10-K 1 a06-2768_110k.htm ANNUAL REPORT PURSUANT TO SECTION 13 AND 15(D)

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-K

 

ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2005

 

or

 

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to           

 


 

Commission file number 001-10898

 


 

The St. Paul Travelers Companies, Inc.

(Exact name of registrant as specified in its charter)

 

Minnesota

 

41-0518860

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

385 Washington Street,

St. Paul, MN 55102

(Address of principal executive offices) (Zip Code)

 

(651) 310-7911

(Registrant’s telephone number, including area code)

 


 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common stock, without par value

 

New York Stock Exchange

 

 

 

Guarantee with respect to the 7.6% Trust Preferred Securities
of St. Paul Travelers Capital Trust I

 

New York Stock Exchange

 

 

 

4.5% Convertible Junior Subordinated Notes due 2032

 

New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act:    None

 

Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act).

Yes ý    No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.

Yes o    No ý

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ý    No o

 

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

 

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

 

Large accelerated filer    ý

 

Accelerated filer    o

 

Non-accelerated filer    o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No ý

 

As of June 30, 2005, the aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates was $26,618,644,871.

 

As of February 23, 2006, 695,913,619 shares of the registrant’s common stock (without par value) were outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement relating to the 2006 Annual Meeting of Shareholders are incorporated by reference into Part III of this report.

 

 



 

The St. Paul Travelers Companies, Inc.

 

Annual Report on Form 10-K

 

For Fiscal Year Ended December 31, 2005

 

TABLE OF CONTENTS

 

Item Number

 

Page

 

Part I

1

1.

Business

1

1A.

Risk Factors

37

1B.

Unresolved Staff Comments

44

2.

Properties

45

3.

Legal Proceedings

46

4.

Submission of Matters to a Vote of Security Holders

51

 

Part II

52

5.

Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

52

6.

Selected Financial Data

54

7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

56

7A.

Quantitative and Qualitative Disclosures About Market Risk

108

8.

Financial Statements and Supplementary Data

110

9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

190

9A.

Controls and Procedures

190

9B.

Other Information

193

 

Part III

193

10.

Directors and Executive Officers of the Registrant

193

11.

Executive Compensation

195

12.

Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters

195

13.

Certain Relationships and Related Transactions

197

14.

Principal Accounting Fees and Services

197

 

Part IV

197

15.

Exhibits and Financial Statement Schedules

197

 

Signatures

197

 

Index to Consolidated Financial Statements and Schedules

199

 

Exhibit Index

207

 



 

PART I

 

Item  1.                                 BUSINESS

 

The St. Paul Travelers Companies, Inc. (together with its consolidated subsidiaries, the Company) is a holding company principally engaged, through its subsidiaries, in providing a wide range of commercial and personal property and casualty insurance products and services to businesses, government units, associations and individuals. The Company, known as The St. Paul Companies, Inc. (SPC) prior to its merger with Travelers Property Casualty Corp. (TPC) in 2004, is incorporated as a general business corporation under the laws of the state of Minnesota and is one of the oldest insurance organizations in the United States, dating back to 1853. The principal executive offices of the Company are located at 385 Washington Street, St. Paul, Minnesota 55102, and the telephone number is (651) 310-7911.

 

On April 1, 2004, TPC merged with a subsidiary of SPC, as a result of which TPC became a wholly-owned subsidiary of SPC, and SPC changed its name to The St. Paul Travelers Companies, Inc. For accounting purposes, this transaction was accounted for as a reverse acquisition with TPC treated as the accounting acquirer. Accordingly, this transaction was accounted for as a purchase business combination, using TPC’s historical financial information and applying fair value estimates to the acquired assets, liabilities and commitments of SPC as of April 1, 2004. Beginning on April 1, 2004, the results of operations and financial condition of SPC were consolidated with TPC’s results of operations and financial condition. Accordingly, all financial information presented herein for the twelve months ended December 31, 2004 reflects the accounts of TPC for the three months ended March 31, 2004 and the consolidated accounts of SPC and TPC for the nine months ended December 31, 2004. The financial information presented herein for 2003 reflects the accounts of TPC. In connection with the merger, each issued and outstanding share of TPC class A and class B common stock (including the associated preferred stock purchase rights) was exchanged for 0.4334 of a share of the Company’s common stock. All share and per share amounts for all prior periods have been restated to reflect the exchange of TPC’s common stock, par value $0.01 per share, for the Company’s common stock without designated par value, except with regard to share information related to the TPC initial public offering in 2002.

 

TPC is a Connecticut corporation that was formed in 1979 and, prior to its March 2002 initial public offering of class A common stock (IPO), was an indirect wholly-owned subsidiary of Citigroup Inc. (together with its consolidated subsidiaries, Citigroup). TPC was reorganized in connection with its IPO in March 2002. Pursuant to the reorganization, which was completed on March 19, 2002, TPC’s consolidated financial statements were adjusted to exclude the accounts of certain formerly wholly-owned TPC subsidiaries, principally The Travelers Insurance Company and its subsidiaries (being the former U.S. life insurance operations of TPC), certain other wholly-owned non-insurance subsidiaries of TPC and substantially all of TPC’s assets and certain liabilities not related to the property casualty insurance business.

 

In the IPO, on March 21, 2002, TPC issued 231 million shares* of its class A common stock, representing approximately 23% of TPC’s common equity. After the IPO, Citigroup Inc. beneficially owned all of the 500 million shares* of TPC’s outstanding class B common stock, each share of which was entitled to seven votes, and 269 million shares* of TPC’s class A common stock, each share of which was entitled to one vote, representing at the time 94% of the combined voting power of all classes of TPC’s voting securities and 77% of the equity interest in TPC. On August 20, 2002, Citigroup made a tax-free distribution to its stockholders (the Citigroup Distribution), of a portion of its ownership interest in TPC, which, together with the shares issued in the IPO, represented more than 90% of TPC’s common equity and more than 90% of the combined voting power of TPC’s outstanding voting securities. Citigroup received a private letter ruling from the Internal Revenue Service that the Citigroup Distribution was tax-free to Citigroup, its stockholders and TPC. As part of the ruling process, Citigroup agreed to vote the shares it continued to hold of TPC following the Citigroup Distribution pro rata with the shares held by the public and to divest the remaining shares it holds within five years following the Citigroup Distribution. After the merger, this undertaking also applies to shares of Company common stock.

 

At December 31, 2005 and 2004, Citigroup held for its own account 1.80% and 6.50% of the Company’s outstanding common stock, respectively. At December 31, 2003, Citigroup held for its own account 9.87% of TPC’s outstanding common stock.

 

The following discussion of the Company’s business is organized as follows: (i) a description of each of the Company’s three business segments (Commercial, Specialty and Personal) and related services; (ii) a description of Interest Expense and Other; and (iii) certain other information. For a summary of the Company’s revenues, operating income (loss) and total assets by reportable business segments, see note 5 of notes to the Company’s consolidated financial statements.

 


*              Share amounts are unadjusted for the merger of TPC and SPC.

 

1



 

PROPERTY-CASUALTY INSURANCE OPERATIONS

 

COMMERCIAL

 

The Commercial segment offers a broad array of property and casualty insurance and insurance-related services to its clients. Commercial is organized into the following three marketing and underwriting groups, each of which focuses on a particular client base and which collectively comprise Commercial’s core operations:

 

       Commercial Accounts serves primarily mid-sized businesses for casualty products and large and mid-sized businesses for property products. In addition to the traditional middle market, Commercial Accounts includes seven units dedicated to unique business needs.

 

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

 

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

 

Commercial also includes the Special Liability Group (which manages the Company’s asbestos and environmental liabilities); the assumed reinsurance, health care, and certain international and other runoff operations; and policies written by the Company’s Gulf operation (Gulf), which was placed into runoff during the second quarter of 2004. These operations are collectively referred to as Commercial Other.

 

Selected Market and Product Information

 

The following table sets forth Commercial net written premiums by market and product line for the periods indicated. For a description of the product lines and markets referred to in the table, see “—Principal Markets and Methods of Distribution” and “—Product Lines,” respectively.

 

(for the year ended December 31, in millions)

 

2005

 

2004

 

2003

 

% of
Total
2005

 

By market:

 

 

 

 

 

 

 

 

 

Commercial Accounts

 

$

4,386

 

$

4,210

 

$

3,251

 

52.0

%

Select Accounts

 

2,722

 

2,555

 

2,047

 

32.3

 

National Accounts

 

1,230

 

1,040

 

831

 

14.6

 

Total Commercial Core

 

8,338

 

7,805

 

6,129

 

98.9

 

Commercial Other

 

91

 

506

 

733

 

1.1

 

Total Commercial by market

 

$

8,429

 

$

8,311

 

$

6,862

 

100.0

%

 

 

 

 

 

 

 

 

 

 

By product line (1):

 

 

 

 

 

 

 

 

 

Commercial multi-peril

 

$

2,890

 

$

2,517

 

$

2,246

 

34.3

%

Workers’ compensation

 

1,660

 

1,530

 

1,234

 

19.7

 

Commercial automobile

 

1,660

 

1,609

 

1,313

 

19.7

 

Property

 

1,399

 

1,472

 

1,166

 

16.6

 

General liability

 

774

 

1,130

 

833

 

9.2

 

Other

 

46

 

53

 

70

 

0.5

 

Total Commercial by product line

 

$

8,429

 

$

8,311

 

$

6,862

 

100.0

%

 


(1) The reporting of SPC products was conformed to the Company’s product definitions beginning with policy renewals on and after January 1, 2005. Accordingly, the amounts reported by product line are not comparable for the years 2004 and 2005.

 

2



 

Principal Markets and Methods of Distribution

 

Many National Accounts customers require insurance-related services in addition to or in lieu of pure risk coverage, primarily for workers’ compensation and, to a lesser extent, general liability and commercial automobile exposures. These types of services include risk management services, such as claims administration, loss control and risk management information services, and are generally offered in connection with large deductible or self-insured programs. These services generate fee income rather than net written premiums.

 

The Commercial segment distributes its products through approximately 6,300 independent agencies and brokers located throughout the United States that are serviced by approximately 90 field offices and three customer service centers. In recent years, the Commercial segment, particularly in its Select Accounts operation, has made significant investments in enhanced technology utilizing internet-based applications to provide real-time interface capabilities with independent agencies and brokers. Commercial builds relationships with well-established, independent insurance agencies and brokers. In selecting new independent agencies and brokers to distribute its products, Commercial considers each agency’s or broker’s profitability, financial stability, staff experience and strategic fit with its operating and marketing plans. Once an agency or broker is appointed, Commercial carefully monitors its performance.

 

Commercial Accounts sells a broad range of property and casualty insurance products through a large network of independent agents and brokers. Commercial Accounts’ casualty products primarily target mid-sized businesses with 50 to 1,000 employees, while its property products target large and mid-sized businesses. The Company offers a full line of products to its Commercial Accounts customers with an emphasis on guaranteed cost programs. A key objective of Commercial Accounts is continued focus on first party product lines of business, which cover risks of loss to property of the insured

 

Beyond the traditional middle market network, dedicated underwriting units exist to complement the middle market or specifically respond to the unique or unusual business client insurance needs. These units are as follows:

 

                  National Property provides insurance coverage for large commercial property schedules and mid-sized risks covering losses on buildings, business assets and business interruption exposures.

 

                  Transportation provides auto liability, damage coverage, cargo and general liability coverages to the trucking industry. Products have been developed for Non-fleet (generally 1-10 units) and Fleet (11+ units) customers and are distributed through general agents.

 

                  Boiler and Machinery provides comprehensive breakdown coverages for equipment including property and business interruption coverages. Through the BoilerRe unit, Boiler and Machinery also provides reinsurance, underwriting, engineering, claim handling and risk management services to other property casualty carriers that do not have in-house expertise.

 

                  Inland Marine provides insurance which generally covers articles that may be transported from one place to another, goods in transit (other than transoceanic) and movable objects. Coverages include builder’s risk, contractor’s equipment, fine arts, jewelers, motor truck cargo and transportation risks.

 

                  Agribusiness offers property and liability coverages other than workers’ compensation for farms, ranches and larger commercial growers of agricultural products.

 

                  Excess and Surplus coverages are written on a non-admitted basis through established wholesalers. Coverages typically underwritten include commercial auto and general liability.

 

                  National Programs offers tailored insurance products to commercial insureds with similar risk characteristics, underwritten on a program basis. Programs are typically marketed through a single distribution channel. The targeted industries include entertainment, leisure, service, retail and sports.

 

Select Accounts is a leading provider of property casualty products to small businesses. It serves firms with generally fewer than 50 employees. Products offered by Select Accounts are guaranteed cost policies, often a packaged product covering property and liability exposures. Products are sold through independent agents and brokers, who are often the same agents and brokers that sell the Company’s Commercial Accounts, Specialty and Personal products. In addition to the traditional small commercial agency network, Select Accounts has a dedicated servicing unit that serves unique customer needs, including small national programs, architects and engineers, and emerging distribution markets.

 

3



 

Select Accounts offers its independent agents a system for small businesses that helps them connect all aspects of sales and service through a comprehensive service platform. Components of the platform include agency automation capabilities and service centers that function as an extension of an agency’s customer service operations, both of which are highly utilized by agencies. More than 86% of Select Accounts’ eligible business volume is processed by agencies using its automated issuance systems, which allow agents to quote and issue policies from agency offices. Approximately 4,600 agencies have chosen to take advantage of Select Accounts’ service centers, which offer agencies a wide range of services, including coverage and billing inquiries, policy changes, the assistance of licensed service professionals and extended hours of operations.

 

National Accounts sells a variety of casualty products and services to large companies. National Accounts clients generally select loss-sensitive products in connection with a large deductible or self-insured program and, to a lesser extent, a retrospectively rated or a guaranteed cost insurance policy. Through a network of field offices, the Company’s underwriting specialists work closely with national and regional brokers to tailor insurance programs to meet clients’ needs. Workers’ compensation accounted for approximately 76% of sales to National Accounts customers during 2005, based on direct written premiums and fees. National Accounts generated $405 million of fee income in 2005, excluding commercial residual market business discussed below.

 

National Accounts also includes the Company’s commercial residual market business. The Company’s commercial residual market business sells claims and policy management services to workers’ compensation and automobile assigned risk plans and to self-insurance pools throughout the United States. The Company services approximately 36% of the total workers’ compensation assigned risk market. The Company is one of only two servicing carriers that operate nationally. Assigned risk plan contracts generated approximately $203 million in fee income in 2005.

 

National Accounts also includes the Company’s Discover Re operation, which principally provides commercial auto liability, general liability, workers’ compensation and property coverages. It serves retail brokers and insureds who utilize programs such as self-insurance, collateralized deductibles and captive reinsurers.

 

Commercial Other includes the Special Liability Group (which manages the Company’s asbestos and environmental liabilities); the assumed reinsurance, health care, and certain international runoff and other operations; and Gulf, which was placed into runoff during the second quarter of 2004. Certain business previously written by Gulf is now being written in Commercial Accounts and in the Company’s Specialty segment. Gulf provided specialty coverages including management and professional liability, excess and surplus lines, environmental, umbrella and fidelity. Gulf also provided insurance products specifically designed for financial institutions, the entertainment industry and sports organizations.

 

Pricing and Underwriting

 

Pricing levels for Commercial property and casualty insurance products are generally developed based upon an expectation of estimated losses, the expenses of producing business and managing claims, and a reasonable allowance for profit. Commercial has a disciplined approach to underwriting and risk management that emphasizes profitable growth rather than premium volume or market share.

 

Commercial has developed an underwriting and pricing 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. It utilizes proprietary data gathered and analyzed with respect to its Commercial 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 specific industry segments. This methodology enables Commercial to streamline its risk selection process and develop pricing parameters that will not compromise Commercial’s underwriting integrity.

 

For smaller businesses, Select Accounts uses a process based on industry classifications to allow agents and field underwriting representatives to make underwriting and pricing decisions within predetermined classifications, because underwriting criteria and pricing tend to be more standardized for these smaller exposures.

 

4



 

A significant portion of Commercial business is written with large deductible insurance policies. Under workers’ compensation 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, 2005, contractholder receivables and payables on unpaid losses associated with large deductible policies were each approximately $5.23 billion. Retrospectively rated policies are also used for workers’ compensation coverage. Although the retrospectively rated feature of the policy substantially reduces insurance risk for the Company, it introduces additional credit risk to the Company. Premium receivables from holders of retrospectively rated policies totaled approximately $308 million at December 31, 2005. Significant collateral, primarily letters of credit and, to a lesser extent cash collateral and surety bonds, is generally requested for large deductible plans and/or retrospectively rated policies that provide for deferred collection of deductible recoveries and/or ultimate premiums. The amount of collateral requested is predicated upon the creditworthiness of the customer and the nature of the insured risks. Commercial continually monitors the credit exposure on individual accounts and the adequacy of collateral.

 

The Company continually monitors its exposure to natural and manmade peril catastrophic losses and attempts to mitigate such exposure. The Company uses various analyses and methods, including sophisticated computer modeling techniques, to analyze underwriting risks of business in hurricane-prone, earthquake-prone and target risk areas. The Company relies upon this analysis to make underwriting decisions designed to manage its exposure on catastrophe-exposed business. The Company also utilizes reinsurance to manage its aggregate exposures to catastrophes. See “—Reinsurance.”

 

Product Lines

 

Commercial Multi-Peril provides a combination of property and liability coverage. Property insurance covers damages such as those caused by fire, wind, hail, water, theft and vandalism, and protects businesses from financial loss due to business interruption resulting from a covered loss. Liability coverage insures businesses against third parties from accidents occurring on their premises or arising out of their operations, such as injuries sustained from products sold.

 

Workers’ Compensation provides coverage for employers for specified benefits payable under state or federal law for workplace injuries to employees. There are typically four types of benefits payable under workers’ compensation policies: medical benefits, disability benefits, death benefits and vocational rehabilitation benefits. 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. The Company offers the following three types of workers’ compensation products:

 

                  guaranteed cost insurance products, in which policy premium charges are fixed for the period of coverage and do not vary as a result of the insured’s loss experience;

 

                  loss-sensitive insurance products, including large deductible and retrospectively rated policies, in which fees or premiums are adjusted based on actual loss experience of the insured during the policy period; and

 

                  service programs, which are generally sold to the Company’s National Accounts customers, where the Company receives fees rather than premiums for providing loss prevention, risk management, and claim and benefit administration services to organizations under service agreements. The Company also participates in state assigned risk pools as a servicing carrier and pool participant.

 

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.

 

Property provides coverage for loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, earthquakes, hail, and severe winter weather. Also covered are manmade events such as theft, vandalism, fires, explosions, terrorism and financial loss due to business interruption resulting from covered property damage. For additional information on terrorism coverages, see “—Terrorism Risk Insurance Act of 2002 and Terrorism Risk Insurance Extension Act of 2005.” Property also includes specialized equipment insurance, which provides coverage for loss or damage resulting from the mechanical breakdown of boilers and machinery, and ocean and inland marine, which provides coverage for goods in transit and unique, one-of-a-kind exposures.

 

5



 

General Liability provides coverage for liability exposures including bodily injury and property damage arising from products sold and general business operations. Specialized liability policies may also include coverage for directors’ and officers’ liability arising in their official capacities, employment practices liability insurance, fiduciary liability for trustees and sponsors of pension, health and welfare, and other employee benefit plans, errors and omissions insurance for employees, agents, professionals and others arising from acts or failures to act under specified circumstances, as well as umbrella and excess insurance. Errors and omissions insurance for professionals (such as lawyers, accountants, doctors and other health care providers) is sometimes also known as professional liability insurance.

 

Geographic Distribution

 

The following table shows the distribution of Commercials’ direct written premiums for the states that accounted for the majority of premium volume for the year ended December 31, 2005:

 

State

 

% of
Total

 

California

 

13.5

%

New York

 

8.0

 

Texas

 

6.3

 

Florida

 

5.3

 

Illinois

 

4.8

 

Massachusetts

 

4.6

 

New Jersey

 

4.5

 

Pennsylvania

 

3.7

 

All Others (1)

 

49.3

 

Total

 

100.0

%

 


(1)                   No other single state accounted for 3.0% or more of the total direct written premiums written in 2005 by the Company.

 

SPECIALTY

 

The Specialty segment was created upon the merger of TPC and SPC. It combined SPC’s specialty operations, including SPC’s Bond and Construction operations, with TPC’s Bond and Construction operations, which were included in TPC’s Commercial segment prior to the merger. The Specialty segment provides a full range of standard and specialized insurance coverages and services through dedicated underwriting, claims handling and risk management groups. In many of its businesses, Specialty competes through the use of proprietary rates and policy forms. The segment comprises two primary groups: Domestic Specialty and International Specialty.

