTINUED) In 1995, the Companies settled a case involving a policyholder (a major producer of asbestos and asbestos products) that had exhausted applicable policy limits on asbestos products claims and asserted coverage under policy provisions for other types of liability. The Companies obtained a release from the insured for all current and future asbestos bodily injury claims and certain asbestos property damage claims (along with all environmental claims) under existing policies in exchange for fixed, scheduled cash payments, which were recorded on a discounted basis. In connection with this settlement, $120 million of property-casualty reserves not previously classified as covering asbestos-related claims were transferred to asbestos reserves. No amounts were transferred from environmental reserves, and the environmental-related portion of the settlement was covered by existing environmental reserves. As a result, this settlement did not affect 1995 results of operations. As part of the settlement, the Companies also agreed, among other things, to make insurance coverage available to the insured in the year 2000 (on a one-time basis), for a percentage of all asbestos defense and indemnity claim payments made by the insured during the years 2000 through 2007. The Companies' payment obligations would be subject to annual dollar caps. Given the uncertainty as to whether the insured will elect to purchase this additional insurance, no related premiums or losses have been recorded by the Companies at this time. Related premiums and losses will be recorded if it becomes probable that the insured will elect to purchase the additional insurance coverage. Reserving for asbestos-related claims is subject to significant uncertainties and management is currently unable to make a reasonable estimate as to the ultimate amount of losses or a reasonable range of losses for all asbestos-related claims and related litigation expenses. Management has continued to evaluate reserves for asbestos liabilities as the Companies continue to gather and analyze new information and reassess its reserving techniques for these claims in order to determine whether it can better estimate its liability. In connection with such evaluation, the Companies added $335 million ($218 million, after tax) to asbestos-related claims reserves in the fourth quarter of 1995. While the Companies expect to recover some of its asbestos losses from its reinsurers, due to the uncertainty in estimating amounts to be recovered, no reinsurance benefits were recorded in establishing this addition to reserves. Further adjustments may be made to such reserves as loss patterns develop and other information is obtained, and the amount ultimately paid for such claims could differ materially from reserves, although any difference cannot be reasonably estimated at this time. Environmental and asbestos-related loss and loss adjustment expense reserves as reflected on the Combined Balance Sheets at December 31, were as follows (before reinsurance and net of discounts on certain environmental and asbestos settlement):
1995 1994 -------- ------ (MILLIONS) Environmental Liability............................................................ $1,005.9 $436.1 Asbestos Bodily Injury*............................................................ 754.3 295.9 Asbestos Property Damage*.......................................................... 22.3 29.9 -------- ------ Total Environmental and Asbestos-Related Reserves.................................. $1,782.5 $761.9 -------- ------ -------- ------
- ------------ * Includes $107.4 million and $12.6 million of reserves transferred to asbestos bodily injury and asbestos property damage reserves, respectively, in 1995. Workers' Compensation Claims Estimating workers' compensation reserves is particularly difficult (and, therefore, more subject to change than many other types of property-casualty claims), largely because of the length of the "tail" associated with workers' compensation claims. Workers' compensation claim costs are dependent on a number of complex factors including social and economic trends and changes in doctrines of legal liability and damage awards. Adjustments will be made to such reserves as loss patterns develop and new information becomes available and such adjustments may be material. F-48 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 12. RESERVES--(CONTINUED) Other Policyholders of the Companies also seek insurance coverage from the Companies for other long-term exposure claims against them, including claims relating to silicone-based personal products, lead paint and other allegedly toxic or harmful substances. Evaluating and reserving for these types of exposures is complex and subject to many uncertainties including those stemming from coverage issues, long latency periods and changing or expanding laws and legal theories of liability. Adjustments will be made to such reserves as loss patterns develop and new information becomes available and such adjustments may be material. 13. FINANCIAL INSTRUMENTS ESTIMATED FAIR VALUE The carrying values and estimated fair values of the Companies' financial instruments at December 31, 1995 and 1994 were as follows:
