UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________to________
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Commission file number 0-27394
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GE Global Insurance Holding Corporation
(Exact name of registrant as specified in its charter)
Delaware 95-3435367
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
5200 Metcalf, Overland Park, Kansas 66202 (913) 676-5200
(Address of principal executive offices) (Zip Code) Registrant's telephone
number, including area code)
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SECURITIES REGISTERED PURSUANT
TO SECTION 12(b) OF THE ACT:
Name of each
Title of each class exchange on which registered
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7% Notes Due February 15, 2026 New York Stock Exchange
6.45% Notes Due March 1, 2019 New York Stock Exchange
7.5% Notes Due June 15, 2010 New York Stock Exchange
7.75% Notes Due June 15, 2030 New York Stock Exchange
SECURITIES REGISTERED PURSUANT
TO SECTION 12(g) OF THE ACT:
Title of each class
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Common Stock, par value $5,000 per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No[ ]
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 the 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. [X]
Aggregate market value of the voting stock held by nonaffiliates of the
registrant at March 8, 2002. None.
At March 8, 2002, 1,000 shares of common stock with a par value of $5,000 per
share were outstanding.
REGISTRANT MEETS THE CONDITIONS SET FORTH IN GENERAL INSTRUCTION I(1)(a) AND (b)
OF FORM 10-K AND IS THEREFORE FILING THIS FORM 10-K WITH THE REDUCED DISCLOSURE
FORMAT.
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business...........................................................................................1
Item 2. Properties........................................................................................12
Item 3. Legal Proceedings.................................................................................13
Item 4. Submission of Matters to a Vote of Security Holders...............................................13
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters.........................13
Item 6. Selected Financial Data...........................................................................13
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.....................................................................14
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................24
Item 8. Financial Statements and Supplementary Data.......................................................24
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure......................................................................24
PART III
Item 10. Directors and Executive Officers of the Registrant................................................24
Item 11. Executive Compensation............................................................................24
Item 12. Security Ownership of Certain Beneficial Owners and Management....................................24
Item 13. Certain Relationships and Related Transactions....................................................24
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...................................25
PART I
Item 1. Business.
GE Global Insurance Holding Corporation ("GE Global Insurance" and, together
with its subsidiaries, "the Company"), through its direct and indirect
subsidiaries, is principally engaged in the reinsurance business in the United
States and throughout the world. All outstanding common stock of GE Global
Insurance is owned by General Electric Capital Services, Inc. ("GE Capital
Services"), which in turn is wholly-owned by General Electric Company ("GE
Company").
The principal executive offices of GE Global Insurance are located at 5200
Metcalf, Overland Park, Kansas 66202 (Telephone number (913) 676-5200).
Overview of the Reinsurance Industry
Reinsurance is a form of insurance in which a reinsurer indemnifies a primary
insurer against part or all of the liability assumed by the primary insurer
under one or more insurance policies. Reinsurance may provide a primary insurer
with several major benefits: a reduction in net liability of individual risks,
protection against catastrophic losses, reduction of financial leverage and
stabilization of operating results. Reinsurance may also provide a primary
insurer the ability to increase its underwriting capacity by allowing the
primary insurer to accept larger risks and to more rapidly expand its book of
business.
The global reinsurance industry is operating in an unprecedented environment in
the aftermath of the events of September 11. After years of the effect of excess
market capacity, the global market finds itself in a capacity crunch and with
many market participants declining to write coverage that includes terrorism.
The challenges associated with quantifying terrorism risk today are significant.
Primary insurers continue to consider alternatives to traditional risk transfer,
including insurance captives, structured securities and derivative products.
Global reinsurers are offering ways to meet the demands of this changing global
market by expanding their markets, entering into new reinsurance niches,
offering new reinsurance products and spreading their risks geographically. This
changing reinsurance environment may affect the industry's profitability, which
has historically been influenced by the insurance industry's underwriting cycle,
changes in interest rates and catastrophic events.
General
GE Global Insurance is one of the largest reinsurance groups in the world, with
subsidiaries providing risk management solutions for well over a century. The
Company writes substantially all types of property and casualty, healthcare and
life reinsurance and some lines of primary health, property and casualty and
excess workers' compensation insurance.