 

Domestic Specialty includes the following marketing and underwriting organizations, each of which possesses customer expertise and offers products and services to address its respective customers’ specific needs:

 

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

 

                  Construction offers a variety of products and services, including traditional insurance, consisting of workers’ compensation, general liability and commercial auto coverages, and other risk management solutions, to a broad range of contractors. The Company offers guaranteed cost products for smaller and mid-sized policyholders and loss sensitive programs for larger accounts where the customer and the Company work together in actively managing and controlling exposure and claims and where they share risk through policy features such as deductibles or retrospective rating.

 

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

 

6



 

                  Other Domestic Specialties include the following underwriting groups that provide unique combinations of insurance coverage, risk management, claims handling and other services for a targeted client’s needs:

 

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

 

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

 

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

 

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

 

                   Underwriting Facilities underwrites liability and property facilities produced by wholesalers and managing general agents (MGAs). MGAs are licensed insurance agents that manage customers with unique requirements, primarily those with moderate- to high-hazard exposures requiring expertise in the surplus lines marketplace and the ability to use policy forms not subject to regulatory requirements. Coverages include property, commercial auto and general liability.

 

                   Umbrella/Excess and Surplus Group, which consists of two distinct business units:

 

(a)                   Specialty Excess and Umbrella (SEU) focuses on umbrella and excess liability business distributed by retail agents and brokers, where other insurance companies are providing the primary coverage. This group also provides coverages in the case where other Company business groups prefer to outsource the underwriting of umbrella and excess business based on the expertise and/or limit capacity of SEU. The coverages underwritten are typically commercial auto, general liability and product liability. Umbrella coverage may also be underwritten over a company that retains risk or has a self-insured retention, instead of a scheduled underlying policy.

 

(b)                  Excess & Surplus Lines (E&S Lines) offers mono-line umbrella and excess coverage where the Company does not write the primary casualty coverage, or where other business groups within the Company prefer to outsource the underwriting of umbrella and excess business based on the expertise and/or limit capacity of E&S Lines. Business is written on a non-admitted basis through established wholesalers. The coverages typically underwritten include commercial auto, general liability and product liability.

 

In November 2005, the Company sold its Personal Catastrophe Risk business, which had been included in the Specialty segment. In accordance with the terms of the agreement, the Company retained responsibility for the pre-sale claims and claim adjustment expense reserves related to this business and remains responsible for any changes in estimates in those reserves through a quota-share reinsurance agreement.

 

International Specialty includes coverages marketed and underwritten to several specialty customer groups within the United Kingdom, Canada and the Republic of Ireland, the Company’s participation in Lloyd’s, and the Global Underwriting business group.

 

Specialty’s International Operations are located in the United Kingdom, Canada and the Republic of Ireland, where it offers specialized insurance and risk management services to several specialty customer groups, including those in the technology, public services, and financial and professional services industry sectors. The Company’s international operations primarily underwrite employers’ liability (similar to workers’ compensation coverage in the United States), public and product liability (the equivalent of general liability), professional indemnity (similar to professional liability coverage), motor (similar to automobile coverage in the United States) and property.

 

7



 

The Global Underwriting business group underwrites “home-foreign” business, representing coverage for a U.S. organization’s property-liability exposures in a foreign country, and “reverse-flow” business, which involves coverage of a foreign organization’s property or liability exposures located in the United States, as part of a global program controlled by foreign insurers.

 

At Lloyd’s, Specialty underwrites four principal lines of business—aviation, marine, global property, and accident and special risks—through Syndicate 5000, for which the Company provides 100% of the capital. During the second half of 2004, the Company made a decision to exit certain portions of the Lloyd’s personal lines business. In early 2005, the Company sold the right to renew this business as well as the operating companies that supported it.

 

Select Market and Product Information

 

The following table sets forth Specialty net written premiums by market and product line for the periods indicated. For a description of the markets and product lines referred to in the table, see “—Principal Markets and Methods of Distribution” and “—Product Lines,” respectively.

 

(for the year ended December 31, in millions)

 

2005

 

2004

 

2003

 

% of Total
2005

 

By market:

 

 

 

 

 

 

 

 

 

Bond

 

$

1,267

 

$

1,183

 

$

781

 

22.1

%

Construction

 

916

 

844

 

474

 

16.0

 

Financial and Professional Services

 

850

 

636

 

 

14.9

 

Other

 

1,605

 

1,186

 

 

28.0

 

Total Domestic Specialty

 

4,638

 

3,849

 

1,255

 

81.0

 

International Specialty

 

1,091

 

922

 

3

 

19.0

 

Total Specialty by market

 

$

5,729

 

$

4,771

 

$

1,258

 

100.0

%

 

 

 

 

 

 

 

 

 

 

By product line (1):

 

 

 

 

 

 

 

 

 

General liability

 

$

2,104

 

$

1,535

 

$

332

 

36.7

%

Fidelity and surety

 

1,026

 

967

 

531

 

17.9

 

Workers’ compensation

 

439

 

374

 

117

 

7.7

 

Commercial automobile

 

372

 

388

 

105

 

6.5

 

Property

 

577

 

301

 

17

 

10.1

 

Commercial multi-peril

 

120

 

284

 

153

 

2.1

 

International

 

1,091

 

922

 

3

 

19.0

 

Total Specialty by product line

 

$

5,729

 

$

4,771

 

$

1,258

 

100.0

%

 


(1) The reporting of SPC products was conformed to the Company’s product definitions beginning with policy renewals on and after January 1, 2005. Accordingly, the amounts reported by product line are not comparable for the years 2004 and 2005.

 

Principal Markets and Methods of Distribution

 

Specialty distributes the majority of its specialty commercial products domestically through the same base of approximately 6,300 independent agencies and brokers that distribute the Commercial segment’s products. These brokers and independent agencies are located throughout the United States and are serviced by three customer service centers. In recent years, Specialty has made significant investments in enhanced technology utilizing internet-based applications to provide real-time interface capabilities with its independent agencies and brokers. Specialty specifically seeks distribution specialists that match the specialty expertise of its underwriting group. Specialty builds relationships with well-established, independent insurance agencies and brokers. In selecting new independent agencies and brokers to distribute its products, Specialty considers each agency’s or broker’s profitability, financial stability, staff experience and strategic fit with its operating and marketing plans. Once an agency or broker is appointed, its ongoing performance is monitored.

 

Specialty also distributes property and casualty products through selected wholesalers using surplus lines contracts, both on a brokerage and managing general underwriting basis. Wholesalers are used because they serve certain markets that are not typically served by our appointed retail agents. The wholesale surplus lines market allows for more flexibility to write certain classes of business due to the absence of rate and form regulation for surplus lines business. In working with wholesalers on a

 

8



 

brokerage basis, Specialty underwrites the business and sets the premium level. In working with wholesalers on a managing general underwriting (MGU) basis, the MGUs produce and underwrite business that conforms to Specialty’s underwriting guidelines that have been specifically designed for each facility.

 

Specialty distributes its specialty products internationally through brokers in the domestic markets of each of the three countries in which it operates, the United Kingdom, Canada and the Republic of Ireland. Specialty also writes business at Lloyd’s, where its products are distributed through Lloyd’s accredited brokers. By virtue of Lloyd’s worldwide licenses, Specialty has access to international markets across the world.

 

Pricing and Underwriting

 

Pricing levels for Specialty property and casualty insurance products are generally developed based upon an expectation of estimated losses, the expenses of producing business and managing claims, and a reasonable allowance for profit. Specialty has a disciplined approach to underwriting and risk management that emphasizes profitable growth rather than premium volume or market share.

 

Specialty has developed an underwriting and pricing methodology that incorporates dedicated underwriting, claims, engineering, actuarial and product development disciplines for particular industries. This approach is designed to maintain high quality underwriting and pricing discipline, based on an in-depth knowledge of the specific industry. The underwriters and engineers use proprietary data gathered and analyzed over many years to assess and evaluate risks prior to quotation, and then use proprietary forms to tailor insurance coverage to insureds within the target markets. This methodology enables Specialty to streamline its risk selection process and develop pricing parameters that will not compromise its underwriting integrity.

 

A portion of Specialty business is written with large deductible insurance policies. Under some workers’ compensation insurance contracts with deductible features, Specialty is obligated to pay the claimant the full amount of the claim. Specialty is subsequently reimbursed by the contractholder for the deductible amount and is subject to credit risk until such reimbursement is made. At December 31, 2005, contractholder receivables and payables on unpaid losses associated with large deductible policies were each approximately $281 million. Significant collateral, primarily letters of credit and, to a lesser extent surety bonds and cash collateral, is generally requested for large deductible plans that provide for deferred collection of deductibles. The amount of collateral requested is predicated upon the creditworthiness of the customer and the nature of the insured risks. Specialty continually monitors the credit exposure and the adequacy of collateral.

 

Product Lines

 

General Liability provides coverage for liability exposures including bodily injury and property damage arising from products sold and general business operations. Specialized liability policies may also include coverage for directors’ and officers’ liability arising in their official capacities, employment practices liability insurance, fiduciary liability for trustees and sponsors of pension, health and welfare, and other employee benefit plans, errors and omissions insurance for employees, agents, professionals and others arising from acts or failures to act under specified circumstances, as well as umbrella and excess insurance. Errors and omissions insurance for professionals (such as lawyers, accountants, doctors and other health care providers) is sometimes also known as professional liability insurance.

 

Fidelity and Surety provides fidelity insurance coverage, which protects an insured for loss due to embezzlement or misappropriation of funds by an employee, and surety, which is a three-party agreement whereby the insurer agrees to pay a third party or make complete an obligation in response to the default, acts or omissions of an insured. Surety is generally provided for construction performance, legal matters such as appeals, trustees in bankruptcy and probate and other performance bonds. This product line includes surety business written in the Company’s following subsidiaries: St. Paul Guarantee (Canada), Afianzadora Insurgentes (Mexico) and St. Paul Travelers Casualty and Surety Company of Europe (United Kingdom).

 

Workers’ Compensation provides coverage for employers for specified benefits payable under state or federal law for workplace injuries to employees. There are typically four types of benefits payable under workers’ compensation policies: medical benefits, disability benefits, death benefits and vocational rehabilitation benefits. 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.

 

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.

 

9



 

Property provides coverage for loss or damage to buildings, inventory and equipment from natural disasters, including hurricanes, windstorms, earthquakes, hail, and severe winter weather. Also covered are manmade events such as theft, vandalism, fires, explosions, terrorism and financial loss due to business interruption resulting from covered property damage. For additional information on terrorism coverages, see “Reinsurance—Terrorism Risk Insurance Act of 2002.” Property also includes ocean and inland marine insurance, which provides coverage for goods in transit, and unique one-of-a-kind exposures.

 

Commercial Multi-Peril provides a combination of property and liability coverage. Property insurance covers damages such as those caused by fire, wind, hail, water, theft and vandalism, and protects businesses from financial loss due to business interruption resulting from a covered loss. Liability coverage insures businesses against third parties from accidents occurring on their premises or arising out of their operations, such as injuries sustained from products sold.

 

International provides coverage predominantly through operations in the United Kingdom, Canada and the Republic of Ireland, and at Lloyd’s. The coverage provided in those markets includes employers’ liability (similar to workers’ compensation coverage in the United States), public and product liability (the equivalent of general liability), professional indemnity (similar to directors and officers or errors and omissions coverages), motor (similar to automobile coverage in the United States) and property. While the covered hazard may be similar to those in the U.S. market, the different legal environments can make the product risks and coverage terms potentially very different from those in the United States. International does not include surety business written in the Company’s Canadian, Mexican or United Kingdom subsidiaries.

 

Geographic Distribution

 

The following table shows the distribution of Specialty’s direct written premiums for the states that accounted for the majority of Domestic Specialty premium volume for the year ended December 31, 2005:

 

State

 

% of
Total

 

California

 

12.2

%

Texas

 

8.8

 

New York

 

7.3

 

Florida

 

7.0

 

Illinois

 

4.2

 

Pennsylvania

 

3.6

 

New Jersey

 

3.2

 

Massachusetts

 

3.0

 

All Others (1)

 

50.7

 

Total

 

100.0

%

 


(1)                   No other single state accounted for 3.0% or more of the total direct written premiums written in 2005 by the Company.

 

PERSONAL

 

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

 

Selected Product and Distribution Channel Information

 

The following table sets forth net written premiums for Personal by product line for the periods indicated. For a description of the product lines referred to in the accompanying table, see “—Product Lines.” In addition, see “—Principal Markets and Methods of Distribution” for a discussion of distribution channels for Personal’s product lines.

 

10



 

(for the year ended December 31, in millions)

 

2005

 

2004

 

2003

 

% of Total
2005

 

By product line:

 

 

 

 

 

 

 

 

 

Personal automobile

 

$

3,477

 

$

3,433

 

$

3,054

 

55.8

%

Homeowners and other

 

2,751

 

2,496

 

2,027

 

44.2

 

Total Personal

 

$

6,228

 

$

5,929

 

$

5,081

 

100.0

%

 

Principal Markets and Methods of Distribution

 

Personal products are distributed primarily through approximately 7,800 independent agents located throughout the United States, supported by personnel in eleven marketing regions, three single state companies and six business service centers. In selecting new independent agencies to distribute its products, Personal considers each agency’s profitability, financial stability, staff experience and strategic fit with Personal’s operating and marketing plans. Once an agency is appointed, Personal carefully monitors its performance. While the principal markets for Personal’s insurance products are in states along the East Coast, in the South and Texas, Personal is expanding its geographic presence across the United States.

 

Personal operates single state companies in Massachusetts, New Jersey and Florida with products marketed primarily through independent agents. These states represented approximately 19% of Personal direct written premiums in 2005. The companies were established to manage complex markets in Massachusetts and New Jersey and property catastrophe exposure in Florida. Each company has dedicated resources in underwriting, claim, finance, legal and service functions.

 

Personal uses a consistent operating model with agents outside of the single state companies (see discussion above). The model provides technological alternatives to agents to maximize their ease of doing business. Personal agents quote and issue approximately 98% of Personal’s policies directly from their agencies by leveraging either their own agency management system or using Personal’s proprietary quote and issuance systems which allows agents to rate, quote and issue policies on line. All of these quote and issue platforms interface with Personal’s underwriting and rating systems, which edit transactions for compliance with Personal’s underwriting and pricing programs. Business processed by agents on these platforms is subject to consultative review by Personal’s in-house underwriters. Personal also provides a download capability that refreshes the individual agency system databases of approximately 4,800 agents each day with updated policy information.

 

Personal continues to develop functionality to provide its agents with a comprehensive array of online service capabilities packaged together in an easy-to-use agency service portal, including customer service, marketing and claim functionality. Agencies can also choose to shift the ongoing core service responsibility for Personal’s customers to one of the Company’s four Customer Care Centers, where the Company renders customer service on behalf of an agency by providing a comprehensive array of direct customer service needs, including response to billing and coverage inquiries, and policy changes. Approximately 1,190 agents take advantage of this service alternative.

 

Personal also markets through additional distribution channels, including sponsoring organizations such as employers and consumer associations, and joint marketing arrangements with other insurers. Personal handles the sales and service for these programs either through a sponsoring independent agent or through two of the Company’s call center locations. The Company is one of the leading providers of personal lines products to members of affinity groups. A number of well-known corporations make available the Company’s product offerings to their employees primarily through a payroll deduction payment process. The Company has significant relationships with the majority of the American Automobile Association (AAA) clubs in the United States and other affinity groups that make available Personal’s product offerings to their members. Since 1995, the Company has had a marketing agreement with GEICO to underwrite homeowners business for their auto customers. This agreement has added profitable business and helped to geographically diversify the homeowners line of business.

 

Pricing and Underwriting

 

Pricing levels for Personal property and casualty insurance products are generally developed based upon an expectation of estimated losses, the expense of producing, issuing and servicing the business and a reasonable allowance for profit and contingencies. The Company has a disciplined approach to underwriting and risk management that emphasizes profitable growth rather than premium volume or market share.

 

11



 

Personal has developed a product management methodology that integrates the disciplines of underwriting, claim, actuarial and product development. This approach is designed to maintain high quality underwriting discipline and pricing segmentation. Proprietary data is analyzed with respect to Personal’s business over many years. Personal uses a variety of proprietary and vendor produced risk differentiation models to facilitate its pricing segmentation. Personal’s product managers establish strict underwriting guidelines integrated with its filed pricing and rating plans, which enable Personal to streamline its risk selection and pricing processes.

 

Pricing for personal automobile insurance is driven by changes in the 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 projected claim costs, and obtaining approval from state regulatory authorities when necessary for filed rate changes.

 

Pricing in the homeowners business is also driven by changes in the frequency of claims and by inflation in the cost of building supplies, labor and household possessions. Most homeowners policies offer, but do not require, 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 those related to weather and earthquakes. In order to reduce the Company’s exposure to catastrophe losses, Personal limits the writing of new homeowners business and selectively takes underwriting action on existing business in some markets. In addition, underwriting standards have been tightened, price increases have been implemented in some catastrophe-prone areas, and deductibles are in place in hurricane and wind and hail prone areas. Personal uses computer-modeling techniques to assess its level of exposure to loss in hurricane and earthquake catastrophe-prone areas. Changes to methods of marketing and underwriting in some jurisdictions are subject to state-imposed restrictions, which can make it more difficult for an insurer to significantly reduce catastrophe exposures.

 

Insurers writing personal lines property and casualty policies may be unable to increase prices until some time after the costs associated with coverage have increased, primarily because of state insurance rate regulation. The pace at which an insurer can change rates in response to increased costs depends, in part, on whether the applicable state law requires prior approval of rate increases or notification to the regulator either before or after a rate change is imposed. In states with prior approval laws, rates must be approved by the regulator before being used by the insurer. In states having “file-and-use” laws, the insurer must file rate changes with the regulator, but does not need to wait for approval before using the new rates. A “use-and-file” law requires an insurer to file rates within a period of time after the insurer begins using the new rate. Approximately one-half of the states require prior approval of most rate changes.

 

Independent agents either submit applications to the Company’s service centers for underwriting review, quote, and issuance or they utilize one of its automated quote and issue systems. Automated transactions are edited by the Company’s systems and issued if they conform to established guidelines. Exceptions are reviewed by underwriters in the Company’s business centers. Audits are conducted by business center underwriters and agency managers, on a systematic sampling basis, across all of the Company’s independent agency generated business. Each agent is assigned to a specific employee or team of employees responsible for working with the agent on business plan development, marketing, and overall growth and profitability. The Company uses agency level management information to analyze and understand results and to identify problems and opportunities.

 

The Personal products sold through additional marketing channels utilize the same quote and issuance systems discussed previously and exceptions are underwritten by the Company’s employees. Underwriters work with Company management on business plan development, marketing, and overall growth and profitability. Channel-specific production and claim information is used to analyze results and identify problems and opportunities.

 

Product Lines

 

The primary coverages in Personal are personal automobile and homeowners insurance sold to individuals. Personal had approximately 6.6 million policies in force at December 31, 2005.

 

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.

 

12



 

Homeowners and Other 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 and rental property contents. The Company also writes coverage for personal watercraft, personal articles such as jewelry, and umbrella liability protection.

 

Geographic Distribution

 

The following table shows the distribution of Personal’s direct written premiums for the states that accounted for the majority of premium volume for the year ended December 31, 2005:

 

State

 

% of
Total

 

New York

 

16.3

%

Texas

 

9.2

 

Pennsylvania

 

7.1

 

Massachusetts

 

7.0

 

New Jersey

 

6.3

 

Florida

 

6.0

 

Virginia

 

4.7

 

Georgia

 

4.5

 

Connecticut

 

4.3

 

California

 

3.9

 

Maryland

 

3.0

 

All Others (1)

 

27.7

 

Total

 

100.0

%

 


(1)                   No other single state accounted for 3.0% or more of the total direct written premiums written in 2005 by the Company.

 

CLAIMS MANAGEMENT

 

The Company’s claims management strategies, together with its focus on optimizing claim outcomes, cost efficiency and service are critical to the Company’s ability to grow profitably and reflect these core tenets:

 

                  fair, efficient, fact-based claims management controls losses for the Company and its customers;

 

                  use of advanced technology provides front-line claim professionals with necessary information and facilitates prompt claim resolution;

 

                  specialization of claim professionals and segmentation of claims by complexity, as indicated by severity, coverage and causation, allow the Company to focus its resources effectively;

 

                  effective collaboration, using meaningful management information, across all divisions within the Company facilitates product analysis and enhances risk selection and risk pricing; and

 

                  excellent customer service enhances customer retention.

 

The Company’s claims function is managed through its Claim Services operations. With nearly 13,000 employees, Claim Services employs a diverse group of professionals, including claim adjusters, appraisers, attorneys, investigators, engineers, accountants, system specialists and training, management and support personnel. Approved external service providers, such as independent adjusters and appraisers, investigators and attorneys, are available for use as appropriate.