1995 1994 ---------------------- -------------------- CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE --------- --------- -------- -------- Assets: Cash and cash equivalents................................ $ 1,136.5 $ 1,136.5 $ 676.3 $ 676.3 Short-term investments................................... 137.2 137.2 106.0 106.0 Debt securities.......................................... 11,598.3 11,598.3 9,510.3 9,503.9 Equity securities........................................ 499.9 499.9 1,017.9 1,017.9 Mortgage loans........................................... 1,061.7 1,052.7 1,453.7 1,416.0 Liabilities: Short-term debt.......................................... $ -- $ -- $ 9.1 $ 9.1 Long-term debt........................................... 35.2 35.2 35.5 35.5
Fair value estimates are made at a specific point in time, based on available market information and judgments about the financial instrument, such as estimates of timing and amount of expected future cash flows. Such estimates do not reflect any premium or discount that could result from offering for sale at one time the Companies' entire holdings of a particular financial instrument, nor do they consider the tax impact of the realization of unrealized gains or losses. In many cases, the fair value estimates cannot be substantiated by comparison to independent markets, nor can the disclosed value be realized in immediate settlement of the instrument. In evaluating the Companies' management of interest rate and liquidity risk, and currency exposures, the fair values of all assets and liabilities should be taken into consideration, not only those presented above. The following valuation methods and assumptions were used by the Companies in estimating the fair value of the above financial instruments: Short-term instruments: Fair values are based on quoted market prices or dealer quotations. Where quoted market prices or dealer quotations are not available, the carrying amounts reported in the Combined Balance Sheets approximate fair value. Short-term instruments have a maturity date of one year or less and include cash and cash equivalents, short-term investments and short-term debt. Debt and equity securities: Fair values are based on quoted market prices or dealer quotations. Where quoted market prices or dealer quotations are not available, fair values are estimated by using quoted market prices for similar securities or discounted cash flow methods. F-49 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 13. FINANCIAL INSTRUMENTS--(CONTINUED) Mortgage loans: Fair values are estimated by discounting expected mortgage loan cash flows at market rates which reflect the rates at which similar loans would be made to similar borrowers. The rates reflect management's assessment of the credit quality and the remaining duration of the loans. The fair value estimates of mortgage loans of lower credit quality, including problem and restructured loans, are based on the estimated fair value of the underlying collateral. Long-term debt: Fair value is based on quoted market prices for the same or similar issued debt or, if no quoted market prices are available, on the current rates estimated to be available to the Companies for debt of similar terms and remaining maturities. OFF-BALANCE-SHEET FINANCIAL INSTRUMENTS (INCLUDING DERIVATIVE FINANCIAL INSTRUMENTS): The notional amounts, carrying values and estimated fair values of the Companies' off-balance-sheet financial instruments at December 31, 1995 and 1994 were as follows:
CARRYING VALUE NOTIONAL ASSET FAIR AMOUNT (LIABILITY) VALUE -------- ----------- ----- (MILLIONS) 1995 Foreign exchange forward contracts--sell: Related to investments in nondollar denominated assets.................... $ 65.2 $ (.1) $ (.2) Interest rate swaps: Unrecognized gains........................................................ 380.0 -- 20.4 Unrecognized losses....................................................... 380.0 -- (20.2)
CARRYING VALUE NOTIONAL ASSET FAIR AMOUNT (LIABILITY) VALUE -------- ----------- ----- (MILLIONS) 1994 Foreign exchange forward contracts--sell: Related to net investments in foreign affiliates.......................... $ 27.1 $ .2 $ .2 Related to investments in nondollar denominated assets.................... 206.1 .2 (1.5) Foreign exchange forward contracts--buy: Related to investments in nondollar denominated assets.................... 3.8 (.4) (.1) Interest rate swaps: Unrecognized gains........................................................ 386.4 -- 18.3 Unrecognized losses....................................................... 386.4 -- (18.3)