The Company conducts business and services its accounts through a network of
local offices located in cities throughout the world.
As one of the largest direct writers of reinsurance in the world, the Company
works directly with its clients which enhances the Company's ability to evaluate
its clients and their respective risks and allows the Company to be more
responsive to the individual needs of its customers. The Company utilizes its
network of local offices throughout the world to service the particular needs of
its reinsurance clients. This system enables the Company to provide a wider
range of services targeted at the needs of a particular market.
The Company also competes in the reinsurance broker market throughout the world.
In early 1999, the Company significantly expanded its presence in the
reinsurance broker market by acquiring Eagle Star Reinsurance Company Limited
("Eagle Star Re"). The acquisition of Eagle Star Re significantly enhanced the
Company's distribution channel in the worldwide reinsurance broker market and
further enables the Company to respond to the growing risk management needs of a
wider and more diverse group of customers. The acquisition of Eagle Star Re
positions the Company as one of the largest reinsurance broker writers in the
world.
1
The Company manages and diversifies its risk through the careful underwriting of
risks, active claims management and the purchase of retrocessional coverage,
including aggregate covers on portions of risk. Retrocessional coverage
represents a form of secondary reinsurance where a reinsurer seeks reinsurance
coverage on a specified portion of assumed risks. The Company maintains strict
underwriting controls whereby individual underwriters are assigned maximum
levels of underwriting authority based on specified lines of business. The
assumption of risks greater than the specified maximum amount requires approvals
of designated individuals. Adherence to these underwriting guidelines is
monitored through pre-renewal account reviews, periodic underwriting audits and
computer edit controls. In addition to transactional controls, the Company
employs portfolio monitoring of key risks for all products and controls new
product introductions through the use of required management reviews
("tollgates") to approve such new products and related underwriting guidelines.
The Company's business strategy is to continue to increase revenues by
concentrating on select profitable customer segments and delivering
comprehensive risk transfer and risk management solutions. The Company does not
intend, however, to increase premium income at the expense of its underwriting
results.
On March 4, 1999, the Company completed the acquisition of Eagle Star Re
(subsequently merged with GE Frankona Reinsurance Limited, an affiliate), a
leading London Market non-life reinsurance company principally doing business
through intermediaries. This acquisition significantly enhanced the Company's
worldwide reinsurance broker distribution channel. The cash consideration of
approximately $346 million was provided through existing funds.
Unless otherwise indicated, all financial data has been prepared in accordance
with accounting principles generally accepted in the United States of America
("GAAP").
2
Lines of Business
The Company's two business segments are (1) property and casualty
insurance/reinsurance and (2) life reinsurance. The Company's principal product
lines under the property and casualty segment are traditional property and
casualty reinsurance, healthcare reinsurance and commercial insurance (generally
primary property and casualty insurance) and its principal product lines under
the life reinsurance segment are traditional life reinsurance and financial
reinsurance. The Company also provides primary insurance products to hospitals,
health maintenance organizations and medical professionals as part of its
healthcare product line and to niche customers as part of its commercial
insurance product line.
Unless otherwise indicated, the Company's domestic results include business
written in the United States (including business written in the United States
where the reinsured is outside the United States) and Canada, and the
international results include all other business written by the Company. The
geographic breakdown, based on net premiums written, of the Company's principal
product lines is summarized as follows:
Year ended December 31,
-------------------------------------------------------------------------------
(In millions) 2001 2000 1999
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Inter- Inter- Inter-
Domestic national Domestic national Domestic national
------------ ----------- ------------- ---------- ------------ -----------
Property and Casualty Segment
Property and Casualty............. $1,955 $1,797 $2,103 $2,677 $2,102 $2,470
Healthcare........................ 1,383 67 1,294 76 851 43
Commercial........................ 349 - 404 - 417 -
Life Segment......................... 790 1,051 832 805 615 649
------ ------ ------ ------ ------ ------
Total............................. $4,477 $2,915 $4,633 $3,558 $3,985 $3,162
====== ====== ====== ====== ====== ======
The following is a summary description of the Company's domestic and
international business based on principal product lines:
Property and Casualty Insurance/Reinsurance Segment
Property and Casualty Reinsurance. The Company's largest product line,
traditional property and casualty reinsurance, accounted for approximately 51%
of the Company's worldwide net premiums written in 2001. The Company's premium
volume in the property and casualty segment is derived principally from treaty
agreements, which enable the Company to maintain lower operating costs because
fewer personnel are required to administer treaty business than facultative
business. Most of the Company's casualty business is written on an excess of
loss basis because it better enables the Company to control its exposure on
business that has a relatively longer claim settlement pattern.