 

13



 

Field claim management teams located in 32 claim centers and 89 satellite and specialty-only offices in 49 states are organized to maintain focus on the specific claim characteristics unique to the businesses within the Commercial, Specialty and Personal segments. Claim teams with specialized skills, resources, and workflows are matched to the unique exposures of those businesses with local claim management dedicated to achieving optimal results within each segment. The Company’s home office operations provide additional support in the form of workflow design, quality management, information technology, advanced management information and data analysis, training, financial reporting and control, and human resources strategy. In addition to the field teams, claim staff is dedicated to each of Personal’s single state companies in Florida, Massachusetts and New Jersey. This structure permits the Company to maintain the economies of scale of a larger, established company while retaining the agility to respond promptly to the needs of customers, brokers, agents and underwriters.

 

An integral part of the Company’s strategy to benefit customers and shareholders is its continuing industry leadership in the fight against insurance fraud through its Investigative Services unit. The Company has a nationwide staff of experts that investigate a wide array of insurance fraud schemes using in-house forensic resources and other technological tools. This staff also has specialized expertise in fire scene examinations, medical provider fraud schemes and data mining. The Company also dedicates investigative resources to ensure that violations of law are reported to and prosecuted by law enforcement agencies.

 

Claim Services uses advanced technology, management information, and data analysis to assist the Company in reviewing its claim practices and results to evaluate and improve its performance. The Company’s claim management strategy is focused on segmentation of claims and appropriate technical specialization to drive effective claim resolution. The Company continually monitors its investment in claim resources to maintain an effective focus on claim outcomes and a disciplined approach to continual improvement. In recent years, the Company has invested significant additional resources in many of its  claim handling operations and routinely monitors the effect of its investments to ensure a consistent optimization between outcomes, cost, and service.

 

The Company’s proven catastrophe response strategy and its catastrophe claim handling teams were instrumental in its response to a variety of weather-related losses that impacted the insurance industry in both 2005 and 2004, including Hurricanes Katrina, Rita and Wilma (2005), and Hurricanes Charley, Frances, Ivan and Jeanne (2004).

 

The Company is also a leader in bringing effective claim solutions that provide superior customer service. One example of this is ConciergeClaimTH, a new worry-free auto claim service that features select auto repair facilities with Company appraisers on site to complete an estimate, handle all rental arrangements and monitor the repair process from start to finish. By managing the claim in this way, the Company can help ensure prompt, quality results and create a differentiated, superior claim experience for customers.

 

Another strategic advantage is TravCompTH, a workers’ compensation claim resolution and medical management program that assists adjusters in the prompt investigation and effective management of workers’ compensation claims. Innovative medical and claims management technologies permit nurse, medical and claims professionals to share appropriate vital information that supports prompt investigation, effective return to work and claim resolution strategies. These technologies, together with effective matching of professional skills and authority to specific claim issues, have resulted in more efficient management of workers’ compensation claims with lower medical, wage replacement costs and loss adjustment expenses.

 

REINSURANCE

 

The Company reinsures a portion of the risks it underwrites in order to control its exposure to losses and protect capital resources. 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. Ceded reinsurance involves credit risk, except with regard to mandatory pools, and is generally subject to aggregate loss limits. Although the reinsurer is liable to the Company to the extent of the reinsurance ceded, the Company remains liable as the direct insurer on all risks reinsured. Reinsurance recoverables are reported after reductions for known insolvencies and after allowances for uncollectible amounts. The Company also holds collateral, including trust agreements, 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, business practices and the price of their product offerings. For additional information concerning reinsurance, see note 8 of notes to the Company’s consolidated financial statements.

 

14



 

The Company utilizes a variety of reinsurance agreements to manage its exposure to large property and casualty losses, including:

 

                  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;

 

                  treaty reinsurance, in which reinsurance is provided for a specified type or category of risks; and

 

                  catastrophe reinsurance, in which the Company is indemnified for an amount of loss in excess of a specified retention with respect to losses resulting from a catastrophic event.

 

The following presents the Company’s top five reinsurer groups, by reinsurance recoverables at December 31, 2005 (in millions):

 

Reinsurer Group

 

Reinsurance
Recoverables

 

A.M. Best Rating of Group’s Predominant Reinsurer

 

Munich Re Group

 

$

1,304

 

A

third highest of 16 ratings

 

Swiss Re Group

 

912

 

A+

second highest of 16 ratings

 

GE Insurance Services Group

 

778

 

A

third highest of 16 ratings

 

Berkshire Hathaway Group

 

764

 

A++

highest of 16 ratings

 

American International Group

 

754

 

A+

second highest of 16 ratings

 

 

In November 2005, the Swiss Re Group announced that it had agreed to acquire GE Insurance Solutions, the fifth largest reinsurer worldwide, from General Electric Company. Upon expected consummation of this transaction in mid-2006, the Swiss Re Group would become the Company’s largest reinsurer group with recoverables of $1.69 billion as of December 31, 2005. Consequently, the XL Capital Group is expected to become the Company’s fifth largest reinsurer group with recoverables of $651 million as of December 31, 2005.

 

At December 31, 2005, the Company had $19.57 billion in reinsurance recoverables. Of this amount, $2.21 billion was for mandatory pools and associations that relate primarily to workers’ compensation service business and have the obligation of the participating insurance companies on a joint and several basis supporting these cessions. An additional $3.99 billion was attributable to structured settlements relating primarily to personal injury claims, for which the Company has purchased annuities and remains contingently liable in the event of a default by the companies issuing the annuities. Of the remaining $13.37 billion of reinsurance recoverables at December 31, 2005, $1.20 billion was attributable to asbestos and environmental claims, and the remainder principally reflected reinsurance in support of ongoing and runoff business. At December 31, 2005, $2.40 billion of reinsurance recoverables were collateralized by letters of credit, trust agreements and escrow funds. Also at December 31, 2005, the Company had an allowance for estimated uncollectible reinsurance recoverables of $804 million.

 

For a description of reinsurance-related litigation, see Item 3, “Legal Proceedings.”

 

Current Net Retention Policy

 

The descriptions below relate to the Company’s reinsurance arrangements in effect at January 1, 2006. Most property and casualty reinsurance agreements have terrorism sublimits or exclusions. For third party liability, Commercial limits the net retention to a maximum of $8 million per insured, per occurrence after reinsurance. For third party liability, including but not limited to umbrella liability, professional liability, directors’ and officers’ liability, and employment practices liability, Specialty generally limits the net retentions to $16 million per policy after reinsurance. The net retained amount per risk for Commercial and Specialty property is limited to $15 million, after reinsurance. For surety protection, the Company generally retains up to $24.5 million probable maximum loss (PML) per principal but may retain higher amounts based on the type of obligation, credit quality and other credit risk factors. Personal retains the first $5 million of umbrella policies and purchases facultative reinsurance for limits over $5 million. For personal property insurance, there is a $6 million maximum retention per risk. The Company also utilizes facultative reinsurance to provide additional limits capacity or to reduce retentions on an individual risk basis. The Company may also retain amounts greater than those described herein based upon the individual characteristics of the risk.

 

15



 

Catastrophe Reinsurance

 

The Company utilizes a reinsurance agreement with nonaffiliated reinsurers to manage its exposure to losses resulting from one occurrence. For the accumulation of net property losses arising out of one occurrence, the General Catastrophe reinsurance treaty covers 70% or $875 million of total losses between $750 million and $2 billion. This agreement excludes nuclear, chemical, biochemical and radiological losses for domestic terrorism and all terrorism losses as defined by the Terrorism Risk Insurance Act of 2002 and the Terrorism Risk Insurance Extension Act of 2005. This agreement covers all of the Company’s business except that business written by St Paul Travelers Insurance Company Limited. For business underwritten in the United Kingdom, Republic of Ireland and in the Company’s operations at Lloyd’s, separate reinsurance protections are purchased locally which have lower net retentions more commensurate with the size of the respective local balance sheet. The Company conducts an ongoing review of its risk and catastrophe coverages and makes changes as it deems appropriate.

 

At December 31, 2005, the Company had coverage for one additional limit under its General Catastrophe reinsurance treaty, the term of which runs to June 30, 2006. In part as a result of the severity and frequency of storms in 2005 and 2004, the Company expects the cost of reinsurance to increase, and there may be reduced availability of reinsurance coverage.

 

Terrorism Risk Insurance Act of 2002 and Terrorism Risk Insurance Extension Act of 2005

 

On November 26, 2002, the Terrorism Risk Insurance Act of 2002 (the Terrorism Act) was enacted into Federal law and established the Terrorism Risk Insurance Program (the Program), a temporary Federal program in the Department of the Treasury, that provided for a system of shared public and private compensation for insured losses resulting from acts of terrorism or war committed by or on behalf of a foreign interest. The Program was scheduled to terminate on December 31, 2005.  On December 22, 2005, the Terrorism Risk Insurance Extension Act of 2005 (the Terrorism Extension Act) was enacted into Federal law, reauthorizing the Program through December 31, 2007, while reducing the Federal role under the Program. In order for a loss to be covered under the Program (subject losses), the loss must meet certain aggregate industry loss minimums that vary by Program year of amounts $100 million or less, and must be the result of an event that is certified as an act of terrorism by the U.S. Secretary of the Treasury. The original Program excluded from participation certain of the following types of insurance: Federal crop insurance, private mortgage insurance, financial guaranty insurance, medical malpractice insurance, health or life insurance, flood insurance, and reinsurance. The Terrorism Extension Act exempted from coverage certain additional types of insurance, including commercial automobile, professional liability (other than directors and officers’), surety, burglary and theft, and farm-owners multi-peril.  In the case of a war declared by Congress, only workers’ compensation losses are covered by the Terrorism Act and the Terrorism Extension Act. Both Acts generally require that all commercial property casualty insurers licensed in the United States participate in the Program. Under the Program, a participating insurer is entitled to be reimbursed by the Federal Government for a percentage of subject losses, after an insurer deductible, subject to an annual cap.  The Federal reimbursement percentage remains at 90% for 2006, but decreases to 85% in 2007.  In each case, the deductible is calculated by applying the deductible percentage to the insurer’s direct earned premiums for covered lines from the calendar year immediately preceding the applicable year. The deductible under the Program was 7% for 2003, 10% for 2004 and 15% for 2005, and will be 17.5% for 2006 and 20% for 2007.  The Company’s estimated deductible under the Program is $1.91 billion for 2006.  The annual cap limits the amount of aggregate subject losses for all participating insurers to $100 billion. Once subject losses have reached the $100 billion aggregate during a program year, there is no additional reimbursement from the U.S. Treasury and an insurer that has met its deductible for the program year is not liable for any losses (or portion thereof) that exceed the $100 billion cap. The Company had no terrorism-related losses in 2005, 2004 or 2003.

 

Florida Reinsurance Fund

 

The Company also participates in the Florida Hurricane Catastrophe Fund (FHCF), which is a state-mandated catastrophe reinsurance fund that will provide reimbursement to insurers for a portion of their residential catastrophic hurricane losses. The FHCF is primarily funded by premiums from insurance companies that write residential property business in Florida and, if insufficient, assessments on all Florida  property and casualty lines of business, excluding accident and health, the National Flood Insurance Program, workers’ compensation, and medical malpractice insurance. The FHCF’s resources are limited to these contributions and to its borrowing capacity at the time of a significant catastrophe in Florida. Based on current expected reimbursements for 2004 and 2005 losses, it is expected that the FHCF will be able to pay its obligations without levying assessments. However, if there is future subsequent loss development on the FHCF’s share of the 2004 and 2005 hurricane losses or additional hurricanes in 2006, there can be no assurance that the cash resources of the FHCF will be sufficient to meet its obligations and assessments may be necessary.

 

16



 

RESERVES

 

Claim and claim adjustment expense reserves (loss reserves) represent management’s estimate of ultimate unpaid costs of losses and loss adjustment expenses for claims that have been reported and claims that have been incurred but not yet reported.

 

Management continually refines its reserve estimates in a regular ongoing process that includes review of key assumptions, underlying variables and historical loss experience. The Company reflects adjustments to reserves in the results of operations in the periods in which the estimates are changed. In establishing reserves, the Company takes into account estimated recoveries for reinsurance, salvage and subrogation. The reserves are also reviewed regularly by a qualified actuary employed by the Company. For additional information on the process of estimating reserves and a discussion of underlying variables and risk factors, see “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates.”

 

The process of estimating loss reserves involves a high degree of judgment and requires the consideration of a number of variables. These variables (discussed by product line in the “Critical Accounting Estimates” section) are affected by both internal and external events, such as changes in claims handling procedures, inflation, judicial trends and legislative changes, among others. The impact of many of these items on ultimate costs of claims and claim adjustment expenses is difficult to estimate. Reserve estimation difficulties also differ significantly by product line due to differences in the underlying insurance contract (e.g., claims made versus occurrence), claim complexity, the volume of claims, the potential severity of individual claims, determining the occurrence date for a claim, and reporting lags (the time between the occurrence of the insured event and when it is actually reported to the insurer). Informed judgment is applied throughout the process.

 

The Company derives estimates for unreported claims and development on reported claims principally from actuarial analyses of historical patterns of loss development by accident year for each type of exposure and business unit. Similarly, the Company derives estimates of unpaid loss adjustment expenses principally from actuarial analyses of historical development patterns of the relationship of loss adjustment expenses to losses for each line of business and type of exposure. For a description of the Company’s reserving methods for asbestos and environmental claims, see “Item 7—Asbestos Claims and Litigation,” and “Environmental Claims and Litigation.”

 

Discounting

 

Included in the claims and claim adjustment expense reserves in the consolidated balance sheet are certain reserves discounted to the present value of estimated future payments. The liabilities for losses for some long-term disability payments under workers’ compensation insurance and workers’ compensation excess insurance, which totaled $1.92 billion and $1.99 billion at December 31, 2005 and 2004, respectively, were discounted using a rate of 5% at December 31, 2005 and a range of rates from 3.5% to 5% at December 31, 2004. Reserves related to certain fixed and determinable asbestos-related settlements, where all payment amounts and their timing are known, totaled $34 million and $67 million at December 31, 2005 and 2004, respectively. These reserves were discounted using a rate of 2.6% at December 31, 2005, and at a range of rates from 2.3% to 2.6% at December 31, 2004. Reserves for certain assumed reinsurance business were discounted using a range of rates from 5% to 7.5%, and totaled $79 million and $126 million at December 31, 2005 and 2004, respectively.

 

Other Factors

 

The table on page 21 sets forth the year-end reserves from 1995 through 2005 and the subsequent changes in those reserves, presented on a historical basis. The original estimates, cumulative amounts paid and reestimated reserves in the table for the years 1995 through 2003 have not been restated to reflect the acquisition of SPC in 2004. The table includes SPC reserves beginning at December 31, 2004.

 

17



 

The original estimates, cumulative amounts paid and reestimated reserves in the table for the years 1995 to 2000 have also not been restated to reflect the acquisition of Northland and Commercial Guaranty Casualty, and the year 1995 in the table has not been restated to reflect the acquisition of Aetna’s property and casualty insurance subsidiaries. Beginning in 1996 and 2001, the table includes the reserve activity of Aetna’s property and casualty insurance subsidiaries, and Northland and Commercial Guaranty Casualty, respectively. The data in the table is presented in accordance with reporting requirements of the Securities and Exchange Commission (SEC). Care must be taken to avoid misinterpretation by those unfamiliar with this information or familiar with other data commonly reported by the insurance industry. The accompanying data is not accident year data, but rather a display of 1995 to 2005 year-end reserves and the subsequent changes in those reserves.

 

For instance, the “cumulative deficiency or redundancy” shown in the accompanying table 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 those amounts are not additive. Expressed another way, if the original reserves at the end of 1995 included $4 million for a loss that is finally paid in 2005 for $5 million, the $1 million deficiency (the excess of the actual payment of $5 million over the original estimate of $4 million) would be included in the cumulative deficiencies in each of the years 1995 to 2004 shown in the accompanying table.

 

Various factors may distort the re-estimated reserves and cumulative deficiency or redundancy shown in the accompanying table. For example, a substantial portion of the cumulative deficiencies shown in the accompanying table arise from claims on policies written prior to the mid-1970s involving liability exposures such as asbestos and environmental claims. In the post-1984 period, the Company has developed more stringent underwriting standards and policy exclusions and has significantly contracted or terminated the writing of these risks. See “Item 7—Asbestos Claims and Litigation,” and “Environmental Claims and Litigation.” General conditions and trends that have affected the development of these liabilities in the past will not necessarily recur in the future.

 

Other factors that affect the data in the accompanying table include the discounting of certain reserves, as discussed above, and the use of retrospectively rated insurance policies. For example, workers’ compensation indemnity reserves (tabular reserves) are discounted to reflect the time value of money. Apparent deficiencies will continue to occur as the discount on these workers’ compensation reserves is accreted at the appropriate interest rates. Also, a portion of National Accounts business is underwritten with retrospectively rated insurance policies in which the ultimate loss experience is primarily borne by the insured. For this business, increases in loss experience result in an increase in reserves and an offsetting increase in amounts recoverable from insureds. Likewise, decreases in loss experience result in a decrease in reserves and an offsetting decrease in amounts recoverable from these insureds. The amounts recoverable on these retrospectively rated policies mitigate the impact of the cumulative deficiencies or redundancies on the Company’s earnings but are not reflected in the accompanying table.

 

Because of these and other factors, it is difficult to develop a meaningful extrapolation of estimated future redundancies or deficiencies in loss reserves from the data in the accompanying table.

 

The differences between the reserves, net of reinsurance, for claims and claim adjustment expenses shown in the accompanying table, which is prepared in accordance U.S. generally accepted accounting principles and those reported in the Company’s annual reports filed with insurance regulators, which are prepared in accordance with statutory accounting practices, were $(296) million, $(282) million and $26 million for 2005, 2004 and 2003, respectively. The increase in the differences in 2005 and 2004 compared with the difference in 2003 was primarily driven by the impact of a reinsurance contract which the Company entered into in 2004 that provides coverage for prior accident years.