The notional amounts of these instruments do not represent the Companies' risk of loss. The fair value amounts of these instruments were estimated based on quoted market prices, dealer quotations or internal price estimates believed to be comparable to dealer quotations. These amounts reflect the estimated amounts that the Companies would have to pay or would receive if the contracts were terminated. The Companies engage in hedging activities to manage foreign exchange and interest rate risk. Such hedging activities have principally consisted of using off-balance-sheet instruments including foreign exchange forward contracts and interest rate swap agreements. All of these instruments involve, to varying degrees, elements of market risk and credit risk in excess of the amounts recognized in the Combined Balance Sheets. The Companies F-50 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 13. FINANCIAL INSTRUMENTS--(CONTINUED) evaluate the risks associated with off-balance-sheet financial instruments in a manner similar to that used to evaluate the risks associated with on-balance-sheet financial instruments. Market risk is the possibility that future changes in market prices may make a financial instrument less valuable. For off-balance-sheet financial instruments used for hedging, such market price changes are generally offset by the market price changes in the hedged instruments held by the Companies. Credit risk arises from the possibility that counterparties may fail to perform under the terms of the contract, which could result in an unhedged position. However, unlike on-balance-sheet financial instruments, where credit risk generally is represented by the notional or principal amount, the off-balance-sheet financial instruments' risk of credit loss generally is significantly less than the notional value of the instrument and is represented by the positive fair value of the instrument. The Companies generally do not require collateral or other security to support the financial instruments discussed below. However, the Companies control their exposure to credit risk through credit approvals, credit limits and regular monitoring procedures. There were no material concentrations of off-balance-sheet financial instruments at December 31, 1995. Foreign Exchange Forward Contracts: Foreign exchange forward contracts are agreements to exchange fixed amounts of two different currencies at a specified future date and at a specified price. The Companies utilize foreign exchange forward contracts to hedge their foreign currency exposure arising from certain investments in foreign affiliates and nondollar denominated investment securities. The Companies generally utilize foreign currency contracts with terms of up to three months. At December 31, 1995 the Companies has unhedged foreign currency exposures of $29.8 million and $41.2 million related to net investments in foreign affiliates and investments in nondollar denominated assets, respectively. These exposures include $40.1 million of investments in nondollar denominated assets for which effective markets for hedging vehicles do not currently exist. Interest Rate Swaps The Companies utilize interest rate swaps to manage certain exposures related to changes in interest rates. This swap activity included transactions which were entered into in prior years where the Companies act as an intermediary for entities whose debt the Companies have guaranteed to allow them to convert variable rate debt to a fixed rate, with the Companies retaining no interest rate risk. (Please refer to Note 14.) Interest rate swap activity also includes exchanging variable rate asset returns for fixed rate returns. 14. COMMITMENTS AND CONTINGENT LIABILITIES COMMITMENTS Commitments to extend credit are legally binding agreements to lend monies at a specified interest rate and within a specified time period. Risk arises from the potential inability of counterparties to perform under the terms of the contracts and from interest rate fluctuations. The Companies' exposure to credit risk is reduced by the existence of conditions within the commitment agreements which release the Companies from their obligations in the event of a material adverse change in the counterparty's financial condition. At December 31, 1995 and 1994, the Companies had $79.8 million and $120.0 million, respectively, in commitments to fund partnerships. Through the normal course of investment operations, the Companies commit to either purchase or sell securities or money market instruments at a specified future date and at a specified price or yield. The inability of counterparties to honor these commitments may result in either a higher