The Company's property business is written on both an excess of loss and a
proportional basis. Generally, the Company is the lead reinsurer for any
domestic program in which it participates, enabling it to negotiate the terms of
the reinsurance. The Company also acts as the lead reinsurer on a portion of its
international business.
The Company's international property and casualty business services worldwide
markets, including most European countries and countries in the Middle East, Far
East and Latin America. For the year ended December 31, 2001, approximately 48%
of the Company's international net premiums written from property and casualty
reinsurance was derived from property reinsurance, approximately 20% from
casualty reinsurance and approximately 32% from aviation and marine reinsurance.
Based on 2001 net premiums written, approximately 45% of the Company's
international property and casualty business was written on a direct basis, with
the remainder written through brokers.
3
In recent years, insurance companies have directed more business to the
better-capitalized, more highly-rated reinsurers, which has led to a
consolidation in the reinsurance industry. In competing with a smaller number of
global reinsurers, the Company has found that a number of its global customers
are increasingly demanding that reinsurers provide a broader range of coverages.
In response to this trend, the Company has expanded the property and casualty
risks it reinsures beyond its more traditional property and casualty reinsurance
business to include risks such as errors and omissions and directors and
officers exposures. In addition to the expansion of lines of business, property
and casualty reinsurance has aligned its marketing efforts with its core
expertise in areas such as aviation, national accounts and global accounts.
Management believes that the Company is well positioned to compete on a global
basis in these markets.
The property and casualty reinsurance industry has experienced a significant
increase in catastrophic exposure and loss during the last decade. Increased
population density, particularly in regions susceptible to tropical storms or
earthquakes, and the higher incidence and greater severity of catastrophes, has
increased the losses incurred in many recent catastrophes. As a result of these
developments, the Company has taken steps to limit its exposure by carefully
monitoring and allocating its property and casualty exposure to specific
geographic zones, especially the U.S., Europe, Japan and the Carribeans.
The September 11, 2001 attack on America has also had a dramatic affect on the
insurance and reinsurance industry with the tragic loss of more than 1,000
insurance professionals, including many business associates and brokers with
whom the Company worked. None of the Company's staff suffered any injury.
The industry is playing a key role in the recovery and rebuilding effort. It is
estimated that insurers and reinsurers will pay claims of more than $35 billion
during the next several years. The Company estimated that its net pre-tax losses
will be $575 million from that attack. The Company has paid or anticipates that
it will pay claims for coverage on the World Trade Center complex and
surrounding buildings, its portion of aviation coverage for the four aircraft
involved, life reinsurance claims and business interruption claims. The attack
has led to significant changes in underwriting guidelines, and the Company no
longer provides terrorism coverage in many treaties and policies.
Healthcare. As part of the Company's property and casualty business segment, the
Company provides insurance and reinsurance for the healthcare industry and
targets employers, public entities, manufacturers and others for certain product
lines. Coverages include primary insurance and reinsurance for medical
professional liability and insurance protecting primary insurers (including
self-insurers) in the healthcare market (e.g., excess workers' compensation,
stop loss insurance, HMO reinsurance and provider excess coverages).
The Company is a leader in providing primary medical professional liability
insurance through its subsidiary-Medical Protective Corporation ("Medical
Protective")-one of the oldest professional liability carriers in the United
States. The Company's comprehensive line of medical malpractice insurance,
written on a national basis, covers the needs of individual physicians,
dentists, physician partnerships, corporations and large group practices on an
occurrence and claims-made basis.
The healthcare industry continues to change and evolve due to voluntary
healthcare reform, managed healthcare initiatives, deteriorating profits driven
by the competitive marketplace and the uncertainty related to the extent of
government regulation. In addition, companies that historically specialized in
one line of business and one geographic area have expanded their lines of
business and are now writing multiple lines of business in a broader territory.