 

18



 

(at December 31, in millions)

 

1995(a)

 

1996(a)

 

1997(a)

 

1998(a)

 

1999(a)

 

2000(a)

 

2001(a)(b)

 

2002(a)(b)

 

2003(a)(b)

 

2004(a)(b)(c)

 

2005(a)(b)(c)

 

Reserves for claims and claim adjustment expense originally estimated

 

$

10,090

 

$

21,816

 

$

21,406

 

$

20,763

 

$

19,983

 

$

19,435

 

$

20,197

 

$

23,268

 

$

24,055

 

$

41,446

 

$

42,895

 

Cumulative amounts paid as of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year later

 

1,521

 

3,704

 

4,025

 

4,159

 

4,082

 

4,374

 

5,018

 

5,170

 

4,651

 

8,871

 

 

 

Two years later

 

2,809

 

6,600

 

6,882

 

6,879

 

6,957

 

7,517

 

8,745

 

8,319

 

8,686

 

 

 

 

 

Three years later

 

3,903

 

8,841

 

8,850

 

9,006

 

9,324

 

10,218

 

11,149

 

11,312

 

 

 

 

 

 

 

Four years later

 

4,761

 

10,355

 

10,480

 

10,809

 

11,493

 

12,000

 

13,402

 

 

 

 

 

 

 

 

 

Five years later

 

5,322

 

11,649

 

11,915

 

12,565

 

12,911

 

13,603

 

 

 

 

 

 

 

 

 

 

 

Six years later

 

5,842

 

12,893

 

13,376

 

13,647

 

14,172

 

 

 

 

 

 

 

 

 

 

 

 

 

Seven years later

 

6,146

 

14,154

 

14,306

 

14,697

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eight years later

 

6,668

 

14,987

 

15,225

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine years later

 

7,013

 

15,844

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ten years later

 

7,411

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Reserves reestimated as of

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One year later

 

9,848

 

21,345

 

21,083

 

20,521

 

19,736

 

19,394

 

23,228

 

23,658

 

24,222

 

41,706

 

 

 

Two years later

 

9,785

 

21,160

 

20,697

 

20,172

 

19,600

 

22,233

 

24,083

 

24,592

 

25,272

 

 

 

 

 

Three years later

 

9,789

 

20,816

 

20,417

 

19,975

 

22,302

 

22,778

 

25,062

 

25,553

 

 

 

 

 

 

 

Four years later

 

9,735

 

20,664

 

20,168

 

22,489

 

22,612

 

23,871

 

25,953

 

 

 

 

 

 

 

 

 

Five years later

 

9,711

 

20,427

 

22,570

 

22,593

 

23,591

 

24,872

 

 

 

 

 

 

 

 

 

 

 

Six years later

 

9,661

 

22,851

 

22,625

 

23,492

 

24,559

 

 

 

 

 

 

 

 

 

 

 

 

 

Seven years later

 

10,562

 

22,861

 

23,530

 

24,446

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Eight years later

 

10,553

 

23,759

 

24,425

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine years later

 

10,945

 

24,601

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ten years later

 

11,363

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cumulative deficiency(a)(b)(c)

 

1,273

 

2,785

 

3,019

 

3,683

 

4,576

 

5,437

 

5,756

 

2,285

 

1,217

 

260

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross liability–end of year

 

$

15,213

 

$

30,969

 

$

30,138

 

$

29,411

 

$

28,854

 

$

28,312

 

$

30,617

 

$

33,628

 

$

34,474

 

$

58,984

 

$

61,007

 

Reinsurance recoverables

 

5,123

 

9,153

 

8,732

 

8,648

 

8,871

 

8,877

 

10,420

 

10,360

 

10,419

 

17,538

 

18,112

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net liability–end of year

 

$

10,090

 

$

21,816

 

$

21,406

 

$

20,763

 

$

19,983

 

$

19,435

 

$

20,197

 

$

23,268

 

$

24,055

 

$

41,446

 

$

42,895

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross reestimated liability-latest

 

$

16,473

 

$

33,765

 

$

33,242

 

$

33,567

 

$

34,390

 

$

35,406

 

$

37,991

 

$

36,961

 

$

36,074

 

$

59,191

 

 

 

Reestimated reinsurance recoverables-latest

 

5,110

 

9,164

 

8,817

 

9,121

 

9,831

 

10,534

 

12,038

 

11,408

 

10,802

 

17,485

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net reestimated liability-latest

 

$

11,363

 

$

24,601

 

$

24,425

 

$

24,446

 

$

24,559

 

$

24,872

 

$

25,953

 

$

25,553

 

$

25,272

 

$

41,706

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross cumulative deficiency

 

$

1,260

 

$

2,796

 

$

3,104

 

$

4,156

 

$

5,536

 

$

7,094

 

$

7,374

 

$

3,333

 

$

1,600

 

$

207

 

 

 

 

 

 

1995

 

1996

 

1997

 

1998

 

1999

 

2000

 

2001

 

2002

 

2003

 

2004

 

 

 

 

 

$

2,029

 

$

4,370

 

$

4,301

 

$

4,235

 

$

4,178

 

$

4,128

 

$

3,939

 

$

994

 

$

970

 

$

831

 

 

 

 

Included in the cumulative deficiency by year is the impact of unfavorable prior year reserve development, net of reinsurance, related to asbestos claims and litigation, primarily due to $2,945 million of unfavorable development in 2002, accretion of discount of $25 million in 2003, $416 million of unfavorable development in 2004 and unfavorable development of $831 million in 2005, as follows, in millions:

 

(a)          For 1995, excludes Aetna P&C reserves, which were acquired on April 2, 1996. Accordingly, the reserve development (net reserves for claims and claim adjustment expenses reestimated as of subsequent years less net reserves recorded at the end of the year, as originally estimated) for 1995 relates only to losses recorded by TPC and does not include reserve development recorded by Aetna P&C. For 1996 and subsequent years, includes Aetna P&C reserves and subsequent development recorded by Aetna P&C. At December 31, 1996 Aetna P&C gross reserves were $15,555 million and net reserves were $11,608 million.

 

(b)         Includes reserves of The Northland Company and its subsidiaries and Commercial Guaranty Lloyds Insurance Company which were acquired from Citigroup on October 1, 2001. Also includes reserves of Commercial Guaranty Casualty Insurance Company, which was contributed to TPC by Citigroup on October 3, 2001. At December 31, 2001, these gross reserves were $867 million and net reserves were $633 million.

 

(c)          For years prior to 2004, excludes SPC reserves, which were acquired on April 1, 2004. Accordingly, the reserve development (net reserves for claims and claim adjustment expenses reestimated as of subsequent years less net reserves recorded at the end of the year, as originally estimated) for years prior to 2004 relates only to losses recorded by TPC and does not include reserve development recorded by SPC. For 2004 and subsequent year, includes SPC reserves and subsequent development recorded by SPC. At December 31, 2004, SPC gross reserves were $23,274 million and net reserves were $15,959 million.

 

Asbestos and Environmental Claims

 

Asbestos and environmental claims are segregated from other claims and are handled separately by the Company’s Special Liability Group, a separate unit staffed by dedicated legal, claim, finance and engineering professionals. For additional information on asbestos and environmental claims, see “Item 7—Management’s Discussion and Analysis of Financial Conditions and Results of Operations.”

 

19



 

INTERCOMPANY REINSURANCE POOLING ARRANGEMENTS

 

Most of the Company’s insurance subsidiaries are members of intercompany property and casualty reinsurance pooling arrangements. Pooling arrangements permit the participating companies to rely on the capacity of the entire pool’s capital and surplus rather than just on its own capital and surplus. Under such arrangements, the members share substantially all insurance business that is written, and allocate the combined premiums, losses and expenses. During 2005, the Company combined the previously separate St. Paul Insurance Group and Travelers Property Casualty pools, forming the new St. Paul Travelers Reinsurance Pool effective July 1, 2005, retroactive to January 1, 2005. Travelers Indemnity Company is the lead company of the new pool, which includes 28 companies. The Company also merged Gulf Insurance Company, the lead company of the former Gulf Insurance Group, into Travelers Indemnity Company effective July 1, 2005. As of December 31, 2005, there were two intercompany pooling arrangements: the St. Paul Travelers Reinsurance Pool and the Northland Pool.

 

RATINGS

 

Ratings are an important factor in setting the Company’s competitive position in the insurance marketplace. The Company receives ratings from the following major rating agencies: A.M. Best Company (A.M. Best), Fitch Ratings (Fitch), Moody’s Investors Service (Moody’s) and Standard & Poor’s Corp. (S&P). Rating agencies typically issue two types of ratings: claims-paying (or financial strength) ratings which assess an insurer’s ability to meet its financial obligations to policyholders and debt ratings which assess a company’s prospects for repaying its debts and assist lenders in setting interest rates and terms for a company’s short and long term borrowing needs. Agency ratings are not a recommendation to buy, sell or hold any security, and they may be revised or withdrawn at any time by the rating organization. Each agency’s rating should be evaluated independently of any other agency’s rating. The system and the number of rating categories can vary widely from rating agency to rating agency. Customers usually focus on claims-paying ratings, while creditors focus on debt ratings. Investors use both to evaluate a company’s overall financial strength. The ratings issued on the Company or its subsidiaries by any of these agencies are announced publicly and are available on the Company’s website and from the agencies.

 

The Company’s insurance operations could be negatively impacted by a downgrade in one or more of the Company’s financial strength ratings. If this were to occur, there could be a reduced demand for certain products in certain markets. Additionally, the Company’s ability to access the capital markets could be impacted and higher borrowing costs may be incurred.

 

The following rating agency actions were taken with respect to the Company in 2005 and 2006:

 

                   On January 6, 2005, A.M. Best affirmed the financial strength rating of “A” of St. Paul Guarantee Insurance Company and withdrew the financial strength rating of “A+” of Travelers Casualty and Surety Company of Canada (assigned an NR-5, not formerly followed rating). Both ratings were removed from under review with developing implications. St. Paul Guarantee Insurance Company was assigned a rating outlook of stable. These actions followed the January 1, 2005 completion of the amalgamation of St. Paul Guarantee Insurance Company and Travelers Casualty and Surety Company of Canada.

 

                   On January 31, 2005, A.M. Best placed the financial strength rating of “A+” of Travelers Property Casualty Pool and the debt ratings of “a-” on senior debt, “bbb+ “on subordinated debt, “bbb” on trust preferred securities, “bbb” on preferred stock and “AMB-1” on commercial paper of The St. Paul Travelers Companies, Inc. and its subsidiaries under review with negative implications, pending the close of a potential divestiture of the Company’s investment in Nuveen Investments. Concurrently, A.M. Best affirmed the financial strength rating of “A” of The St. Paul Insurance Group. The rating outlook was stable.

 

                   On January 31, 2005, S&P affirmed it’s “A+” counterparty credit and financial strength ratings on the members of the St. Paul Insurance Group Pool, the members of the Travelers Intercompany Pool, Travelers Casualty and Surety Co., of America, and Travelers Casualty and Surety Co. of Europe Ltd. with a stable outlook. S&P also affirmed its “BBB+/A-2” counterparty credit rating on The St. Paul Travelers Companies, Inc. with a stable outlook.

 

                   On January 31, 2005, Fitch affirmed the “A-” long-term issuer and senior debt ratings of The St. Paul Travelers Companies, Inc., Travelers Property Casualty Corp. and Travelers Insurance Group Holdings, Inc. The “AA-” insurer financial strength (IFS) ratings of members of the Travelers Property Casualty Group and the St. Paul Insurance Group Pool were also affirmed. The outlook for all ratings was stable.

 

20



 

                   On February 1, 2005, Moody’s affirmed the long-term debt ratings (senior unsecured debt at A3) of The St. Paul Travelers Companies, Inc. and also affirmed the Aa3 insurance financial strength (IFSR) of the members of the legacy Travelers intercompany pool. The outlook for these ratings was changed to negative from stable. Moody’s also placed the A1 IFSR of the legacy St. Paul intercompany pool and the A2 IFSR of United States Fidelity and Guaranty Company on review for possible upgrade. The outlook on the A2 IFSR of the Gulf intercompany pool subsidiaries was changed to positive from stable. The outlook of the A1 IFSR of Travelers Casualty and Surety Company of Europe, Limited was changed to positive from developing.

 

                   On April 18, 2005, A.M. Best affirmed the financial strength rating of “A+” of Travelers Property Casualty Pool and the debt ratings of “a-” on senior debt, “bbb+” on subordinated debt, “bbb” on trust preferred securities, “bbb” on preferred stock and “AMB-1” on commercial paper of The St. Paul Travelers Companies, Inc. and subsidiaries. A.M. Best also removed these ratings from under review and assigned a stable outlook. The ratings had been placed under review pending the close of a potential divesture of the Company’s investment in Nuveen Investments.

 

                    On July 13, 2005, A.M. Best assigned a financial strength rating (FSR) of “A+” and an issuer credit rating (ICR) of “aa-” to the members of the newly formed St. Paul Travelers Reinsurance Pool. This ratings action followed the Company’s announcement that it had combined the St. Paul and Travelers pools, forming a new pool effective July 1, 2005, retroactive to January 1, 2005 and merged Gulf Insurance Company, the lead company of the former Gulf Insurance Group, with and into Travelers Indemnity Company, the lead company of the new pool, effective July 1, 2005. The 28 participants in the new pool, 17 reinsured affiliates and Travelers Casualty and Surety of America constitute the 46 members of A.M. Best’s new rating unit, St. Paul Travelers Insurance Companies. As a result of the new pooling arrangement, A.M. Best upgraded the FSRs to “A+” from “A” and the ICRs to “aa-” from “a” of the 18 members of the former St. Paul Insurance Group; affirmed the FSRs of “A+” and ICRs of “aa-” of the 24 members of the former Travelers Property Casualty Pool; and upgraded the FSRs to “A+” from “A-” and ICRs to “aa-” from “a-” of three members of the former Gulf Insurance Group. In addition, A.M. Best affirmed the debt ratings of “a-” on senior debt, “bbb+” on subordinated debt, “bbb” on trust preferred securities, “bbb” on preferred stock and AMB-1 on commercial paper of the Company and its subsidiaries. The outlook for all ratings was stable.

 

                   On July 14, 2005, Moody’s upgraded the insurance financial strength ratings of the legacy St. Paul, United States Fidelity and Guaranty (USF&G) and Gulf Insurance Group to “Aa3” following the completion of the pooling of the St. Paul and USF&G companies with the legacy Travelers Property Casualty Pool (whose pooled companies were already rated “Aa3” for insurance financial strength) and the merger of the Gulf Insurance Company with and into Travelers Indemnity Company. Moody’s also affirmed the long-term and short-term ratings of The St. Paul Travelers Companies, Inc. (senior unsecured debt at “A3,” commercial paper at Prime-2) and those of its downstream debt-issuing subsidiaries. The ratings outlook was negative.

 

                   On September 29, 2005, Fitch affirmed all ratings of The St. Paul Travelers Companies, Inc., including the “A-” long-term issuer rating; the “A-” rating on the Company’s senior unsecured notes; and the “BBB+” ratings on the Company’s subordinated notes and capital securities. Additionally, Fitch affirmed the “AA-” insurer financial strength (IFS) ratings on members of the St. Paul Travelers Reinsurance Pool. The rating outlooks were stable.

 

                   On November 17, 2005, S&P changed the debt rating outlook of The St. Paul Travelers Companies, Inc. to “positive” from “stable.”  S&P also changed the outlook of members of the St. Paul Travelers Insurance Group to “positive” from “stable.”

 

                   On November 21, 2005, A.M. Best assigned a debt rating of “a-” to the $400 million senior unsecured notes due 2015 issued by the Company in November 2005.

 

                   On November 21, 2005, S&P assigned its “BBB+” senior debt rating to the $400 million senior unsecured notes due 2015 issued by the Company in November 2005.

 

                   On November 21, 2005, Fitch assigned an “A-” debt rating to the $400 million senior unsecured notes due 2015 issued by the Company in November 2005.

 

                   On November 22, 2005, Moody’s assigned an “A3” debt rating to the $400 million senior unsecured notes due 2015 issued by the Company in November 2005.

 

21



 

                   On February 2, 2006, Fitch affirmed all ratings of the Company, including the “A-” long-term issuer rating, “A-” ratings on the Company’s senior unsecured notes, and “BBB+” ratings on the Company’s subordinated notes in capital securities. Additionally, Fitch affirmed the “AA-” insurer financial strength (IFS) ratings on members of the St. Paul Travelers Inter-Company Pool. The rating outlooks are stable.

 

Claims – Paying Ratings

 

The following table summarizes the current claims-paying (or financial strength) ratings of the St. Paul Travelers Reinsurance Pool, Travelers C&S of America, Northland Pool, Travelers Personal single state companies, Travelers Europe, Discover Reinsurance Company, Afianzadora Insurgentes, S.A., St. Paul Guarantee Insurance Company and St. Paul Travelers Insurance Company Limited by A.M. Best, Moody’s, S&P and Fitch as of February 27, 2006. The table also presents the position of each rating in the applicable agency’s rating scale.

 

 

 

A.M. Best

 

Moody’s

 

S&P

 

Fitch

 

St. Paul Travelers Reinsurance Pool(a,b)

 

A+ (2nd of 16)

 

Aa3 (4th of 21)

 

A+ (5th of 21)

 

AA- (4th of 24)

 

Travelers C&S of America

 

A+ (2nd of 16)

 

Aa3 (4th of 21)

 

A+ (5th of 21)

 

AA- (4th of 24)

 

Northland Pool(c)

 

A (3rd of 16)

 

 

 

 

First Floridian Auto and Home Ins. Co.

 

A (3rd of 16)

 

 

 

AA- (4th of 24)

 

First Trenton Indemnity Company

 

A (3rd of 16)

 

 

 

AA- (4th of 24)

 

The Premier Insurance Co. of MA

 

A (3rd of 16)

 

 

 

AA- (4th of 24)

 

Travelers Europe

 

A+ (2nd of 16)

 

Aa3 (4th of 21)

 

A+ (5th of 21)

 

 

Discover Reinsurance Company

 

A- (4th of 16)

 

 

 

 

Afianzadora Insurgentes, S.A.

 

A- (4th of 16)

 

 

 

 

St. Paul Guarantee Insurance Company

 

A (3rd of 16)

 

 

 

 

St. Paul Travelers Insurance Company Limited

 

A (3rd of 16)

 

 

 

 

 


(a)                   The St. Paul Travelers Reinsurance Pool consists of:  The Travelers Indemnity Company, The Charter Oak Fire Insurance Company, The Phoenix Insurance Company, The Travelers Indemnity Company of Connecticut, The Travelers Indemnity Company of America, Travelers Property Casualty Company of America, Travelers Commercial Casualty Company, TravCo Insurance Company, The Travelers Home and Marine Insurance Company, Travelers Casualty and Surety Company, The Standard Fire Insurance Company, The Automobile Insurance Company of Hartford, Connecticut, Travelers Casualty Insurance Company of America, Farmington Casualty Company, Travelers Commercial Insurance Company, Travelers Casualty Company of Connecticut, Travelers Property Casualty Insurance Company, Travelers Personal Security Insurance Company, Travelers Personal Insurance Company, Travelers Excess and Surplus Lines Company, St. Paul Fire and Marine Insurance Company, St. Paul Surplus Lines Insurance Company, Athena Assurance Company, St. Paul Protective Insurance Company, St. Paul Medical Liability Insurance Company, Discover Property & Casualty Insurance Company, Discover Specialty Insurance Company, and United States Fidelity and Guaranty Company.

 

(b)                  The following affiliated companies are 100% reinsured by one of the pool participants noted in (a) above: Atlantic Insurance Company, Commercial Guaranty Lloyds Insurance Company, Fidelity and Guaranty Insurance Company, Fidelity and Guaranty Insurance Underwriters, Inc., Gulf Group Lloyds, Gulf Underwriters Insurance Company, Travelers Auto Insurance Co. of New Jersey, Seaboard Surety Company, Select Insurance Company, St. Paul Fire and Casualty Insurance Company, St. Paul Guardian Insurance Company, St. Paul Mercury Insurance Company, The Travelers Lloyds Insurance Company, Travelers Lloyds of Texas Insurance Company, and USF&G Insurance Company of Mississippi.

 

(c)                   The Northland Pool consists of Northland Insurance Company, Northfield Insurance Company, Northland Casualty Company, Mendota Insurance Company, Mendakota Insurance Company, American Equity Insurance Company and American Equity Specialty Insurance Company.

 

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Debt Ratings

 

The following table summarizes the current debt, preferred stock and commercial paper ratings of the Company and its subsidiaries by A.M. Best, Moody’s, S&P and Fitch as of February 27, 2006. The table also presents the position of each rating in the applicable agency’s rating scale.

 

 

 

A.M. Best

 

Moody’s

 

S&P

 

Fitch

 

Senior debt

 

a- (7th of 22)

 

A3 (7th of 21)

 

BBB+ (8th of 22)

 

A- (7th of 22)

 

Subordinated debt

 

bbb+ (8th of 22)

 

Baa (8th of 21)

 

BBB (9th of 22)

 

A- (7th of 22)

 

Junior subordinated debt

 

bbb+ (8th of 22)

 

Baa (8th of 21)

 

BBB- (10th of 22)

 

BBB+ (8th of 22)

 

Trust preferred securities

 

bbb (9th of 22)

 

Baa (8th of 21)

 

BBB- (10th of 22)

 

BBB+ (8th of 22)

 

Preferred stock

 

bbb (9th of 22)

 

Baa2 (9th of 21)

 

BBB- (10th of 22)

 

BBB+ (8th of 22)

 

Commercial paper.

 

AMB-1 (2nd of 6)

 

Prime-2 (2nd of 4)

 

A-2 (3rd of 8)

 

F-2 (3rd of 8)

 

 

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 in federal, state and municipal obligations, corporate bonds, preferred and common equity securities, mortgage loans, real estate and certain other investments, subject to specified limits and certain other qualifications.

 

At December 31, 2005, the carrying value of the Company’s investment portfolio was $68.29 billion, of which 93% was invested in fixed maturity investments and short-term investments (of which 60% was invested in federal, state or municipal government obligations), 1% in mortgage loans and real estate, 1% in equity securities and 5% in other investments. The average duration of the fixed maturity portfolio, including short-term investments, was 3.9 years at December 31, 2005. Non-investment grade securities totaled approximately $1.75 billion, representing approximately 3% of the Company’s fixed maturity investment portfolio as of December 31, 2005.

 

The following table sets forth information regarding the Company’s investments. See note 6 of notes to the Company’s consolidated financial statements for additional information regarding the Company’s investment portfolio.

 

(for the year ended December 31, in millions)

 

2005

 

2004

 

2003

 

Average investments (a)

 

$

66,695

 

$

55,139

 

$

35,306

 

Net investment income

 

$

3,165

 

$

2,663

 

$

1,869

 

Average pretax yield (b)

 

4.7

%

4.8

%

5.3

%

Average pretax equivalent yield (b)

 

5.6

%

5.6

%

6.2

%

Average aftertax yield (b)

 

3.7

%

3.7

%

4.0

%

 


(a)                   Reduced by payables for securities lending and repurchase agreements, and adjusted for the impact of unrealized investment gains and losses, receivables for investment sales and payables on investment purchases.

(b)                  Excluding net realized and unrealized investment gains and losses.

 

DERIVATIVES

 

See note 16 of notes to the Company’s consolidated financial statements for a discussion of the policies and transactions related to the Company’s derivative financial instruments.