or lower replacement cost. Also, there is likely to be a change in the value of the securities underlying the commitments. At December 31, 1995, the F-51 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 14. COMMITMENTS AND CONTINGENT LIABILITIES--(CONTINUED) Companies had commitments to purchase investments of $66.9 million, the fair value of which was $67.3 million. The Companies had no commitments to purchase investments in 1994. FINANCIAL GUARANTEES The Companies no longer write municipal bond insurance and such business previously written by the Companies was reinsured with another company. It is not practicable to estimate the fair value of the business that has been ceded. AC&S was a writer of financial guarantees on obligations secured by real estate, corporate debt obligations, and of municipal and non-municipal tax-exempt entities through December 31, 1987, and ceased writing such guarantees as of January 1, 1988. The aggregate net par value of financial guarantees outstanding at December 31, 1995 and 1994 was $656.4 million and $728.3 million, respectively. Future runoff of financial guarantees as of December 31, 1995 after adjusting for extensions granted on certain guarantees, is estimated to be $31.9 million for 1996, $135.4 million for 1997, $276.7 million for 1998, $3.8 million for 1999, $7.4 million for 2000 and $201.2 million thereafter. It is not practicable to estimate a fair value for AC&S' financial guarantees because AC&S no longer writes such guarantees, there is no quoted market price for such contracts, and it is not practicable to reliably estimate the timing and amount of all future cash flows due to the unique nature of each of these contracts. Total reserves for the financial guarantee business, which include reserves for defaults, probable losses not yet identified and unearned premiums, were $40.5 million and $47.7 million at December 31, 1995 and 1994, respectively. Premium income received from such guarantees is recognized pro rata over the contract coverage period. REINSURANCE AGREEMENT In connection with the 1992 sale of Am Re, Am Re and AC&S entered into a reinsurance agreement which provides that to the extent Am Re incurred losses in 1991 and prior that were still outstanding at January 1, 1992 in excess of $2.7 billion, AC&S has an 80% participation in payments on those losses up to a maximum payment by AC&S of $500 million. In 1995, Am Re increased reserves for asbestos, environmental and other latent liabilities. As a result of this increase, losses of approximately $228 million ($120 million after discount), which were largely workers' compensation life table indemnity claims, were ceded to AC&S. There was no material impact on 1995 earnings as AC&S had previously established reserves. It is reasonably possible that additional undiscounted losses of up to approximately $270 million pretax could be ceded to the company in the future. STRUCTURED SETTLEMENTS The Companies have settled claims through the purchase of structured settlement annuities under which they remain liable to the claimants. Such structured settlements of $1,189.3 million and $1,097.2 million are reflected in reinsurance recoverables on the Combined Balance Sheet at December 31, 1995 and 1994, respectively. Included in such liabilities is $352.4 million and $280.0 million of structured settlements purchased from affiliates, consisting of $177.2 million and $153.4 million from Aetna Life Insurance Company at December 31, 1995 and 1994, respectively, and $175.2 million and $126.6 million from Aetna Life Insurance and Annuity Company at December 31, 1995 and 1994, respectively. F-52 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 14. COMMITMENTS AND CONTINGENT LIABILITIES--(CONTINUED) LITIGATION The Companies are continuously involved in numerous lawsuits arising, for the most part, in the ordinary course of their business operations either as liability insurers defending third-party claims brought against their insureds or as insurers defending coverage claims brought against them, including lawsuits related to issues of policy coverage and judicial interpretation. One such area of coverage litigation involves legal liability for environmental and asbestos-related claims. These lawsuits and other factors make reserving for these claims subject to significant uncertainties. While the ultimate outcome of such litigation cannot be determined at this time, such litigation, net of reserves established therefore and giving effect to reinsurance probable of recovery, is not expected to result in judgments for amounts material to the financial condition of the Companies, although it may adversely affect results of operations in future periods. 