The Company believes that it is well positioned to compete in the healthcare
market because of its wide range of experience in providing healthcare liability
coverage and excess protection for self-insured employers, and utilizing
multiple products and services to provide healthcare solutions.
Commercial Insurance. An additional component of the Company's domestic property
and casualty business is its commercial insurance product line, which generally
consists of primary commercial property and casualty policies written on an
admitted and non-admitted basis in niche markets. Commercial products include
professional liability programs and niche programs in the general property and
casualty area. This coverage provides insurance for errors and omissions (E&O)
arising out of the professional activities of the insureds and commercial
property and casualty coverages for niche programs.
4
Professional classes underwritten include lawyers, property and casualty
insurance agents and brokers, life and health insurance agents and brokers,
accountants and a few miscellaneous classes. The majority of this business
provides coverage to lawyers and property and casualty and life insurance agents
and brokers.
Competition for the classes of business underwritten within the Company's
commercial insurance product line has recently increased as more companies have
redirected their resources to the targeted niche markets. In order to compete
for this business, the Company has provided value-added services, including
enhanced underwriting and automated processing services, to its wholesalers and
managing general agents producing such business.
Life Reinsurance Segment
Life Reinsurance. The Company is engaged in the reinsurance of various life
insurance products, including term, whole and universal life, annuities, group
life, group and individual long-term health and disability products and provides
financial reinsurance to life insurers. Based on net premiums written, life
reinsurance accounted for approximately 25% of the Company's worldwide business
in 2001.
With respect to life reinsurance, the Company writes mostly on a direct basis
with primary insurers. The Company's life reinsurance business consists
principally of treaty business and is written generally on a pro-rata basis. The
Company's domestic life reinsurance business is written in every state in the
United States. The Company's international life reinsurance business services
worldwide markets with an emphasis in Western Europe. For the year ended
December 31, 2001, approximately 57% of the Company's international life
reinsurance net premiums written were for traditional life reinsurance, with the
balance for health and disability reinsurance.
The Company believes that continued increases in life expectancy, consumer
trends to shift to more investment types of life insurance products, decreases
in public funding for social programs in Europe and deregulation of the life
reinsurance markets in Europe and Japan present increased opportunities for the
Company's life reinsurance business line.
Financial Reinsurance. Financial reinsurance does not transfer significant
underwriting risk to the reinsurer and is designed primarily to enhance the
current statutory surplus of the ceding company while reducing future statutory
earnings as amounts are repaid to the reinsurer. These financial transactions
are effectively collateralized by anticipated future income streams from
selected insurance policies. Financial reinsurance typically has a duration of
three to five years.
Property and Casualty Reserves for Unpaid Claims and Claim Expenses
The Company's insurance/reinsurance subsidiaries maintain reserves to cover
their estimated ultimate liability for unpaid claims and claim expenses with
respect to reported and unreported claims incurred as of the end of each
accounting period (net of estimated related salvage and subrogation claims).
These reserves are estimates that involve actuarial and statistical projections
of the expected cost of the ultimate settlement and administration of unpaid
claims based on facts and circumstances then known, estimates of future trends
in claims severity and other variable factors such as inflation, new concepts of
liability and changes in claim settlement procedures. The inherent uncertainties
of estimating claim reserves are exacerbated for reinsurers by the significant
periods of time that often elapse between the occurrence of an insured claim,
the reporting of the claim to the primary insurer and, ultimately, to the
reinsurer, and the primary insurer's payment of that claim and subsequent
indemnification by the reinsurer. As a consequence, actual claims and claim
expenses paid may deviate, perhaps substantially, from estimates reflected in
the insurance companies' reserves in their financial statements. Adjustments to
previously reported reserves for net claims and claim expenses are considered
changes in estimates for accounting purposes and are reflected in the financial
statements in the period in which the adjustment occurs.