 

COMPETITION

 

The property and casualty insurance industry is highly competitive in the areas of price, service, product offerings, agent relationships and method of distribution, i.e., use of independent agents, exclusive agents and/or salaried employees. According to A.M. Best, there are approximately 975 property casualty organizations in the United States, comprising approximately 2,400 property casualty companies. Of those organizations, the top 150 accounted for approximately 92% of the consolidated industry’s total net written premiums in 2004. Several property and casualty insurers writing commercial lines of business, including the Company, 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 costs from workers’ compensation cases and jury awards in third-party liability cases.

 

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Commercial. The insurance industry is represented in the commercial marketplace by many insurance companies of varying size as well as other entities offering risk alternatives such as self-insured retentions or captive programs. Market competition works within the insurance regulatory framework to set the price charged for insurance products and the level of service provided. 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, and the availability of reinsurance. 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. Additionally, many large commercial customers self-insure their risks or utilize large deductibles on purchased insurance.

 

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, regional insurance companies and companies that have developed niche programs for specific industry segments. Companies compete on price, product offerings, response time in policy issuance and claim and loss prevention services. Additionally, improved efficiency through automation and response time to customer needs are key to success in this market. Commercial Accounts also utilizes dedicated units to tailor insurance programs to unique insurance needs. These units are national property, transportation, boiler and machinery, inland marine, agribusiness, excess and surplus and national programs.

 

Select Accounts business is typically written through independent agents and, to a lesser extent, regional brokers. Both national and regional property casualty insurance companies compete in the Select Accounts market which generally comprises lower hazard, “main street” business customers. Risks are underwritten and priced using standard industry practices and a combination of proprietary and standard industry product offerings. Competition in this market is primarily based on price, product offerings and response time in policy services. Select Accounts has established a strong marketing relationship with its distribution network and has provided it with defined underwriting policies, a broad array of products, competitive prices and one of the most efficient automated environments in the industry. In addition, the Company has established centralized service centers to help agents perform many service functions, in return for a fee. Select Accounts’ overall service platform is one of the strongest in the small business commercial market.

 

National Accounts business is typically written through national brokers and, to a lesser extent, regional brokers. Insurance companies compete in this market based on price, product offerings, claim and loss prevention services, managed care cost containment and risk management information systems. National Accounts also offers a large nationwide network of localized claim service centers which provide greater flexibility in claims adjusting and allows National Accounts to more quickly respond to the needs of its customers. National Accounts’ residual market business 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 through a bid process based on the quality of service and price. National Accounts services approximately 36% of the total workers’ compensation assigned risk market, making the Company one of the largest servicing insurers in the industry.

 

Discover Re competes with traditional providers of commercial insurance coverages, as well as other underwriters of property and casualty insurance in the alternative risk transfer market that offer coverages both on a bundled and unbundled basis, risk retention groups, self-insurance plans, captives managed by others, and a variety of other risk-financing vehicles and mechanisms. 

 

The market in which Gulf competed included small to mid-size niche companies that target specific lines of insurance and larger, multi-line companies that focus on various segments of the specialty accounts market. Prior to being placed in runoff in 2004, Gulf’s business was generally written through retail and wholesale agents and brokers throughout the United States.

 

Specialty. The competitive landscape in which the Specialty segment operates is affected by many of the same factors described previously for the Commercial segment. The Company’s domestic and international insurance subsidiaries compete with other stock companies, mutual companies, alternative risk sharing groups and other underwriting organizations. Competitors in this market are primarily national property-casualty insurance companies willing to write most classes of business using traditional products and pricing and, to a lesser extent, regional insurance companies and companies that have developed niche programs for specific industry segments. In addition, many large commercial customers self-insure their risks or utilize large deductibles on purchased insurance.

 

24



 

Bond underwrites and markets its products to national, mid-sized and small businesses and organizations as well as individuals, and distributes them through both national and wholesale brokers, and retail agents and regional brokers. Bond competes in the highly competitive surety and executive liability marketplaces. Both national and regional property casualty insurance companies compete with Bond. Bond’s reputation for timely and consistent decision-making, a nationwide network of local underwriting, claims and industry experts and strong producer and customer relationships as well as its ability to offer its customers a full range of products, enable it to compete effectively. Bond’s ability to cross-sell its products to customers of the Commercial and Personal segments provides further competitive advantages for the Company.

 

Construction business has historically been written through independent agents and brokers. Competitors in this industry include both national and regional property casualty insurance companies. Companies compete on price, coverage offerings, claim and loss prevention services, managed care cost containment and risk management information systems. Construction offers a nationwide network of localized, dedicated claim service professionals that provide greater flexibility in claims adjusting and allows Construction to more quickly respond to the needs of its customers. In addition, dedicated risk control professionals work directly with customers in the evaluation, design and implementation of safety programs to better control risk and exposure to loss.

 

Financial and Professional Services business is typically written through national brokers, regional brokers, and independent agents. Insurance companies compete on price and product offerings. The Company has developed a strong reputation in this complex, dynamic market segment and has an advantage over many of its competitors in offering a wide breadth of professional and general property and casualty coverages to its financial and professional customers.

 

There are several other domestic business groups in Specialty that compete in focused target markets. Each of these markets are different and require unique combinations of industry knowledge, proprietary coverage forms, specialized risk control and loss handling services, and partnerships with agents and brokers that also focus on these markets. In some cases the competition is national carriers with similarly dedicated underwriting and marketing groups. In other cases smaller regional companies tend to be the primary competition. In either case these businesses have regional structures that allow them to deliver personalized service and local knowledge to their customer base. Specialized agents and brokers supplement this strategy. In all of these businesses, the competitive strategy is market leadership attained through focused industry knowledge applied to insurance and risk needs.

 

International Specialty competes with numerous international and local country insurers in the United Kingdom, Canada and the Republic of Ireland. Companies compete on the basis of price, product offerings and the level of claim and risk management services provided. Specialty has developed expertise in various specialty markets in these countries similar to those served in the United States and provides both property and casualty coverage for these markets. This specialty focus is a particular competitive advantage in these countries where our competitors have not developed expertise in these specialty markets.  Products are generally distributed through a fairly small number of local country brokers whose customer groups align with the Company’s specialty markets.

 

At Lloyd’s, International Specialty competes with other syndicates operating in the Lloyd’s market as well as international and domestic insurers in the various markets where International Specialty writes business worldwide. Syndicates are increasingly capitalized by corporate capital, much of which is provided by large international insurance enterprises. Competition is again based on price and product offerings. International Specialty has an exclusive focus on lines it believes it can underwrite effectively and profitably with an emphasis on short-tail insurance primary lines. Specialty underwrites four major classes of business at Lloyd’s: aviation, marine, global property, and accident and special risks.

 

Personal. Personal lines insurance is written by hundreds of insurance companies of varying sizes. Although national companies write the majority of the business, Personal also faces competition from local or regional companies which often have a competitive advantage because of their knowledge of the local marketplace and their relationship with local agents. Personal believes that the principal competitive factors are price, service, perceived stability of the insurer and name recognition. Personal competes for business within each independent agency since these agencies also offer policies of competing companies. At the agency level, competition is primarily based on price and the level of service, including claims handling, as well as the level of automation and the development of long-term relationships with individual agents. Personal also competes with insurance companies that use exclusive agents or salaried employees to sell their products. In addition to its traditional independent agency distribution, Personal has broadened its distribution of products by marketing to sponsoring organizations, including employee and affinity groups, and through joint marketing arrangements with other insurers. Personal believes that its continued focus on expense management practices, underwriting and pricing segmentation, and claim settlement effectiveness strategies enable Personal to price its products competitively in all of its distribution channels.

 

25



 

REGULATION

 

State Regulation

 

The Company’s insurance subsidiaries are subject to regulation in the various states and jurisdictions in which they transact business. The extent of regulation varies, but generally derives from statutes that delegate regulatory, supervisory and administrative authority to a department of insurance in each state. The regulation, supervision and administration relate, among other things, to 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 obligations, deposits of securities for the benefit of policyholders, approval of policy forms and the regulation of market conduct, including the use of credit information in underwriting as well as other 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. At the present time, the Company’s insurance subsidiaries are collectively licensed to transact insurance business in all states, the District of Columbia, Guam, Puerto Rico, Bermuda, and the U.S. Virgin Islands, as well as Australia, Canada, New Zealand, the Philippines, the United Kingdom, the Republic of Ireland, South Africa and Central and South America.

 

As part of ongoing, industry-wide investigations, the Company and its affiliates have received subpoenas and written requests for information from government agencies and authorities, including 18 states and the SEC. The areas of inquiry addressed to the Company include its relationship with brokers and agents, the Company’s involvement with “non-traditional” insurance and reinsurance products, branding requirements for salvage automobiles and the reporting of workers’ compensation premiums. The Company is cooperating with these subpoenas and requests for information. See “Part I – Item 3 – Legal Proceedings” for further discussion.  

 

Insurance Holding Company Statutes

 

As a holding company, the Company is not regulated as an insurance company. However, as the Company owns capital stock in insurance subsidiaries, it is subject to state insurance holding company statutes, as well as certain other laws, of each of the states of domicile of the Company’s insurance subsidiaries. All holding company statutes, as well as other laws, require disclosure and, in some instances, prior approval of material transactions between an insurance company and an affiliate. The holding company statutes as well as other laws also require, among other things, prior approval of an acquisition of control of a domestic insurer, some transactions between affiliates and the payment of extraordinary dividends or distributions.

 

Insurance Regulation Concerning Dividends

 

The Company’s principal insurance subsidiaries are domiciled in the states of Connecticut and Minnesota. The insurance holding company laws of both states applicable to the Company’s subsidiaries require 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 10% of the insurer’s capital and surplus as of the preceding December 31, or the insurer’s net income for the twelve-month period ending the preceding December 31, in each case determined in accordance with statutory accounting practices and by state regulation. This declaration or payment is further limited by adjusted unassigned 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 some instances somewhat more restrictive, limitations on the payment of dividends.

 

Assessments for Guaranty Funds and Second-Injury Funds and Other Mandatory Pooling Arrangements

 

Virtually all states require insurers licensed to do business in their state to bear a portion of the loss suffered by some 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. Part of these payments is recoverable through future premium rates, premium tax credits or policy surcharges. Significant increases in assessments could limit the ability of the Company’s insurance subsidiaries to recover such assessments through tax credits or other means. 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 leveled off in 2005 and in certain states began to decrease.  These assessments may increase in the future if additional insolvencies occur. 

 

26



 

Many states have laws that established second-injury funds to provide compensation to injured employees for aggravation of a prior condition or injury. Insurers writing workers’ compensation in those states having second-injury funds are subject to the laws creating the funds, including the various funding mechanisms that those states have adopted to fund the second-injury funds. Several of the states having larger second-injury funds utilize a premium surcharge that effectively passes the cost of the fund to policyholders. Other states assess the insurer based on paid losses and allow the insurer to recoup the assessment through future premium rates.

 

The Company’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 that 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. In the event that a member of that pool becomes insolvent, the remaining members assume an additional pro rata share of the liabilities of the pool. The underwriting results of these pools traditionally have been unprofitable. Combined earned premiums related to such pools and assigned risks for the Company were $174 million, $168 million and $160 million in 2005, 2004 and 2003, respectively. The related combined underwriting losses for the Company were $112 million, $71 million and $111 million in 2005, 2004 and 2003, respectively.

 

Proposed legislation and regulatory changes have been introduced in the states from time to time that would modify some of the laws and regulations affecting the financial services industry, including the use of information. The potential impact of that legislation on the Company’s businesses cannot be predicted at this time.

 

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 that is domiciled, or, in some cases, having substantial business that it is deemed to be commercially domiciled, in that state. The Company owns, directly or indirectly, all of the shares of stock of property and casualty insurance companies domiciled in the states of Arizona, California, Connecticut, Delaware, Florida, Illinois, Indiana, Iowa, Maryland, Massachusetts, Minnesota, Mississippi, New Jersey, New York, Texas and Wisconsin. “Control” is generally presumed to exist through the ownership of 10% (5% in the case of Florida) or more of the voting securities of a domestic insurance company or of any company that controls a domestic insurance company. Any purchaser of shares of common stock representing 10% (5% in the case of Florida) or more of the voting power of the Company’s capital stock will be presumed to have acquired control of the Company’s domestic insurance subsidiaries unless, following application by that purchaser in each insurance subsidiary’s state of domicile, the relevant insurance commissioner determines otherwise.

 

In addition to these filings, the laws of many states contain provisions requiring pre-notification to state agencies prior to any change in control of a non-domestic insurance company admitted to transact business in that state. While these pre-notification statutes do not authorize the state agency to disapprove the change of control, they do authorize issuance of cease and desist orders with respect to the non-domestic insurer if it is determined that some conditions, such as undue market concentration, would result from the acquisition.

 

Any transactions that would constitute a change in control of any of the Company’s insurer subsidiaries would generally require prior approval by the insurance departments of the states in which the Company’s insurance subsidiaries are domiciled or commercially domiciled and may require preacquisition notification in those states that have adopted preacquisition notification provisions and in which such insurance subsidiaries are admitted to transact business.

 

One of the Company’s insurance subsidiaries and the Company’s operations at Lloyd’s are domiciled in the United Kingdom. Insurers in the United Kingdom are subject to change of control restrictions in the Financial Services and Markets Act of 2000 including approval of the Financial Services Authority. Insurers in the Republic of Ireland are subject to regulation by the Irish Financial Services Regulatory Authority.

 

Some of the Company’s other insurance subsidiaries are domiciled in, or authorized to conduct insurance business in, Canada. Authorized insurers in Canada are subject to change of control restrictions in Section 407 of the Insurance Companies Act, including approval of the Office of the Superintendent of Financial Institutions.

 

These requirements may deter, delay or prevent transactions affecting the control of or the ownership of common stock, including transactions that could be advantageous to the Company’s shareholders.

 

27



 

Insurance Regulatory Information System

 

The National Association of Insurance Commissioners (NAIC) Insurance Regulatory Information System (IRIS) was developed to help state regulators identify companies that may require special attention. The IRIS system consists of a statistical phase and an analytical phase whereby financial examiners review annual statements and financial ratios. The statistical phase consists of twelve key financial ratios based on year-end data that are generated from the NAIC database annually, and each ratio has an established “usual range” of results. These ratios assist state insurance departments in executing their statutory mandate to oversee the financial condition of insurance companies.

 

A ratio result 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. Generally, an insurance company will become subject to regulatory scrutiny if it falls outside the usual ranges of four or more of the ratios.

 

Based on preliminary 2005 IRIS ratios calculated by the Company, most of the Company’s insurance subsidiaries in the St. Paul Travelers Reinsurance pool had results outside the usual range for the two-year reserve development ratio, with ratios ranging from 20% to 39% (versus the usual value of less than 20%), due to reserve strengthening actions that occurred in 2004 and the combining of the two pools that occurred in 2005. In addition, Discover Reinsurance Company had results outside the normal range for the one-year and two-year reserve development ratios, with ratios of 32% and 116%, respectively, compared to the usual value of less than 20%, due to reserve strengthening actions in 2005 and 2004. Discover Reinsurance Company also had a result outside the normal range for the two-year operating ratio (128% versus the usual value of less than 100%) due to the same reserve strengthening actions.

 

In 2004, most of the Company’s insurance subsidiaries in the Travelers Property Casualty pool had IRIS ratio results outside the usual range for the estimated current reserve deficiency to surplus ratio, with ratios ranging from 26% to 37% above the usual value of less than 25%, due to the lags in the ratio’s ability to reflect changes in business volume and business mix. Also in 2004, St. Paul Fire and Marine Insurance Company, United States Fidelity and Guaranty Company, Discover Reinsurance Company and most of the St. Paul Fire and Marine pool members had unusual values in the one-year and two-year reserve development ratios above the usual values of less than 20%, due to reserve strengthening actions that occurred in 2003 and 2004. Those one-year and two-year reserve development ratios for St. Paul Fire and Marine Insurance Company were 24% and 40%, for United States Fidelity and Guaranty Company the ratios were 78% and 29%, and for Discover Reinsurance Company the ratios were 64% and 151%. The one-year and two-year reserve development ratios for the St. Paul Fire and Marine pool members with unusual values ranged from 22% to 45% and 40% to 93% respectively. United States Fidelity and Guaranty Company and Discover Reinsurance Company had two-year operating ratios of 159% and 108%, respectively, compared to the usual value of less than 100%, due to the 2004 reserve strengthening actions. United States Fidelity and Guaranty Company and Discover Reinsurance Company also had change in surplus ratios of 63% and 78%, respectively, compared to a usual value of less than 50%, due to 2004 capital contributions from their parent companies. Discover Reinsurance Company also had a surplus aid to surplus ratio of 17% compared to the usual value of less than 15%.

 

Management does not anticipate regulatory action as a result of the 2005 IRIS ratio results. In all of these instances in prior years, regulators have been satisfied upon follow-up that no regulatory action was required. It is possible that similar results could occur in the future. No regulatory action has been taken by any state insurance department or the NAIC with respect to IRIS ratios of any of the Company’s insurance subsidiaries for the year ended December 31, 2004.

 

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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 most property and casualty insurance companies, which is designed to determine minimum capital requirements and to raise the level of protection that statutory surplus provides for policyholder obligations. The RBC formula for property and casualty insurance companies measures three major areas of risk facing property and casualty insurers:

 

                  underwriting, which encompasses the risk of adverse loss developments and inadequate pricing;

 

                  declines in asset values arising from market and/or credit risk; and

 

                  off-balance sheet risk arising from adverse experience from non-controlled assets, guarantees for affiliates or other contingent liabilities and reserve and premium growth.

 

Under laws adopted by individual states, insurers having total adjusted capital less 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 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 requires 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, authorizes the relevant insurance commissioner to take whatever regulatory actions considered necessary to protect the best interest of the policyholders and creditors of the insurer which may include the actions necessary to cause the insurer to be placed under regulatory control, i.e., rehabilitation or liquidation, 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 place the insurer under regulatory control if surplus falls below 70% of the RBC amount.

 

The formulas have not been designed to differentiate among adequately capitalized companies that operate with higher levels of capital. Therefore, it is inappropriate and ineffective to use the formulas to rate or to rank these companies. At December 31, 2005, all of the Company’s property and casualty insurance subsidiaries had total adjusted capital in excess of amounts requiring company or regulatory action at any prescribed RBC action level.

 

OTHER INFORMATION

 

General Business Factors

 

In the opinion of the Company’s management, no material part of the business of the Company and its subsidiaries is dependent upon a single customer or group of customers, the loss of any one of which would have a materially adverse effect on the Company, and no one customer or group of affiliated customers accounts for as much as 10% of the Company’s consolidated revenues.

 

Employees

 

At December 31, 2005, the Company had approximately 31,900 employees. The Company believes that its employee relations are satisfactory. None of the Company’s employees are subject to collective bargaining agreements.

 

Source of Funds

 

For a discussion of the Company’s sources of funds and maturities of the long-term debt of the Company, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources,” and note 10 of notes to the Company’s consolidated financial statements.

 

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Taxation

 

For a discussion of tax matters affecting the Company and its operations, see note 11 of notes to the Company’s consolidated financial statements.

 

Financial Information about Industry Segments

 

For financial information regarding industry segments of the Company, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and note 5 of notes to the Company’s consolidated financial statements.

 

Recent Transactions

 

For information regarding recent transactions of the Company, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and note 1 of notes to the Company’s consolidated financial statements.

 

Company Website and Availability of SEC Filings

 

The Company’s Internet website is www.stpaultravelers.com. Information on the Company’s website is not a part of this Form 10-K. The Company makes available free of charge on its website or provides a link on its website to the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, and any amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as soon as reasonably practicable after those reports are electronically filed with, or furnished to, the SEC. To access these filings, go to the Company’s website, then click on “SEC Filings” under the “Investors” heading.

 

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Glossary of Selected Insurance Terms

 

Accident year

 

The annual calendar 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 that report.

 

 

 

Admitted insurer

 

A company licensed to transact insurance business within a state.

 

 

 

Annuity

 

A contract that pays a periodic benefit over the remaining life of a person (the annuitant), the lives of two or more persons or for a specified period of time.

 

 

 

Assigned risk pools

 

Reinsurance pools which cover risks for those unable to purchase insurance in the voluntary market. Possible reasons for this inability include the risk being too great or the profit being too small under the required insurance rate structure. The costs of the risks associated with these pools are charged back to insurance carriers in proportion to their direct writings.

 

 

 

Assumed reinsurance

 

Insurance risks acquired from a ceding company.

 

 

 

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 or able 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.

 

 

 

Case reserves

 

Claim department estimates of anticipated future payments to be made on each specific individual reported claim.