15. CONCENTRATIONS OF INVESTMENT CREDIT RISK At December 31, 1995, the Companies had an investment in common stock of MBIA, Inc. with a carrying value of $286.0 million representing 7% of shareholder's equity, and an investment in preferred stock of Federated Investors with a carrying value of $100.7 million representing 3% of shareholder's equity. Subsequent to December 31, 1995, the Companies sold all of their investment in Federated Investors and 82% of their investment in MBIA, Inc. These sales resulted in a combined realized capital gain of $173.8 million (pretax) which will be reflected in 1996 results. The Companies' holdings in debt securities were $11.6 billion and $9.5 billion as of December 31, 1995 and 1994, respectively. The debt securities in the Companies' portfolio are generally rated by external rating agencies, and, if not externally rated, are rated by the Companies on a basis believed to be similar to that used by the rating agencies. At December 31, 1995 and 1994, the average quality rating of the Companies' portfolio of debt securities was AA and the composition by quality ratings and market sector were as follows: DEBT SECURITIES QUALITY RATINGS DEBT SECURITIES INVESTMENTS BY MARKET SECTOR
DECEMBER 31, --------------- 1995 1994 ---- ---- AAA.............................. 54% 59% AA............................... 11% 10% A................................ 21% 18% BBB.............................. 11% 9% BB & Below....................... 3% 4% DECEMBER 31, --------------- 1995 1994 ---- ---- Corporate........................ 28% 23% Treasuries/Agencies.............. 27% 36% Mortgage-Backed Securities....... 15% 13% Financial........................ 12% 6% Public Utilities................. 7% 6% Other Loan Backed................ 6% 3% Municipals....................... 5% 13%
At December 31, 1995 and 1994, mortgage loan balances, net of specific impairment reserves, by property type and geographic region were as follows: F-53 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 15. CONCENTRATIONS OF INVESTMENT CREDIT RISK--(CONTINUED) DECEMBER 31, 1995
MIXED OFFICE RETAIL APARTMENT HOTEL/MOTEL INDUSTRIAL USE/OTHER TOTAL ------ ------ --------- ----------- ---------- ---------- -------- (MILLIONS) South Atlantic.................. $175.6 $ 60.9 $ 51.8 $ 2.7 $ 3.1 $ 49.5 $ 343.6 Middle Atlantic................. 147.1 64.8 -- -- 19.9 .1 231.9 New England..................... 120.5 66.9 59.7 44.2 -- -- 291.3 South Central................... 10.7 14.6 .5 1.7 -- -- 27.5 North Central................... 3.4 20.2 38.3 11.1 .8 .9 74.7 Pacific and Mountain............ 69.9 28.9 18.4 -- 7.3 3.1 127.6 Other........................... -- -- -- -- -- 9.5 9.5 ------ ------ --------- ----- ----- ----- -------- Total....................... $527.2 $256.3 $ 168.7 $59.7 $ 31.1 $ 63.1 1,106.1 ------ ------ --------- ----- ----- ----- ------ ------ --------- ----- ----- ----- Less general portfolio loss reserve......................... 44.4 -------- Adjusted total, net of reserves........................ $1,061.7 -------- --------
DECEMBER 31, 1994
MIXED OFFICE RETAIL APARTMENT HOTEL/MOTEL INDUSTRIAL USE/OTHER TOTAL ------ ------ --------- ----------- ---------- ---------- -------- (MILLIONS) South Atlantic.................. $159.5 $165.2 $ 58.9 $ 62.1 $ 3.2 $ 59.0 $ 507.9 Middle Atlantic................. 196.1 67.0 30.1 -- 17.6 .5 311.3 New England..................... 122.6 65.6 59.4 45.1 .4 3.8 296.9 South Central................... 32.1 12.1 13.3 2.0 3.8 .9 64.2 North Central................... 31.7 40.3 55.1 23.5 .9 1.2 152.7 Pacific and Mountain............ 118.6 29.2 7.6 -- 7.7 4.3 167.4 Other........................... -- -- -- -- -- 11.8 11.8 ------ ------ --------- ----------- ----- ----- -------- Total....................... $660.6 $379.4 $ 224.4 $ 132.7 $ 33.6 $ 81.5 1,512.2 ------ ------ --------- ----------- ----- ----- ------ ------ --------- ----------- ----- ----- Less general portfolio loss reserve......................... 58.5 -------- Adjusted total, net of reserves........................ $1,453.7 -------- --------
As of December 31, 1995 and 1994, the Companies' investments in problem, potential problem and restructured mortgage loans by property type and geographic distribution were as follows: PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED MORTGAGE LOANS BY PROPERTY TYPE GEOGRAPHIC DISTRIBUTION OF PROBLEM, POTENTIAL PROBLEM AND RESTRUCTURED MORTGAGE LOANS
DECEMBER 31, --------------- 1995 1994 ---- ---- Apartment....................... 13.3% 9.0% Hotel/Motel..................... -- % .8% Office.......................... 48.8% 72.4% Retail.......................... 37.9% 17.0% Other........................... -- % .8% DECEMBER 31, --------------- 1995 1994 ---- ---- Middle Atlantic................. 11.9% 22.1% New England..................... .2% 1.3% North Central................... 13.4% 32.6% Pacific and Mountain............ 62.2% 7.3% South Atlantic.................. 12.3% 17.6% South Central................... -- % 19.1%