5
When a claim is reported to a ceding company, the ceding company's claims
personnel establish a "case reserve" for the estimated amount of the ultimate
payment. The estimate reflects the informed judgment of such personnel based on
general insurance reserving practices and on the experience and knowledge of
such personnel regarding the nature and value of the specific type of claim. The
Company, in turn, typically establishes a case reserve when it receives notice
of a claim from the ceding company. Such reserves are based on an independent
evaluation by the Company's claims departments, taking into consideration
coverage, liability, severity of injury or damage, jurisdiction, an assessment
of the ceding company's ability to evaluate and handle the claim and the amount
of reserves recommended by the ceding company. Case reserves are adjusted
periodically by the claims departments based on subsequent developments and
audits of ceding companies. The Company has reorganized its claim teams into
integrated groups to align with the Company's business structure. In the course
of this reorganization, the team recognized that best practices existed in many
of the original claims teams. In order to leverage these best practices across
the new claims organization, the Global Claims Team launched the Claims Six
Sigma initiative. Claims Six Sigma has focused on establishing common processes
in areas such as claims adjudication, subrogation, auditing, alternative dispute
resolution and use of structured settlements.
In accordance with GAAP, the Company also maintains reserves for claims incurred
but not reported ("IBNR"). Such reserves are established to provide for future
case reserves and loss payments on incurred claims that have not yet been
reported to an insurer or reinsurer. In calculating IBNR reserves, the Company
uses generally accepted actuarial reserving techniques that take into account
quantitative loss experience data, together with, where appropriate, qualitative
factors. IBNR reserves are based on claim experience and are grouped both by
class of business and by accident year. IBNR reserves are also adjusted to take
into account certain additional factors, such as changes in the volume of
business written, reinsurance contract terms and conditions, the mix of
business, claims processing and inflation, that can be expected to affect the
Company's liability for claims over time.
The potential for adverse development of the Company's reserves for its
international business, as compared to that of its domestic business, is reduced
because the international operations have a relatively low proportion of longer
tail exposures.
Reserve Development. The development of the Company's net balance sheet property
and casualty liabilities for unpaid claims and claim expenses for accident years
1991 through 2001 is summarized in the following table.
Net Liability. The first row of data shows the estimated net liability for
unpaid claims and claim expenses at December 31 for each year from 1991 to 2001.
The liability includes both case and IBNR reserves as of each year-end date, net
of anticipated recoveries from other reinsurers. The rows immediately following
the first row of data show cumulative paid data at December 31, as of one year,
two years, . . ., 10 years of subsequent payments.
Net Liability Re-estimated. The middle rows of data show the re-estimated amount
for previously reported net liability based on experience as of the end of each
subsequent calendar year's results. This estimate is changed as more information
becomes known about the underlying claims for individual years. The cumulative
redundancy (deficiency) shown in the table is the aggregate net change in
estimates over the period of years subsequent to the calendar year reflected at
the top of the respective columns. The amount in the line titled "Redundancy
(Deficiency) at December 31, 2001," represents for each calendar year (the "Base
Year") the aggregate change in (i) the Company's original estimate of net
liability for unpaid claims and claim expenses for all years prior to and
including the Base Year compared to (ii) the Company's re-estimate as of
December 31, 2001, of net liability for unpaid claims and claim expenses for all
years prior to and including the Base Year. A redundancy means that the original
estimate was greater than the re-estimate and a deficiency means that the
original estimate was less than the re-estimate.