 

 

 

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, resulting from natural and manmade events, including risks such as fire, earthquake, windstorm, explosion, terrorism and other similar events. Each catastrophe has unique characteristics. Catastrophes are not predictable as to timing or amount in advance, and therefore their effects are not included in earnings or claims and claim adjustment expense reserves prior to occurrence. A catastrophe may also result in the payment of reinstatement premiums and assessments from various pools.

 

 

 

Catastrophe loss

 

Loss and directly identified loss adjustment expenses from catastrophes.

 

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Catastrophe reinsurance

 

A form of excess of loss 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.” These reinsurance contracts are typically designed to cover property insurance losses but can be written to cover casualty insurance losses such as from workers’ compensation policies.

 

 

 

Cede; ceding company

 

When an insurer reinsures its liability with another insurer or a “cession,” it “cedes” business and is referred to as the “ceding company.”

 

 

 

Ceded reinsurance

 

Insurance risks transferred to another company as reinsurance. See “Reinsurance.”

 

 

 

Claim

 

Request by an insured for indemnification by an insurance company for loss incurred from an insured peril.

 

 

 

Claim adjustment expenses

 

See “Loss adjustment expenses (LAE).”

 

 

 

Claims and claim adjustment expenses

 

See “Loss” and “Loss adjustment expenses.”

 

 

 

Claims and claim adjustment expense reserves

 

See “Loss reserves.”

 

 

 

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 property and casualty insurance that are written for businesses.

 

 

 

Commercial multi-peril policies

 

Refers to policies which cover both property and third-party liability exposures.

 

 

 

Commutation agreement

 

An agreement between a reinsurer and a ceding company whereby the reinsurer pays an agreed upon amount in exchange for a complete discharge of all obligations, including future obligations, between the parties for reinsurance losses incurred.

 

 

 

Deductible

 

The amount of loss that an insured retains.

 

 

 

Deferred acquisition costs

 

Primarily commissions and premium-related taxes that vary with and are primarily related to the production of new contracts and are deferred and amortized to achieve a matching of revenues and expenses when reported in financial statements prepared in accordance with Generally Accepted Accounting Principles (GAAP).

 

 

 

Direct written premiums

 

The amounts charged by an insurer to insureds in exchange for coverages provided in accordance with the terms of an insurance contract. The amounts exclude the impact of all reinsurance premiums, either assumed or ceded.

 

 

 

Earned premiums or premiums earned

 

That portion of property casualty premiums written that applies to the expired portion of the policy term. Earned premiums are recognized as revenues under both Statutory Accounting Practices (SAP) and GAAP.

 

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Excess liability

 

Additional casualty coverage above a layer of insurance exposures.

 

 

 

Excess of loss reinsurance

 

Reinsurance that indemnifies the reinsured against all or a specified portion of losses over a specified dollar amount or “retention.”

 

 

 

Expense ratio

 

See “Underwriting expense ratio.”

 

 

 

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

 

Fidelity insurance coverage protects an insured for loss due to embezzlement or misappropriation of funds by an employee. Surety is a three-party agreement in which the insurer agrees to pay a second party or make complete an obligation in response to the default, acts or omissions of an insured.

 

 

 

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.

 

 

 

Incurred but not reported (IBNR) reserves

 

Reserves for estimated losses and LAE that have been incurred but not yet reported to the insurer. This includes amounts for unreported claims, development on known cases, and re-opened claims.

 

 

 

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 art and others.

 

 

 

IRIS ratios

 

Financial ratios calculated by the NAIC to assist state insurance departments in monitoring the financial condition of insurance companies.

 

 

 

Large deductible policy

 

An insurance policy where the customer assumes at least $25,000 or more of each loss. Typically, the insurer is responsible for paying the entire loss under those policies and then seeks reimbursement from the insured for the deductible amount.

 

 

 

Lloyd’s

 

An insurance marketplace based in London, England, where brokers, representing clients with insurable risks, deal with Lloyd’s underwriters, who represent investors. The investors are grouped together into syndicates that provide capital to insure the risks.

 

 

 

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 expenses (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

 

For SAP, it is the ratio of incurred losses and loss adjustment expenses to net earned premiums. For GAAP, it is the ratio of incurred losses and loss adjustment expenses reduced by an allocation of fee income to net earned premiums.

 

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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. As the term is used in this document, “loss reserves” is meant to include reserves for both losses and LAE.

 

 

 

Loss reserve development

 

The increase or decrease in incurred claims and claim adjustment expenses as a result of the re-estimation of claims and claim adjustment expense reserves at successive valuation dates for a given group of claims. Loss reserve development may be related to prior year or current year development.

 

 

 

Losses incurred

 

The total losses sustained by an insurance company under a policy or policies, whether paid or unpaid. Incurred losses include a provision for IBNR.

 

 

 

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

 

Direct written premiums plus assumed reinsurance premiums less premiums ceded to reinsurers.

 

 

 

Operating income (loss)

 

Net income (loss) excluding the after-tax impact of net realized investment gains (losses), discontinued operations and cumulative effect of changes in accounting principles when applicable.

 

 

 

Operating income (loss) per share

 

Operating income (loss) on a per share basis.

 

 

 

Operating return on equity

 

The ratio of operating income to average equity excluding net unrealized investment gains and losses and discontinued operations, net of tax.

 

 

 

Personal lines

 

The various kinds of property and casualty insurance that are written for individuals or families.

 

 

 

Pool

 

An organization of insurers or reinsurers through which particular types of risks are underwritten with premiums, losses and expenses being shared in agreed-upon percentages.

 

 

 

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. This term includes agents and brokers.

 

 

 

Property insurance

 

Insurance that provides coverage to a person or business with an insurable interest in tangible property for that person’s or business’s property loss, damage or loss of use.

 

 

 

Quota share reinsurance

 

Reinsurance wherein the insurer cedes an agreed-upon fixed percentage of liabilities, premiums and losses for each policy covered on a pro rata basis.

 

 

 

Rates

 

Amounts charged per unit of insurance.

 

 

 

Reinstatement premiums

 

Additional premiums payable to reinsurers to restore coverage limits that have been exhausted as a result of reinsured losses under certain excess of loss reinsurance treaties.

 

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Reinsurance

 

The practice whereby one insurer, called the reinsurer, in consideration of a premium paid to that insurer, agrees to indemnify another insurer, called the ceding company, for part or all of the liability of 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 for those unable to purchase insurance in the voluntary market. Possible reasons for this inability include the risk being too great or the profit potential too small under the required insurance rate structure. 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 a policyholder company retains on any one risk or group of risks. The term may apply to an insurance policy, where the policyholder is an individual, family or business, or a reinsurance policy, where the policyholder is an insurance company.

 

 

 

Retention ratio

 

Current period renewal accounts or policies as a percentage of total accounts or policies available for renewal.

 

 

 

Retrospective premiums

 

Premiums related to retrospectively rated policies.

 

 

 

Retrospective rating

 

A plan or method which permits adjustment of the final premium or commission on the basis of actual loss experience, subject to certain minimum and maximum limits.

 

 

 

Return on equity

 

The ratio of net income to average equity.

 

 

 

Risk-based capital (RBC)

 

A measure adopted by the NAIC and enacted by states for determining the minimum statutory capital and surplus requirements of insurers. Insurers having total adjusted capital less than that required by the RBC calculation will be subject to varying degrees of regulatory action depending on the level of capital inadequacy.

 

 

 

Risk retention group

 

An alternative form of insurance in which members of a similar profession or business band together to self insure their risks.

 

 

 

Run-off business

 

An operation which has been determined to be nonstrategic; includes non-renewals of inforce policies and a cessation of writing new business, where allowed by law.

 

 

 

Salvage

 

The amount of money an insurer recovers through the sale of property transferred to the insurer as a result of a loss payment.

 

 

 

Second-injury fund

 

The employer of an injured, impaired worker is responsible only for the workers’ compensation benefit for the most recent injury; the second-injury fund would cover the cost of any additional benefits for aggravation of a prior condition. The cost is shared by the insurance industry and self-insureds, funded through assessments to insurance companies and self-insureds based on either premiums or losses.

 

 

 

Self-insured retentions

 

That portion of the risk retained by a person for its own account.

 

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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.

 

 

 

Specialty lines

 

The various kinds of specialized property and casualty insurance that are written for businesses and professionals.

 

 

 

Statutory accounting practices (SAP)

 

The practices and procedures prescribed or permitted by domiciliary state insurance regulatory authorities in the United States 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 recognized on the statutory balance sheet. 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, usually funded through the purchase of an annuity.

 

 

 

Subrogation

 

A principle of law incorporated in insurance policies, which enables an insurance company, after paying a claim under a policy, to recover the amount of the loss from another who is legally liable for it.

 

 

 

Third-party liability

 

A liability owed to a claimant (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 that 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 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 that coverage.

 

 

 

Underwriting expense ratio

 

For SAP, it is the ratio of underwriting expenses incurred less other income to net written premiums. For GAAP, it is the ratio of underwriting expenses incurred reduced by an allocation of fee income and billing and policy fees to net earned premiums.

 

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Underwriting gain or loss

 

Net earned premiums and fee income less claims and claim adjustment expenses and insurance-related expenses.

 

 

 

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 nonadmitted 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 and federal laws) under which employers provide insurance for benefit payments to their employees for work-related injuries, deaths and diseases, regardless of fault.

 

Item 1A. RISK FACTORS

 

You should carefully consider the following risks and all of the other information set forth in this report, including our consolidated financial statements and the notes thereto. 

 

Catastrophe losses could materially reduce our profitability and adversely impact our ratings, our ability to raise capital and the availability and cost of reinsurance. Our property and casualty insurance operations expose us to claims arising out of catastrophes. Catastrophes can be caused by various natural events, including hurricanes, windstorms, earthquakes, hail, severe winter weather and fires. Catastrophes can also be man-made, such as a terrorist attack (including those involving nuclear, biological, chemical or radiological events) or a consequence of war or political instability. The geographic distribution of our business subjects us to catastrophe exposure from hurricanes in the Northeast, Florida, Gulf Coast and Mid-Atlantic regions, as well as catastrophe exposure from earthquakes in California and the New Madrid and Pacific Northwest regions and other weather-related catastrophe exposure in the United Kingdom.  The incidence and severity of catastrophes are inherently unpredictable. Over the last several years, changing climactic conditions have added to the unpredictability and frequency of natural disasters in certain parts of the world and created additional uncertainty as to future trends and exposures.  It is possible that both the frequency and severity of natural and man-made catastrophic events will increase.  In particular, we expect that the trend of increased severity and frequency of storms experienced in 2005 and 2004 will continue into 2006.

 

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. States have from time to time passed legislation that has the effect of limiting the ability of insurers to manage catastrophe risk, such as legislation prohibiting insurers from withdrawing from catastrophe-prone areas. In addition, following catastrophes, there are sometimes legislative initiatives and court decisions which seek to expand insurance coverage for catastrophe claims beyond the original intent of the policies.  Also, our ability to increase pricing to the extent necessary to offset rising costs of catastrophes, particularly in the Personal segment, requires approval of regulatory authorities of certain states. 

 

Catastrophe losses could materially and adversely affect our financial results for any fiscal quarter or year and may materially reduce our profitability or harm our financial condition, which in turn could adversely affect our financial strength and claims-paying ratings and could impair our ability to raise capital on acceptable terms or at all.  Also, particularly in light of the frequency and severity of storms in the past two years, rating agencies may increase their capital requirements, which may require us to raise capital to maintain our ratings or adversely affect our ratings. In addition, catastrophic events could cause us to exhaust our available reinsurance limits and could adversely impact the cost and availability of reinsurance.  We have limited terrorism coverage in our reinsurance program, and although the Terrorism Risk Insurance Extension Act of 2005 provides benefits in the event of certain acts of terrorism, it may not be extended beyond 2007 or its benefits may be reduced. 

 

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Our business could be harmed because of our potential exposure to asbestos and environmental claims and related litigation.

 

Asbestos Claims. We believe that the property and casualty insurance industry has suffered from court decisions and other trends that have attempted to expand insurance coverage for asbestos claims far beyond the intent of insurers and policyholders.  As a result, we continue to experience a significant number of asbestos claims being tendered to us by our policyholders (which includes others seeking coverage under a policy) including claims against our policyholders by individuals who do not appear to be impaired by asbestos exposure.  Factors underlying these claim filings include intensive advertising by lawyers seeking asbestos claimants, the focus by plaintiffs on new and previously peripheral defendants and entities seeking bankruptcy protection as a result of asbestos-related liabilities.  In addition to contributing to the overall number of claims, bankruptcy proceedings may increase asbestos-related losses by initially delaying the reporting of claims and later by significantly accelerating and increasing loss payments by insurers, including us.  Bankruptcy proceedings are also causing increased settlement demands against those policyholders who are not in bankruptcy but that remain in the tort system.  In addition, our asbestos-related loss and loss expense experience is impacted by the exhaustion or unavailability due to insolvency of other insurance sources potentially available to policyholders along with the insolvency or bankruptcy of other defendants.  We are currently involved in coverage litigation concerning a number of policyholders who have filed for bankruptcy, including, among others, ACandS, Inc., who in some instances have asserted that all or a portion of their asbestos-related claims are not subject to aggregate limits on coverage as described generally in the next paragraph. Also see “Part I — Item 3 — Legal Proceedings”. These trends are expected to continue in the near term.  As a result of the factors described above, there is a high degree of uncertainty with respect to future exposure from asbestos claims. 

 

In some instances, policyholders continue to assert that their claims for asbestos-related insurance are not subject to aggregate limits on coverage and that each individual bodily injury claim should be treated as a separate occurrence under the policy.  It is difficult to predict whether these policyholders will be successful on both issues or whether we will be successful in asserting additional defenses.  To the extent both issues are resolved in policyholders’ favor and other additional Company defenses are not successful, our coverage obligations under the policies at issue would be materially increased and bounded only by the applicable per-occurrence limits and the number of asbestos bodily injury claims against the policyholders.  Accordingly, it is difficult to predict the ultimate cost of the claims for coverage not subject to aggregate limits.

 

Many coverage disputes with policyholders are only resolved through settlement agreements.  Because many policyholders make exaggerated demands, it is difficult to predict the outcome of settlement negotiations.  Settlements involving bankrupt policyholders may include extensive releases which are favorable to us but which could result in settlements for larger amounts than originally anticipated. Also, courts may not approve proposed settlements, which would result in additional litigation and potentially less beneficial outcomes for us.  As in the past, we will continue to pursue settlement opportunities.

 

In addition, proceedings have been launched directly against insurers, including us, challenging insurers’ conduct in respect of asbestos claims, and claims by individuals seeking damages arising from alleged asbestos-related bodily injuries.  There may be additional filings of other direct actions against insurers, including us, in the future.  It is difficult to predict the outcome of these proceedings, including whether the plaintiffs will be able to sustain these actions against insurers based on novel legal theories of liability. 

 

Environmental Claims. We continue to receive claims from policyholders who allege that they are liable for injury or damage arising out of their alleged disposition of toxic substances. Mostly, these claims are due to various legislative as well as regulatory efforts aimed at environmental remediation. For instance, the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), enacted in 1980 and later modified, enables private parties as well as federal and state governments to take action with respect to releases and threatened releases of hazardous substances. This federal statute permits the recovery of response costs from some liable parties and may require liable parties to undertake their own remedial action. Liability under CERCLA may be joint and several with other responsible parties.

 

We have been, and continue to be, involved in litigation involving insurance coverage issues pertaining to environmental claims. We believe that some court decisions have interpreted the insurance coverage to be broader than the original intent of the insurers and policyholders. These decisions often pertain to insurance policies that were issued by us prior to the mid-1970s. These decisions continue to be inconsistent and vary from jurisdiction to jurisdiction. Environmental claims when submitted rarely indicate the monetary amount being sought by the claimant from the policyholder, and we do not keep track of the monetary amount being sought in those few claims which indicate a monetary amount.  

 

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Asbestos and Environmental Claims. It is difficult to determine the ultimate exposure for asbestos and environmental claims and related litigation As a result, these reserves are subject to revision as new information becomes available and as claims develop.  The continuing uncertainties include, without limitation, the risks and lack of predictability inherent in complex litigation, any impact from the bankruptcy protection sought by various asbestos producers and other asbestos defendants, a further increase or decrease in asbestos and environmental claims which cannot now be anticipated, the role of any umbrella or excess policies we have issued, the resolution or adjudication of some disputes pertaining to the amount of available coverage for asbestos and environmental claims in a manner inconsistent with our previous assessment of these claims, the number and outcome of direct actions against us and future developments pertaining to our ability to recover reinsurance for asbestos and environmental claims. In addition, our asbestos-related loss and loss expense experience has been impacted by the exhaustion or unavailability due to insolvency of other insurance sources potentially available to policyholders along with the insolvency or bankruptcy of other defendants. It is also not possible to predict changes in the legal and legislative environment and their impact on the future development of asbestos and environmental claims.  This development will be affected by future court decisions and interpretations, as well as changes in applicable legislation, including proposed legislation related to asbestos reform. It is also difficult to predict the ultimate outcome of large coverage disputes until settlement negotiations near completion and significant legal questions are resolved or, failing settlement, until the dispute is adjudicated. This is particularly the case with policyholders in bankruptcy where negotiations often involve a large number of claimants and other parties and require court approval to be effective. See the “Asbestos Claims and Litigation” and “Environmental Claims and Litigation” sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Also see “Part I — Item 3, Legal Proceedings.”

 

Because of the uncertainties set forth above, additional liabilities may arise for amounts in excess of the current reserves for asbestos and environmental claims.  In addition, our estimate of claims and claim adjustment expenses may change.  These additional liabilities or increases in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to our operating results and financial condition in future periods.

 

Reinsurance may not protect us against losses. We use reinsurance to help manage our 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 our business volume and profitability. Although the reinsurer is liable to us to the extent of the ceded reinsurance, we remain liable as the direct insurer on all risks reinsured. As a result, ceded reinsurance arrangements do not eliminate our obligation to pay claims. Accordingly, we are subject to credit risk with respect to our ability to recover amounts due from reinsurers. In addition, some of our reinsurance claims may be disputed by the reinsurers, and we may ultimately receive partial or no payment. This is a particular risk in the case of claims that relate to insurance policies written many years ago, including those relating to asbestos and environmental claims. Reinsurance may not protect us against losses and may not be available to us in the future at commercially reasonable rates or at all.

 

We are exposed to, and may face adverse developments involving, mass tort claims such as those relating to exposure to potentially harmful products or substances.  In addition to asbestos and environmental pollution, we face exposure to other types of mass tort claims, including claims related to exposure to potentially harmful products or substances, including lead paint, silica and welding rod fumes.  Establishing claim and claim adjustment expense reserves for mass tort claims is subject to uncertainties because of many factors, including expanded theories of liability, disputes concerning medical causation with respect to certain diseases, geographical concentration of the lawsuits asserting the claims and the large rise in the total number of claims without underlying epidemiological developments suggesting an increase in disease rates. Moreover, evolving judicial interpretations regarding the application of various tort theories and defenses, including application of various theories of joint and several liabilities, as well as the application of insurance coverage to these claims, impede our ability to estimate our ultimate liability for such claims. 

 

Because of the uncertainties set forth above, additional liabilities may arise for amounts in excess of the current related reserves.  In addition, our estimate of claims and claim adjustment expenses may change.  These additional liabilities or increases in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to our operating results in future periods.

 

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If actual claims exceed our loss reserves, or if changes in the estimated level of loss reserves are necessary, our financial results could be significantly and adversely affected.  Claim and claim adjustment expense reserves (loss reserves) represent management’s estimate of ultimate unpaid costs of losses and loss adjustment expenses for claims that have been reported and claims that have been incurred but not yet reported. Loss reserves do not represent an exact calculation of liability, but instead represent management estimates, generally utilizing actuarial expertise and projection techniques, at a given accounting date. These loss reserve estimates are expectations of what the ultimate settlement and administration of claims will cost upon final resolution in the future, based on our assessment of facts and circumstances then known, review of historical settlement patterns, estimates of trends in claims severity and frequency, expected interpretations of legal theories of liability and other factors. In establishing reserves, we also take into account estimated recoveries from reinsurance, salvage and subrogation.

 

The process of estimating loss reserves involves a high degree of judgment and is subject to a number of variables. These variables can be affected by both internal and external events, such as changes in claims handling procedures, economic inflation, legal trends and legislative changes, among others. The impact of many of these items on ultimate costs for claims and claim adjustment expenses is difficult to estimate. Loss reserve estimation difficulties also differ significantly by product line due to differences in claim complexity, the volume of claims, the potential severity of individual claims, the determination of occurrence date for a claim and reporting lags (the time between the occurrence of the policyholder event and when it is actually reported to the insurer). Informed judgment is applied throughout the process. We continually refine our loss reserve estimates in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. We rigorously attempt to consider all significant facts and circumstances known at the time loss reserves are established. Due to the inherent uncertainty underlying loss reserve estimates including but not limited to the future settlement environment, final resolution of the estimated liability will be different from that anticipated at the reporting date. Therefore, actual paid losses in the future may yield a materially different amount than currently reserved—favorable or unfavorable.