F-54 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 15. CONCENTRATIONS OF INVESTMENT CREDIT RISK--(CONTINUED) "Problem loans" are defined to be loans with payments over 60 days past due, loans on properties in the process of foreclosure, loans on properties involved in bankruptcy proceedings and loans on properties subject to redemption. "Restructured loans" are loans whose original contract terms have been modified to grant concessions to the borrower and are currently performing pursuant to such modified terms. In connection with the Companies' adoption of FAS Nos. 114 and 118 on January 1, 1995 (please see Note 1 of Notes to Combined Financial Statements), management has revised the definition of "potential problem loans" to include all loans which are performing pursuant to existing terms and are considered likely to become classified as problem or restructured loans. Prior to January 1, 1995, potential problem loans were performing loans which management believed were likely to become classified as problem or restructured loans in the next 12 months or so. As a result of the revised definition, potential problem loans at December 31, 1995 are approximately $65 million higher than they would have been had the definition not been changed. Potential problem loans are identified through the portfolio review process on the basis of known information about the ability of borrowers to comply with present loan terms. Identifying such potential problem loans requires significant judgment as to likely future market conditions and developments specific to individual properties and borrowers. Provision for losses that management believes are likely to arise from such potential problem loans is included in the specific impairment reserves. (Please see Note 3 for a discussion of mortgage loan impairment reserves.) The Companies' equity real estate balances were $264.7 million and $262.0 million at December 31, 1995 and 1994, respectively. The Companies' equity real estate balances at December 31, 1995 and 1994 by property type and geographic distribution were as follows: EQUITY REAL ESTATE BY PROPERTY TYPE GEOGRAPHIC DISTRIBUTION OF EQUITY REAL ESTATE
DECEMBER 31, --------------- 1995 1994 ---- ---- Apartment....................... -- % 6.0% Hotel/Motel..................... 21.3% 17.3% Industrial...................... 8.6% 8.7% Land............................ 14.3% 13.2% Office.......................... 47.1% 44.1% Retail.......................... 7.6% 9.5% Other........................... 1.1% 1.2% DECEMBER 31, --------------- 1995 1994 ---- ---- Middle Atlantic................. 7.9% 8.2% New England..................... 12.5% 16.1% North Central................... 18.3% 12.3% Pacific and Mountain............ 37.9% 40.1% South Atlantic.................. 16.7% 20.4% South Central................... 6.7% 2.9%
F-55 THE AETNA CASUALTY AND SURETY COMPANY AND THE STANDARD FIRE INSURANCE COMPANY AND THEIR SUBSIDIARIES NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED) 16. SEGMENT INFORMATION
COMMERCIAL PERSONAL LINES LINES COMBINED ---------- -------- ------------- (IN MILLIONS) 1995 Revenues Premiums............................................................. $ 2,833 $1,285 $ 4,118 Net investment income................................................ 757 145 902 Fee & other income................................................... 78 4 82 Realized investment gains (losses)................................... 151 48 199 ---------- -------- ------------- Total............................................................ 3,819 1,482 5,301 ---------- -------- ------------- Income (loss) before federal income taxes.............................. (607) 201 (406) Net income (loss)...................................................... (377) 134 (243) ---------- -------- ------------- Total assets........................................................... 19,670 3,729 23,399 ---------- -------- ------------- ---------- -------- ------------- 1994 Revenues Premiums............................................................. 3,006 1,349 4,355 Net investment income................................................ 661 163 824 Fee & other income................................................... 110 6 116 Realized investment gains (losses)................................... (2) 8 6 ---------- -------- ------------- Total............................................................ 3,775 1,526 5,301 ---------- -------- ------------- Income (loss) before federal income taxes.............................. (135) 44 (91) Net income (loss)...................................................... (74) 37 (37) ---------- -------- ------------- Total assets........................................................... 