6
Changes in Historical Reserves for Unpaid Claims and Claim Expenses
For the Last Ten Years - GAAP Basis as of December 31, 2001
Year ended December 31,
---------------------------------------------------------------------------------------------------------
(In millions) 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
---------------------------------------------------------------------------------------------------------
Net liability for unpaid
claims and claim
expenses $3,596 $3,991 $4,525 $5,071 $9,351 $9,458 $9,114 $12,495 $13,210 $12,202 $12,303
Cumulative paid as of:
One year later....... 665 802 949 1,115 1,964 1,949 2,176 2,867 4,811 4,758 ---
Two years later...... 1,103 1,274 1,602 1,804 3,130 3,189 3,241 5,803 7,782 --- ---
Three years later.... 1,499 1,739 2,054 2,341 3,933 3,881 4,863 7,263 --- --- ---
Four years later..... 1,784 2,036 2,424 2,708 4,464 5,294 5,648 --- --- --- ---
Five years later..... 2,008 2,293 2,690 2,988 5,686 5,919 --- --- --- --- ---
Six years later...... 2,208 2,485 2,952 3,318 6,151 --- --- --- --- --- ---
Seven years later.... 2,362 2,688 3,181 3,540 --- --- --- --- --- --- ---
Eight years later.... 2,531 2,841 3,353 --- --- --- --- --- --- --- ---
Nine years later..... 2,653 2,985 --- --- --- --- --- --- --- --- ---
Ten years later...... 2,772 --- --- --- --- --- --- --- --- --- ---
Net liability
re-estimated
as of:
One year later....... $3,625 $3,919 $4,612 $5,173 $9,192 $9,229 $9,179 $12,410 $13,749 $13,314 ---
Two years later...... 3,587 4,066 4,656 5,313 8,959 9,127 8,655 12,115 14,504 --- ---
Three years later.... 3,701 4,095 4,793 5,256 8,907 8,549 8,453 11,987 --- --- ---
Four years later..... 3,687 4,238 4,747 5,155 8,392 8,252 8,601 --- --- --- ---
Five years later..... 3,818 4,154 4,668 4,902 8,029 8,389 --- --- --- --- ---
Six years later...... 3,771 4,075 4,487 4,804 8,180 --- --- --- --- --- ---
Seven years later.... 3,711 3,942 4,402 4,854 --- --- --- --- --- --- ---
Eight years later.... 3,592 3,906 4,461 --- --- --- --- --- --- --- ---
Nine years later..... 3,591 3,946 --- --- --- --- --- --- --- --- ---
Ten years later...... 3,643 --- --- --- --- --- --- --- --- --- ---
Redundancy (Deficiency)
at December 31, 2001 (47) 45 64 217 1,171 1,069 513 508 (1,294) (1,112) ---
Effect of foreign
exchange (1) (41) (21) 2 (25) (708) (672) (344) (729) (589) 216 ---
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
Redundancy (Deficiency)
at December 31, 2001,
excluding foreign
exchange $ (88) $ 24 $ 66 $ 192 $ 463 $ 397 $ 169 $ (221) $(1,883) $ (896) $ ---
====== ====== ====== ====== ====== ====== ====== ====== ======= ====== ======
(In millions) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
----------------------------------------------------------------------------------------------
Balance at December 31 - gross..... $4,815 $5,312 $6,020 $11,145 $10,869 $10,936 $15,342 $17,435 $16,932 $20,882
Less reinsurance recoverables...... (824) (787) (949) (1,794) (1,411) (1,822) (2,847) (4,225) (4,730) (8,579)
------ ------ ------ ------- ------- ------- ------- ------- ------- -------
Balance at December 31 - net....... 3,991 4,525 5,071 9,351 9,458 9,114 12,495 13,210 12,202 12,303
------ ------ ------ ------- ------- ------- ------- ------- ------- -------
Latest re-estimated liability -
gross........................... 5,079 5,546 5,958 9,724 9,888 10,336 15,520 20,340 19,364 ---
Less re-estimated reinsurance
recoverables.................... (1,133) (1,085) (1,104) (1,544) (1,499) (1,735) (3,533) (5,836) (6,050) ---
------ ------ ------ ------- ------- ------- ------- ------- ------- -------
Latest re-estimated liability -
net............................ 3,946 4,461 4,854 8,180 8,389 8,601 11,987 14,504 13,314 ---
------ ------ ------ ------ ------ ------ ------- ------- ------- -------
Gross redundancy (deficiency)...... (264) (234) 62 1,421 981 600 (178) (2,905) (2,432) ---
Effect of foreign exchange (1)..... (30) (3) (35) (859) (816) (402) (1,091) (934) 382 ---
------- ------ ------ ------ ------- ------- ------- ------- ------- ------
Gross redundancy (deficiency),
excluding foreign exchange...... $ (294) $ (237) $ 27 $ 562 $ 165 $ 198 $(1,269) $(3,839) $(2,050) $ ---
====== ====== ====== ====== ======= ======= ======= ======= ======= =======
(1) The results of the Company's international operations translated from
functional currencies into U.S. dollars are included with the Company's
U.S. underwriting operations in this table. The foreign currency
translation impact on the cumulative redundancy (deficiency) arises from
the difference between reserve developments translated at the exchange
rates at the end of the year in which the liabilities were originally
estimated and the exchange rates at the end of the year in which the
liabilities were re-estimated.