 

There are also risks which impact the estimation of ultimate costs for catastrophes.  For example, the estimation of reserves related to hurricanes can be affected by the inability by us and our insureds to access portions of the impacted areas, the complexity of factors contributing to the losses, the legal and regulatory uncertainties and the nature of the information available to establish the reserves.  Complex factors include, but are not limited to: determining whether damage was caused by flooding versus wind; evaluating general liability and pollution exposures; estimating additional living expenses; the impact of demand surge; infrastructure disruption; fraud; the effect of mold damage and business interruption costs; and reinsurance collectibility.  The timing of a catastrophe’s occurrence, such as at or near the end of a reporting period, can also affect the information available to us in estimating reserves for that reporting period.  The estimates related to catastrophes are adjusted as actual claims emerge. 

 

Because of the uncertainties set forth above, additional liabilities may arise for amounts in excess of the current related reserves.  In addition, our estimate of claims and claim adjustment expenses may change.  These additional liabilities or increases in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to our operating results in future periods.

 

A portion of our loss reserves are for asbestos and environmental claims and related litigation which aggregated $4.79 billion at December 31, 2005. While the ongoing study of asbestos and environmental claims and associated liabilities considers the inconsistencies of court decisions as to coverage, plaintiffs’ expanded theories of liability and the risks inherent in complex litigation and other uncertainties, in the opinion of our management, it is possible that the outcome of the continued uncertainties regarding these claims could result in liability in future periods that differs from current reserves by an amount that could be material to our operating results and financial condition in future periods. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Asbestos Claims and Litigation” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Environmental Claims and Litigation.”

 

For a discussion of claims and claim adjustment expense reserves by product line, including examples of common factors that can affect required reserves, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Estimates—Claims and Claim Adjustment Expense Reserves.”

 

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The effects of emerging claim and coverage issues on our business are uncertain. As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claim and coverage may emerge. These issues may adversely affect our business by either extending coverage beyond our underwriting intent or by increasing the number or size of claims. Examples of emerging claims and coverage issues include:

 

      increases in the number and size of claims related to expenses for testing and remediation of mold conditions;

 

      increases in the number and size of claims relating to construction defects, which often present complex coverage and damage valuation questions;

 

•     adverse changes in loss cost trends, including inflationary pressures in medical costs and auto and home repair costs;

 

      judicial expansion of policy coverage and the impact of new theories of liability; and

 

      a growing trend of plaintiffs targeting property and casualty insurers, including us, in purported class action litigation relating to claim-handling and other practices.

 

The effects of these and other unforeseen emerging claim and coverage issues are extremely hard to predict and could harm our business and adversely affect our results of operations.

 

The insurance industry is the subject of a number of investigations by state and federal authorities in the United States.  We cannot predict the outcome of these investigations or the impact on our business or financial results. As part of ongoing, industry-wide investigations, we and our affiliates have received subpoenas and written requests for information from government agencies and authorities, including from the Attorneys General of numerous states, various states’ insurance and business regulators and the Securities and Exchange Commission.  The areas of inquiry addressed to us include our relationship with brokers and agents, our involvement with “non-traditional” insurance and reinsurance products, branding requirements for salvage automobiles and the reporting of workers’ compensation premiums.  We and our affiliates may receive additional subpoenas and requests for information with respect to these or other areas from government agencies or authorities.  We are cooperating with these subpoenas and requests for information.  For further information, see “Part I — Item 3 — Legal Proceedings”.

 

It would be premature to reach any conclusions as to the likely outcome of these matters or the impact on our business or financial results.  Potential outcomes could include enforcement proceedings or settlements resulting in fines, penalties and/or changes in business practices that could adversely affect our results of operations. In addition, these investigations may result in changes in laws and regulations affecting the industry in general which could, in turn, also adversely affect our results of operations.

 

Our businesses are heavily regulated and changes in regulation may reduce our profitability and limit our growth. We are extensively regulated and supervised in the jurisdictions in which we conduct business, including licensing and supervision by government regulatory agencies in such jurisdictions.  This regulation is generally designed to protect the interests of policyholders, and not necessarily the interests of insurers, their shareholders and other investors.  This regulation also relates to authorization for lines of business, capital and surplus requirements, investment limitations, underwriting limitations, transactions with affiliates, dividend limitations, changes in control, premium rates and a variety of other financial and nonfinancial components of an insurer’s business.

 

In recent years, the state insurance regulatory framework has come under increased federal scrutiny, and some state legislatures have considered or enacted laws that may alter or increase state authority to regulate insurance companies and insurance holding companies. Further, the National Association of Insurance Commissioners (NAIC) and state insurance regulators continually reexamine existing laws and regulations, specifically focusing on modifications to holding company regulations, interpretations of existing laws and the development of new laws and regulations. In addition, Congress and some federal agencies from time to time investigate the current condition of insurance regulation in the United States to determine whether to impose federal regulation or to allow an optional federal incorporation, similar to banks. We cannot predict with certainty the effect any proposed or future legislation or NAIC initiatives may have on the conduct of our business. Insurance laws or regulations that are adopted or amended may be more restrictive than current requirements or may result in higher costs.

 

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Although the United States federal government does not directly regulate the insurance business, changes in federal legislation and administrative policies in several areas, including changes in financial services regulation and federal taxation, can significantly harm the insurance industry, including us.

 

Assessments and other surcharges for guaranty funds, second-injury funds, catastrophe funds and other mandatory pooling arrangements may reduce our profitability. Virtually all states require insurers licensed to do business in their state to bear a portion of the loss suffered by some insureds as the result of impaired or insolvent insurance companies. These assessments have leveled off in the recent year and in certain states, have begun to decrease.  These assessments may, however, increase in the future if additional insolvencies occur.  Many states also have laws that established second-injury funds to provide compensation to injured employees for aggravation of a prior condition or injury which are funded by either assessments based on paid losses or premium surcharge mechanisms. In addition, as a condition to the ability to conduct business in various states, our insurance subsidiaries must 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 that coverage from private insurers. The effect of these assessments and mandatory shared-market mechanisms or changes in them could reduce our profitability in any given period or limit our ability to grow our business.

 

A downgrade in our claims-paying and financial strength ratings could significantly reduce our business volumes, adversely impact our ability to access the capital markets and increase our borrowing costs. Claims-paying and financial strength ratings have become increasingly important to an insurer’s competitive position.  Rating agencies review their ratings periodically, and our current ratings may not be maintained in the future.  A downgrade in one or more of our ratings could negatively impact our business volumes, because demand for certain of our products in certain markets may be reduced or our ratings could fall below minimum levels required to maintain existing business.  Additionally, we may find it more difficult to access the capital markets and higher borrowing costs may be incurred.  If our capital position were to deteriorate or one or more rating agencies were to substantially increase their capital requirements, we may need to raise equity capital in the future in order to maintain our ratings or limit the extent of a downgrade. For example, the frequency or severity of weather-related catastrophes in the last two years may lead rating agencies to substantially increase their capital requirements. The ratings are not in any way a measure of protection offered to investors in our securities and should not be relied upon with respect to making an investment in our securities.  For further discussion about our ratings, see, “Item 1 Business – Ratings”.

 

Our investment portfolio may suffer reduced returns or losses which could reduce our profitability. Investment returns are an important part of our overall profitability. Accordingly, fluctuations in the fixed income or equity markets could impair our profitability, financial condition or cash flows.

 

Fluctuations in interest rates affect our returns on, and the market value of, fixed income and short-term investments, which comprised approximately 93% of the market value of our investment portfolio as of December 31, 2005.  In addition, defaults by third parties, primarily from investments in liquid corporate and municipal bonds, who fail to pay or perform on their obligations could reduce our net investment income and net realized investment gains or result in investment losses.

 

We invest a portion of our assets in equity investments, which are subject to greater volatility than fixed income investments. General economic conditions, stock market conditions and many other factors beyond our control can adversely affect the value of our equity investments and our ability to control the timing of the realization of net investment income. As a result of these factors, we may not realize an adequate return on our investments, may incur losses on sales of our investments and may be required to write down the value of our investments, which would reduce our profitability.

 

The intense competition that we face could harm our ability to maintain or increase our profitability and premium volume. The property and casualty insurance industry is highly competitive and we believe that it will remain highly competitive in the foreseeable future. We compete with both domestic and foreign insurers, some of which have greater financial resources than we do. In addition, several property and casualty insurers writing commercial lines of business now offer products for alternative forms of risk protection, including large deductible programs and various forms of self-insurance that utilize captive insurance companies and risk retention groups. Continued growth in alternative forms of risk protection could reduce our premium volume. Following the terrorist attack on September 11, 2001 and again following the hurricane activity in 2004 and 2005, a number of new insurers and reinsurers were formed to compete in the industry, and a number of existing market participants have raised new capital which may enhance their ability to compete.  Financial institutions are now able to offer services similar to us as a result of the Gramm-Leach-Bliley Act, which repealed U.S. laws that separated commercial banking, investment banking and insurance activities.

 

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Our competitive position is based on many factors, including:

 

      our perceived overall financial strength,

 

      ratings assigned by independent rating agencies,

 

      geographic scope of business,

 

      agent, broker and client relationships,

 

      premiums charged, contract terms and conditions, products and services offered (including the ability to design customized programs),

 

      speed of claims payment,

 

      reputation, experience and qualifications of employees,

 

      local presence and

 

      our ability to keep pace relative to competitors with changes in technology and information systems.

 

We may have difficulty in continuing to compete successfully on any of these bases in the future. If competition limits our ability to write new business at adequate rates, our results of operations will be adversely affected.  See Item 1 – Business – Competition. 

 

The inability of our insurance subsidiaries to pay dividends to us in sufficient amounts would harm our ability to meet our obligations and to pay future dividends. We are a holding company and rely in part on dividends from our insurance subsidiaries to meet our obligations for payment of interest and principal on outstanding debt obligations and to pay dividends to shareholders and corporate expenses. The ability of our insurance subsidiaries to pay dividends to us in the future will depend on their statutory surplus, earnings and regulatory restrictions. 

 

We and our insurance subsidiaries are subject to regulation by some states as an insurance holding company system. This regulation generally provides that transactions between companies within the holding company system must be fair and equitable. Transfers of assets among affiliated companies, certain dividend payments from insurance subsidiaries and certain material transactions between companies within the system may require prior notice to, or prior approval by, state regulatory authorities. Our insurance subsidiaries are 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.  The ability of our insurance subsidiaries to pay dividends to us also is restricted by regulations that set standards of solvency that must be met and maintained, the nature of and limitation on investments, the nature of and limitations on dividends to policyholders and shareholders, the nature and extent of required participation in insurance guaranty funds and the involuntary assumption of hard-to-place or high-risk insurance business, primarily in workers’ compensation insurance lines.  The inability of our insurance subsidiaries to pay dividends to us in an amount sufficient to meet our debt service obligations and other cash requirements could harm our ability to meet our obligations and to pay future dividends.

 

Loss or significant restriction of the use of credit scoring in the pricing and underwriting of personal lines products could reduce our future profitability. In Personal Lines, we use credit scoring as a factor in pricing decisions where allowed by state law. Some consumer groups and regulators have questioned whether the use of credit scoring unfairly discriminates against people with low incomes, minority groups and the elderly and are calling for the prohibition or restriction on the use of credit scoring in underwriting and pricing. Laws or regulations that significantly curtail the use of credit scoring, if enacted in a large number of states, could reduce our future profitability.

 

Disruptions to our relationships with our distributors, independent agents and brokers could adversely affect us.  We market our insurance products primarily through independent agents and brokers.  An important part of our business is written through fewer than a dozen such intermediaries.  Loss of all or a substantial portion of the business provided through such agents and brokers could have an adverse effect on our future business volume and profitability.

 

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If we experience difficulties with outsourcing relationships, our ability to conduct our business might be negatively impacted.  We outsource certain technology functions to third parties and may do so increasingly in the future. If we do not effectively develop and implement our outsourcing strategy, third party providers do not perform as anticipated or we experience technological or other problems with a transition, we may not realize productivity improvements or cost efficiencies and may experience operational difficulties, increased costs and a loss of businessIn addition, our ability to receive services from third party providers outside of the United States might be impacted by cultural differences, political instability, unanticipated regulatory requirements or policies inside or outside of the United States.  As a result, our ability to conduct our business might be negatively impacted.

 

Item 1B. UNRESOLVED STAFF COMMENTS

 

On July 23, 2004, the Company announced that it was seeking guidance from the staff of the Division of Corporation Finance of the Securities Exchange Commission with respect to the appropriate purchase accounting treatment for certain second quarter 2004 adjustments totaling $1.63 billion ($1.07 billion after-tax). The Company recorded these adjustments as charges in its consolidated statement of income in the second quarter of 2004. Through an informal comment process, the staff of the Division of Corporation Finance has subsequently asked for further information, which the Company has provided. Specifically, the staff has asked for information concerning the Company’s adjustments to certain of SPC’s insurance reserves and reserves for reinsurance recoverables and premiums due from policyholders, and how those adjustments may relate to SPC’s reserves for periods prior to the merger. After reviewing the staff’s questions and comments and discussions with the Company’s independent auditors, the Company continues to believe that its accounting treatment for these adjustments is appropriate. If, however, the staff disagrees, some or all of the adjustments being discussed may not be recorded as charges in the Company’s consolidated statement of income, thereby increasing net income for the second quarter and full year 2004 and increasing shareholders’ equity at December 31, 2005 and 2004, in each case by the approximate after-tax amount of the change. The effect on tangible shareholders’ equity (adjusted for the effects of deferred taxes associated with goodwill and intangible assets) at December 31, 2005 and 2004 would not be material. Increases to goodwill and deferred tax liabilities would be reflected on the Company’s balance sheet as of April 1, 2004, either due to purchase accounting or adjustment of SPC’s reserves prior to the merger.

 

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Item 2. PROPERTIES

 

The Company owns its corporate headquarters buildings located at 385 Washington Street and 130 West Sixth Street, St. Paul, Minnesota. These buildings are adjacent to one another and consist of approximately 1.1 million square feet of gross floor space.  The Company also owned properties in Woodbury, Minnesota, where an administrative services building and off-site computer processing operations were located. The Woodbury properties were sold in April of 2005.

 

The Company also owns six buildings in Hartford, Connecticut. The Company currently occupies approximately 1.8 million square feet of office space in these buildings. The Company also owns other real property, which includes office buildings in Fall River, Massachusetts, and in Irving, Texas, and a data center located in Norcross, Georgia. In addition, the Company leases 220 field and claim offices totaling approximately 5.1 million square feet throughout the United States under leases or subleases with third parties.

 

The Company owns a building in London, England, which houses a portion of its operations in the United Kingdom.

 

The Company, through its subsidiaries, owns an investment portfolio of income-producing properties and real estate funds. Included in this portfolio are four office buildings in which the Company holds a 50% ownership interest located in New York, New York, which collectively accounted for approximately 15% of the carrying value of the property portfolio at December 31, 2005.

 

In the opinion of the Company’s management, the Company’s properties are adequate and suitable for its business as presently conducted and are adequately maintained.

 

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Item 3. LEGAL PROCEEDINGS

 

This section describes the major pending legal proceedings, other than ordinary routine litigation incidental to the business, to which the Company or any of its subsidiaries is a party or to which any of the Company’s property is subject.

 

Asbestos and Environmental-Related Proceedings

 

In the ordinary course of its insurance business, the Company receives claims for insurance arising under policies issued by the Company asserting alleged injuries and damages from asbestos, hazardous waste and other toxic substances which are the subject of related coverage litigation, including, among others, the litigation described below.  The Company continues to be subject to aggressive asbestos-related litigation.  The conditions surrounding the final resolution of these claims and the related litigation continue to change.

 

TPC is involved in three significant proceedings (including a bankruptcy proceeding) relating to ACandS, Inc. (ACandS), formerly a national distributor and installer of products containing asbestos.  The proceedings involve disputes as to whether and to what extent any of ACandS’ potential liabilities for current or future bodily injury asbestos claims are covered by insurance policies issued by TPC.  The status of the various proceedings is described below.

 

ACandS filed for bankruptcy in September 2002 (In re: ACandS, Inc., pending in the U.S. Bankruptcy Court for the District of Delaware).  In its proposed plan of reorganization, ACandS sought to establish a trust to pay asbestos bodily injury claims against it and sought to assign to the trust its rights under the insurance policies issued by TPC.  The proposed plan and disclosure statement filed by ACandS claimed that ACandS had settled the vast majority of asbestos-related bodily injury claims currently pending against it for approximately $2.80 billion.  ACandS asserts that, based on a prior agreement between TPC and ACandS and ACandS’ interpretation of the July 31, 2003 arbitration panel ruling described below, TPC is liable for 45% of the $2.80 billion.  On January 26, 2004, the bankruptcy court issued a decision rejecting confirmation of ACandS’ proposed plan of reorganization.  The bankruptcy court found, consistent with TPC’s objections to ACandS’ proposed plan, that the proposed plan was not fundamentally fair, was not proposed in good faith and did not comply with Section 524(g) of the Bankruptcy Code.  ACandS has filed a notice of appeal of the bankruptcy court’s decision and has filed objections to the bankruptcy court’s findings of fact and conclusions of law in the United States District Court.  TPC has moved to dismiss the appeal and objections and has also filed an opposition to ACandS’ objections.

 

An arbitration was commenced in January 2001 to determine whether and to what extent ACandS’ financial obligations for bodily injury asbestos claims are subject to insurance policy aggregate limits.  On July 31, 2003, the arbitration panel ruled in favor of TPC that asbestos bodily injury claims against ACandS are subject to the aggregate limits of the policies issued to ACandS, which have been exhausted.  In October 2003, ACandS commenced a lawsuit seeking to vacate the arbitration award as beyond the panel’s scope of authority (ACandS, Inc. v. Travelers Casualty and Surety Co., U.S.D.Ct. E.D. Pa.).  On September 16, 2004, the district court entered an order denying ACandS’ motion to vacate the arbitration award.  On January 19, 2006, the United States Court of Appeals for the Third Circuit reversed the district court’s decision and declared the arbitration award void on procedural grounds.  On February 8, 2006, TPC filed a motion to stay the issuance of the Third Circuit’s mandate in anticipation of TPC’s petition for a writ of certiorari to the United States Supreme Court.

 

In the other proceeding, a related case pending before the same court and commenced in September 2000 (ACandS v. Travelers Casualty and Surety Co., U.S.D.Ct., E.D. Pa.), ACandS sought a declaration of the extent to which the asbestos bodily injury claims against ACandS are subject to occurrence limits under insurance policies issued by TPC.  TPC filed a motion to dismiss this action based upon the July 31, 2003 arbitration decision described above.  The district court found the dispute was moot as a result of the arbitration panel’s decision.  The district court, therefore, based on the arbitration panel’s decision, dismissed the case. If the January 19, 2006 ruling of the Third Circuit described in the paragraph above survives further appeal, this case will be reinstated.

 

The Company continues to believe it has meritorious positions in these ACandS-related proceedings and intends to litigate vigorously.

 

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In October 2001 and April 2002, two purported class action suits (Wise v. Travelers and Meninger v. Travelers), were filed against TPC and other insurers (not including SPC) in state court in West Virginia.  These cases were subsequently consolidated into a single proceeding in the Circuit Court of Kanawha County, West Virginia.  Plaintiffs allege that the insurer defendants engaged in unfair trade practices by inappropriately handling and settling asbestos claims.  The plaintiffs seek to reopen large numbers of settled asbestos claims and to impose liability for damages, including punitive damages, directly on insurers.  Lawsuits similar to Wise were filed in Massachusetts and Hawaii (these suits are collectively referred to as the “Statutory and Hawaii Actions”).  Also, in November 2001, plaintiffs in consolidated asbestos actions pending before a mass tort panel of judges in West Virginia state court moved to amend their complaint to name TPC as a defendant, alleging that TPC and other insurers breached alleged duties to certain users of asbestos products.  In March 2002, the court granted the motion to amend.  Plaintiffs seek damages, including punitive damages.  Lawsuits seeking similar relief and raising allegations similar to those presented in the West Virginia amended complaint are also pending in Ohio state court against TPC and SPC, in Texas state court against TPC and SPC, and in Louisiana state court against TPC (the claims asserted in these suits, together with the West Virginia suit, are collectively referred to as the “Common Law Claims”).