18,057 3,614 21,671 ---------- -------- ------------- ---------- -------- ------------- 1993 Revenues Premiums............................................................. 3,120 1,489 4,609 Net investment income................................................ 739 225 964 Fee & other income................................................... 149 5 154 Realized investment gains (losses)................................... 142 2 144 ---------- -------- ------------- Total............................................................ 4,150 1,721 5,871 ---------- -------- ------------- Income (loss) before federal income taxes and cumulative effect adjustments............................................................ (242) 28 (214) Net income (loss)...................................................... 200 39 239 ---------- -------- ------------- Total assets........................................................... $ 17,825 $4,075 $21,900 ---------- -------- ------------- ---------- -------- -------------
F-56 ======================================== ===================================== - ---------------------------------------- ------------------------------------- NO DEALER, SALESPERSON OR OTHER INDIVIDUAL HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN OR 4,000,000 INCORPORATED BY REFERENCE IN THIS PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING TRUST PREFERRED SECURITIES PROSPECTUS, IN CONNECTION WITH THE OFFER CONTAINED IN THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS, AND, IF GIVEN OR MADE, ANY SUCH INFORMATION OR TRAVELERS P&C CAPITAL II REPRESENTATION MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY 8% TRUST PREFERRED SECURITIES TRAVELERS/AETNA PROPERTY CASUALTY CORP., TRAVELERS P&C CAPITAL II OR ANY GUARANTEED TO THE EXTENT SET FORTH HEREIN BY UNDERWRITER, DEALER OR AGENT. THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING TRAVELERS/AETNA PROSPECTUS DO NOT CONSTITUTE AN OFFER TO PROPERTY CASUALTY CORP. SELL OR A SOLICITATION OF AN OFFER TO A Member of TravelersGroup[LOGO] BUY ANY OF THE SECURITIES OFFERED HEREBY BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS --------- UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS SUPPLEMENT AND THE ACCOMPANYING PROSPECTUS SUPPLEMENT PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS May 10, 1996 BEEN NO CHANGE IN THE AFFAIRS OF TRAVELERS/AETNA PROPERTY CASUALTY CORP. OR TRAVELERS P&C CAPITAL II SINCE THE DATE (INCLUDING PROSPECTUS HEREOF. DATED APRIL 24, 1996) ------------------- TABLE OF CONTENTS --------- PAGE ---- PROSPECTUS SUPPLEMENT Summary............................... S-4 Risk Factors Relating to the Preferred Securities.......................... S-9 Recent History........................ S-13 Recent Operating Results.............. S-14 Use of Proceeds....................... S-14 Smith Barney Inc. Ratio of Earnings to Combined Fixed Charges and Preferred Stock Dividends........................... S-15 Accounting Treatment.................. S-15 Capitalization........................ S-16 Description of the Preferred Securities.......................... S-18 Description of the Junior Subordinated Debt Securities...................... S-28 Description of Guarantee.............. S-32 Effect of Obligations Under the Junior Subordinated Debt Securities and the Guarantee........................... S-35 United States Federal Income Taxation............................ S-36 Underwriting.......................... S-39 Legal Matters......................... S-40 PROSPECTUS Available Information................. 3 Incorporation of Certain Documents by Reference........................... 4 Prospectus Summary.................... 5 Risk Factors Relating to the Company............................. 15 Recent History........................ 24 Use of Proceeds....................... 24 Capitalization........................ 25 Unaudited Pro Forma Financial Information......................... 27 Selected Historical Financial Information......................... 33 Recent Operating Results.............. 34 Management's Discussion and Analysis of Financial Condition and Results of Operations........................... 35 Business.............................. 61 Management............................ 94 Ownership of Common Stock............. 107 Certain Transactions.................. 108 Description of Capital Stock.......... 113 Certain Indebtedness.................. 120 Description of Junior Subordinated Debt Securities...................... 121 Description of Preferred Securities... 126 Description of Guarantees............. 128 Plan of Distribution.................. 130 Legal Matters......................... 131 Experts............................... 131 Glossary of Selected Insurance Terms............................... G-1 Index to Financial Statements......... F-1
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