 

All of the actions against TPC described in the preceding paragraph, other than the Hawaii Actions, had been subject to a temporary restraining order entered by the federal bankruptcy court in New York that had previously presided over and approved the reorganization in bankruptcy of TPC’s former policyholder Johns-Manville Corporation and affiliated entities.  In August 2002, the bankruptcy court held a hearing on TPC’s motion for a preliminary injunction prohibiting further prosecution of the lawsuits pursuant to the reorganization plan and related orders.  At the conclusion of this hearing, the court ordered the parties to mediation, appointed a mediator and continued the temporary restraining order.  During 2003, the same bankruptcy court extended the existing injunction to apply to an additional set of cases filed in various state courts in Texas and Ohio as well as to the attorneys who are prosecuting these cases.  The order also enjoined these attorneys and their respective law firms from commencing any further lawsuits against TPC based upon these allegations without the prior approval of the court.  Notwithstanding the injunction, additional Common Law Claims were filed and served on TPC.

 

On November 19, 2003, the parties advised the bankruptcy court that a settlement of the Statutory and Hawaii Actions had been reached.  This settlement includes a lump sum payment of up to $412 million by TPC, subject to a number of significant contingencies.  After continued meetings with the mediator, the parties advised the bankruptcy court on May 25, 2004 that a settlement resolving substantially all pending and similar future Common Law Claims against TPC had also been reached.  This settlement requires a payment of up to $90 million by TPC, subject to a number of significant contingencies.  Each of these settlements is contingent upon, among other things, an order of the bankruptcy court clarifying that all of these claims, and similar future asbestos-related claims against TPC, are barred by prior orders entered by the bankruptcy court in connection with the original Johns-Manville bankruptcy proceedings.

 

On August 17, 2004, the bankruptcy court entered an order approving the settlements and clarifying its prior orders that all of the pending Statutory and Hawaii Actions and substantially all Common Law Claims pending against TPC are barred.  The order also applies to similar direct action claims that may be filed in the future.

 

Four appeals were taken from the August 17, 2004 ruling.  These appeals have been consolidated and are currently pending.  The parties have completed briefing all of the issues and a hearing was held before the district court on February 22, 2006.  The Company has no obligation to pay any of the settlement amounts unless and until the orders and relief become final and are not subject to any further appellate review.  It is not possible to predict how appellate courts will rule on the pending appeals.

 

SPC, which is not covered by the bankruptcy court rulings or the settlements described above, has numerous defenses in all of the direct action cases asserting Common Law Claims that are pending against it.  SPC’s defenses include the fact that these novel theories have no basis in law; that they are directly at odds with the well-established law pertaining to the insured/insurer relationship; that there is no generalized duty to warn as alleged by the plaintiffs; and that the applicable statute of limitations as to many of these claims has long since expired. Many of these defenses have been raised in initial motions to dismiss filed by SPC and other insurers.  There have been favorable rulings during 2003 and 2004 in Texas and during 2004 and 2005 in Ohio on some of these motions filed by SPC and other insurers that dealt with statute of limitations and the validity of the alleged causes of actions.  On May 26, 2005, the Court of Appeals of Ohio, Eighth District, affirmed the earliest of these favorable rulings.  In Texas, only one court, in June of 2005, has denied the insurers’ initial challenges to the pleadings.  That ruling was contrary to the rulings by other courts in similar cases, and SPC intends to continue to defend this case vigorously.

 

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The Company is defending its asbestos and environmental-related litigation vigorously and believes that it has meritorious defenses; however, the outcome of these disputes is uncertain.  In this regard, the Company employs dedicated specialists and aggressive resolution strategies to manage asbestos and environmental loss exposure, including settling litigation under appropriate circumstances.  For a discussion of other information regarding the Company’s asbestos and environmental exposure, see “Item 2 — Management’s Discussion and Analysis of Financial Condition and Results of Operations — Asbestos Claims and Litigation”, “— Environmental Claims and Litigation” and “— Uncertainty Regarding Adequacy of Asbestos and Environmental Reserves.”

 

Currently, it is not possible to predict legal outcomes and their impact on the future development of claims and litigation relating to asbestos and environmental claims.  Any such development will be affected by future court decisions and interpretations, as well as changes in applicable legislation.  Because of these uncertainties, additional liabilities may arise for amounts in excess of the current related reserves.  In addition, the Company’s estimate of ultimate claims and claim adjustment expenses may change.  These additional liabilities or increases in estimates, or a range of either, cannot now be reasonably estimated and could result in income statement charges that could be material to the Company’s results of operations and financial condition in future periods.

 

Shareholder Litigation and Related Proceedings

 

TPC and its board of directors were named as defendants in three putative class action lawsuits brought by shareholders alleging breach of fiduciary duty in connection with the merger of TPC and SPC and seeking injunctive relief as well as unspecified monetary damages.  The actions were captioned Henzel, et al. v. Travelers Property Casualty Corp., et al. (Jud. Dist. of Waterbury, Ct. Nov. 17, 2003); Vozzolo v. Travelers Property Casualty Corp., et al. (Jud. Dist. of Waterbury, Ct. Nov. 17, 2003); and Farina v. Travelers Property Casualty Corp., et al. (Jud. Dist. of Waterbury, Ct. December 15, 2003).  The Farina complaint also named SPC and its former subsidiary, Adams Acquisition Corp., as defendants, alleging that they aided and abetted the alleged breach of fiduciary duty.  On March 18, 2004, TPC and SPC announced that all of these lawsuits had been settled, subject to court approval. Before court approval of the settlement, additional shareholder litigation was commenced, as described below.  On September 12, 2005, plaintiffs voluntarily withdrew their complaints without prejudice.

 

Beginning in August 2004, following post-merger announcements by the Company, various shareholders of the Company commenced fourteen putative class action lawsuits against the Company and certain of its current and former officers and directors in the United States District Court for the District of Minnesota.  Plaintiff shareholders alleged that certain disclosures relating to the April 2004 merger between TPC and SPC contained false or misleading statements with respect to the value of SPC’s loss reserves in violation of federal securities laws.  These actions were consolidated under the caption In re St. Paul Travelers Securities Litigation I, and a lead plaintiff and lead counsel were appointed.  An additional putative class action based on the same allegations was brought in New York State Supreme Court.  This action was subsequently transferred to the District of Minnesota and was consolidated with In re St. Paul Travelers Securities Litigation I.  On June 24, 2005, the lead plaintiff filed an amended consolidated complaint.  The complaint did not specify damages.  On August 23, 2005, the Company and the other defendants in In re St. Paul Travelers Securities Litigation I moved to dismiss the amended consolidated complaint.  On November 22, 2005, the parties reached an agreement to settle the case. The settlement also encompasses the Henzel, Vozzolo and Farina cases described above. On December 28, 2005, the Court approved the settlement. 

 

Three other actions against the Company and certain of its current and former officers and directors are pending in the United States District Court for the District of Minnesota.  Two of these actions, which were originally captioned Kahn v. The St. Paul Travelers Companies, Inc., et al. (Nov. 2, 2004) and Michael A. Bernstein Profit Sharing Plan v. The St. Paul Travelers Companies, Inc., et al. (Nov. 10, 2004), are putative class actions brought by certain shareholders of the Company against the Company and certain of its current and former officers and directors.  These actions have been consolidated as In re St. Paul Travelers Securities Litigation II, and a lead plaintiff and lead counsel have been appointed.  On July 11, 2005, the lead plaintiff filed an amended consolidated complaint.  The amended consolidated complaint alleges violations of federal securities laws in connection with the Company’s alleged failure to make disclosure relating to the practice of paying brokers commissions on a contingent basis, the Company’s alleged involvement in a conspiracy to rig bids and the Company’s

 

48



 

allegedly improper use of finite reinsurance products. On September 26, 2005, the Company and the other defendants in In re St. Paul Travelers Securities Litigation II moved to dismiss the amended consolidated complaint for failure to state a claim. In the third of these actions, an alleged beneficiary of the Company’s 401(k) savings plan commenced a putative class action against the Company and certain of its current and former officers and directors captioned Spiziri v. The St. Paul Travelers Companies, Inc., et al. (Dec. 28, 2004). The complaint alleges violations of the Employee Retirement Income Security Act based on allegations similar to those in In re St. Paul Travelers Securities Litigation I. On June 1, 2005, the Company and the other defendants in Spiziri moved to dismiss the complaint. On January 4, 2006, the parties in Spiziri entered into a stipulation of settlement. The settlement remains subject to court approval.

 

In addition, two derivative actions have been brought in the United States District Court for the District of Minnesota against all of the Company’s current directors and certain of the Company’s former Directors, naming the Company as a nominal defendant: Rowe v. Fishman, et al. (Oct. 22, 2004) and Clark v. Fishman, et al. (Nov. 18, 2004). The derivative actions have been consolidated for pretrial proceedings as Rowe, et al. v. Fishman, et al. and a consolidated derivative complaint has been filed. The consolidated derivative complaint asserts state law claims, including breach of fiduciary duty, based on allegations similar to those alleged in In re St. Paul Travelers Securities Litigation I and II described above. On June 10, 2005, the Company and the other defendants in Rowe moved to dismiss the complaint. Oral argument on the motion to dismiss was presented on September 19, 2005.

 

The Company believes that the pending lawsuits have no merit and intends to defend vigorously; however, the Company is not able to provide any assurance that the financial impact of one or more of these proceedings will not be material to the Company’s results of operations in a future period. The Company is obligated to indemnify its officers and directors to the extent provided under Minnesota law. As part of that obligation, the Company will advance officers and directors attorneys’ fees and other expenses they incur in defending these lawsuits.

 

Other Proceedings

 

From time to time the Company is involved in proceedings addressing disputes with its reinsurers regarding the collection of amounts due under the Company’s reinsurance agreements. These proceedings may be initiated by the Company or the reinsurers and may involve the terms of the reinsurance agreements, the coverage of particular claims, exclusions under the agreements, as well as counterclaims for rescission of the agreements. One of these disputes is the action described in the following paragraph.

 

The Company’s Gulf operation brought an action on May 22, 2003, as amended on May 12, 2004, in the Supreme Court of New York, County of New York (Gulf Insurance Company v. Transatlantic Reinsurance Company, et al.), against Transatlantic Reinsurance Company (Transatlantic), XL Reinsurance America, Inc. (XL), Odyssey America Reinsurance Corporation (Odyssey), Employers Reinsurance Company (Employers) and Gerling Global Reinsurance Corporation of America (Gerling), to recover amounts due under reinsurance contracts issued to Gulf and related to Gulf’s February 2003 settlement of a coverage dispute under a vehicle residual value protection insurance policy. The reinsurers have asserted counterclaims seeking rescission of the vehicle residual value reinsurance contracts issued to Gulf and unspecified damages for breach of contract. Separate actions filed by Transatlantic and Gerling have been consolidated with the original Gulf action for pre-trial purposes. On October 1, 2003, Gulf entered into a final settlement agreement with Employers, and all claims and counterclaims with respect to Employers have been dismissed.

 

On May 26, 2004, the Court denied Gulf’s motion to dismiss certain claims asserted by Transatlantic and a joint motion by Transatlantic, XL and Odyssey for summary judgment against Gulf. Discovery is currently proceeding in the matters. Gulf denies the reinsurers’ allegations, believes that it has a strong legal basis to collect the amounts due under the reinsurance contracts and intends to vigorously pursue the actions.

 

Based on the Company’s beliefs about its legal positions in its various reinsurance recovery proceedings, the Company does not expect any of these matters to have a material adverse effect on its results of operations in a future period.

 

49



 

As part of ongoing, industry-wide investigations, the Company and its affiliates have received subpoenas and written requests for information from government agencies and authorities. The areas of inquiry addressed to the Company include its relationship with brokers and agents, the Company’s involvement with “non-traditional insurance and reinsurance products,” branding requirements for salvage automobiles and the reporting of workers’ compensation premiums.  The Company or its affiliates have received subpoenas or written requests for information, in each case with respect to one or more of the areas described above, from: (i) State of California Office of the Attorney General; (ii) State of California Department of Insurance; (iii) Licensing and Market Conduct Compliance Division, Financial Services Commission of Ontario, Canada; (iv) State of Connecticut Insurance Department; (v) State of Connecticut Office of the Attorney General; (vi) State of Delaware Department of Insurance; (vii) State of Florida Department of Financial Services; (viii) State of Florida Office of Insurance Regulation; (ix) State of Florida Department of Legal Affairs Office of the Attorney General; (x) State of Georgia Office of the Commissioner of Insurance; (xi) State of Illinois Department of Financial and Professional Regulation; (xii) State of Iowa Insurance Division; (xiii) State of Maryland Insurance Administration; (xiv) Commonwealth of Massachusetts Office of the Attorney General; (xv) State of Minnesota Department of Commerce; (xvi) State of Minnesota Office of the Attorney General; (xvii) State of New Hampshire Insurance Department; (xviii) State of New York Office of the Attorney General; (xix) State of New York Insurance Department; (xx) State of North Carolina Department of Insurance; (xxi) State of Ohio Office of the Attorney General; (xxii) State of Ohio Department of Insurance; (xxiii) Commonwealth of Pennsylvania Office of the Attorney General; (xxiv) State of Texas Department of Insurance; (xxv) State of Washington Office of the Insurance Commissioner; (xxvi) State of West Virginia Office of Attorney General; (xxvii) the United States Attorney for the Southern District of New York; and (xxviii) the United States Securities and Exchange Commission. The Company and its affiliates may receive additional subpoenas and requests for information with respect to the areas described above from other agencies or authorities.

 

The Company is cooperating with these subpoenas and requests for information. In addition, outside counsel, with the oversight of the Company’s Board of Directors, has been conducting an internal review of certain of the Company’s business practices. This review initially focused on the Company’s relationship with brokers and was commenced after the announcement of litigation brought by the New York Attorney General’s office against a major broker.

 

The internal review was expanded to address the various requests for information described above and to verify whether the Company’s business practices in these areas have been appropriate. The Company’s review has been extensive, involving the examination of e-mails and underwriting files, as well as interviews of current and former employees. The Company also continues to receive and respond to additional requests for information and will expand its review accordingly.

 

To date, the Company has found only a few instances of conduct that were inconsistent with the Company’s employee code of conduct. The Company has responded, and will continue to respond, appropriately to any such conduct.

 

The Company’s internal review with respect to finite reinsurance considered finite products the Company both purchased and sold. The Company has completed its review with respect to the identified finite products purchased and sold, and has concluded that no adjustment to previously issued financial statements is required. The related industry-wide investigations previously described are ongoing, as are the Company’s efforts to cooperate with the authorities, and the various authorities could ask that additional work be performed or reach conclusions different from the Company’s. Accordingly, it would be premature to reach any conclusions as to the likely outcome of these matters.

 

Six putative class action lawsuits and two individual actions were brought against a number of insurance brokers and insurers, including the Company and/or certain of its affiliates, by plaintiffs who allegedly purchased insurance products through one or more of the defendant brokers. Plaintiffs allege that various insurance brokers conspired with each other and with various insurers, including the Company and/or certain of its affiliates, to artificially inflate premiums, allocate brokerage customers and rig bids for insurance products offered to those customers. Five of the class actions were filed in federal district court, and the complaints are captioned:  Shell Vacations LLC v. Marsh & McLennan Companies, Inc., et al. (N.D. Ill. Jan. 14, 2005), Redwood Oil Company v. Marsh & McLennan Companies, Inc., et al. (N.D. Ill. Jan. 21, 2005), Boros v. Marsh & McLennan Companies, Inc., et al. (N.D. Cal. Feb. 4, 2005), Mulcahey v. Arthur J. Gallagher & Co., et al. (D.N.J. Feb. 23, 2005) and Golden Gate Bridge, Highway, and Transportation District v. Marsh & McLennan Companies, Inc., et al. (D.N.J. Feb. 23, 2005). The plaintiff in one of the five actions, Shell Vacations LLC, later voluntarily dismissed its complaint. To the extent they were not originally filed there, the federal class actions were transferred by the Judicial Panel on Multidistrict Litigation to the United States District Court for the District of

 

50



 

New Jersey and have been consolidated with other class actions under the caption In re Insurance Brokerage Antitrust Litigation, a multidistrict litigation proceeding in that District. On August 1, 2005, nineteen plaintiffs, including the four named plaintiffs in the above-referenced class actions, filed an amended consolidated class action complaint naming various brokers and insurers, including the Company and certain of its affiliates, on behalf of a putative nationwide class of policyholders. The complaint includes causes of action under the Sherman Act, the Racketeer Influenced and Corrupt Organizations Act, state common law and the laws of the various states prohibiting antitrust violations. Plaintiffs seek monetary damages, including punitive damages and trebled damages, permanent injunctive relief, restitution, including disgorgement of profits, interest and costs, including attorneys’ fees. On November 29, 2005, all defendants moved to dismiss the complaint for failure to state a claim. On February 13, 2006, the named plaintiffs moved to certify a nationwide class consisting of all persons who between August 26, 1994 and the date of class certification engaged the services of a broker defendant (or related entity) in connection with the procurement or renewal of insurance and who entered into or renewed a contract of insurance with one or more of the insurer defendants, including the Company. One individual action naming various brokers and insurers, including several of the Company’s affiliates, was filed in federal district court and is captioned Delta Pride Catfish, Inc. v. Marsh USA, Inc., et al. (D. Miss. Sept. 13, 2005).  That action has also been transferred to the District of New Jersey and is being coordinated with In re Insurance Brokerage Antitrust Litigation.  On January 17, 2006, all defendants moved to dismiss the complaint in Delta Pride Catfish, Inc. for failure to state a claim.  One other putative class action, Bensley Construction, Inc. v. Marsh & McLennan Companies, Inc., et al. (Mass. Super. Ct. May 16, 2005), and one other individual action, Office Depot, Inc. v. Marsh & McLennan Companies, Inc., et al. (Fla. Cir. Ct. June 22, 2005), have been filed in state court and assert claims that are similar to those asserted in In re Insurance Brokerage Antitrust Litigation against various brokers and insurers, including the Company and/or certain of its affiliates, but have not been consolidated with In re Insurance Brokerage Antitrust Litigation.  Certain defendants in Bensley Construction, Inc., including the Company, have removed the action to the United States District Court for the District of Massachusetts.  On February 13, 2006, the action was transferred to the District of New Jersey for coordination with In re Insurance Brokerage Antitrust LitigationOffice Depot, Inc. was brought in Florida state court and names several of the Company’s subsidiaries.  On November 9, 2005, the court entered an order staying Office Depot pending resolution of In re Insurance Brokerage Antitrust Litigation.  The plaintiff in Office Depot, Inc. has appealed.  The Company believes that these lawsuits have no merit and intends to defend vigorously.

 

In addition to those described above, the Company is involved in numerous lawsuits, not involving asbestos and environmental claims, arising mostly in the ordinary course of business operations either as a liability insurer defending third-party claims brought against policyholders, or as an insurer defending claims brought against it relating to coverage or the Company’s business practices. While the ultimate resolution of these legal proceedings could be material to the Company’s results of operations in a future period, in the opinion of the Company’s management none would likely have a material adverse effect on the Company’s financial condition or liquidity.

 

Item 4.                                    SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

NONE.

 

EXECUTIVE OFFICERS OF THE REGISTRANT

 

Information about the Company’s executive officers is incorporated by reference from Part III, Item 10 of this Report.

 

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PART II

 

Item 5.                                    MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The Company’s common stock is traded on the New York Stock Exchange, where it is assigned the symbol “STA.” Prior to the merger of SPC and TPC, SPC’s common stock traded on the New York Stock Exchange under the symbol “SPC.” The number of holders of record, including individual owners, of the Company’s common stock was 94,191 as of February 23, 2006. This is not the actual number of beneficial owners of the Company’s common stock, as shares are held in “street name” by brokers and others on behalf of individual owners. The following table sets forth the amount of cash dividends declared per share and the high and low closing sales prices of the Company’s common stock for each quarter during the last two fiscal years. SPC historical data is presented in the table for the first quarter of 2004, as SPC common stock was issued to effect the merger, and SPC, as renamed, was the continuing public company registrant following the merger.

 

 

 

High

 

Low

 

Cash
Dividend
Declared

 

2005

 

 

 

 

 

 

 

First Quarter

 

$

39.40

 

$

35.89

 

$

0.22

 

Second Quarter

 

39.87

 

33.71

 

0.23

 

Third Quarter

 

45.14

 

39.60

 

0.23

 

Fourth Quarter

 

46.70

 

41.37

 

0.23

 

 

 

 

 

 

 

 

 

2004

 

 

 

 

 

 

 

First Quarter

 

$

43.35

 

$

39.20

 

$

0.50

 

Second Quarter

 

42.99

 

39.18

 

0.22

 

Third Quarter

 

39.70

 

32.53

 

0.22

 

Fourth Quarter

 

37.54

 

30.99

 

0.22

 

 

The Company paid cash dividends p