Note: For a description of the purpose of the above table and the various table
sections, please refer to the immediately preceding section entitled "Reserve
Development."
7
A number of major trends that occurred within the insurance industry, the
economy in general and several Company-specific factors have had a significant
effect on the Company's liabilities for unpaid claims and claim expenses during
the period covered by the preceding table.
Claims and claim expense reserve development in the mid 1980's reflected the
inadequate premium rates which resulted from intense competition in the market
during that period. In the late 1980's, the reinsurance market generally reacted
to the rate deficiencies and the resulting claims and claim expense reserve
development by increasing rates and strengthening claims and claim expense
reserves. This is reflected, with respect to the Company, in the significant
improvements in the overall reserve adequacy in the early 1990's. The increase
in reserve redundancies indicated for 1995 through 1997 is attributable to the
favorable claim environment that existed during that period.
The indicated deficiency in the 1998 reserve position is attributable to higher
than normal claim and claim expense development across a number of lines of
business, including property coverages (which was most highly impacted by much
higher than expected industry-wide losses with respect to Hurricane Georges),
long-term disability and communications/media liability.
The significant indicated deficiency that has developed with respect to the 1999
recorded reserves is primarily attributable to the combination of the effects of
continued insufficient pricing within the overall property and casualty
insurance/reinsurance industry and the insurance industry's undervaluing the
initial loss estimates for certain European windstorms occurring late in
December 1999. Based on the continued escalation in reported losses relative to
associated premiums, it became more apparent during 2000 that the level of
general price erosion that occurred in the primary property and casualty
insurance industry in recent years was significantly greater than had been
previously contemplated. In response to this new information, it became
necessary for the Company to increase claim reserves to reflect the higher
ultimate loss projections resulting from this increasing trend of claim
development on these more recent underwriting years.
Unfortunately, the escalation in reported losses relative to associated premiums
that emerged in 2000 continued in 2001, and at a pace greater than had been
anticipated in the actuarial reserve studies completed in late 2000. As a
result, in 2001, it again became necessary for the Company to increase claim
reserves to reflect the higher ultimate loss projections for prior year loss
events. The majority of the adverse development in 2001, and to a lesser extent
in 2000, related to higher projected losses on liability coverages, especially
in the hospital liability, nonstandard automobile (automobile insurance extended
to higher-risk drivers) and commercial general liability lines of business. The
total adverse development on prior year loss events recognized in 2001
aggregated approximately $800 million.
To a lesser degree, development of asbestos and environmental claims has
affected the Company's results. Higher than anticipated levels of inflation in
certain lines of reinsurance businesses has also had an adverse effect on
liabilities for claims and claim expenses, particularly in excess of loss
reinsurance.
8
The Company's reconciliation of its beginning and ending property and casualty
reserves for unpaid claims and claim expenses on a GAAP basis is summarized as
follows:
Year ended December 31,
-----------------------------------
(In millions) 2001 2000 1999
-----------------------------------
Balance at January 1 - gross............................. $16,932 $17,435 $15,342
Less reinsurance recoverables............................ (4,730) (4,225) (2,847)
------- ------- -------
Balance at January 1 - net............................... 12,202 13,210 12,495
------- ------- -------
Claims and expenses incurred:
Current year.......................................... 4,579 4,401 4,162
Prior years........................................... 811 934 233
------- ------- -------
5,390 5,335 4,395
------- ------- -------
Claims and expenses paid:
Current year.......................................... (761) (1,290) (1,228)
Prior years........................................... (4,758) (4,811) (2,867)
------- ------- -------
(5,519) (6,101) (4,095)
------- ------- -------
Claim reserves related to acquired companies............. - 279 793
Claim reserves related to disposed companies............. - - (202)
Foreign exchange and other............................... 230 (521) (176)
------- ------- -------
Balance at December 31 - net............................. 12,303 12,202 13,210
Add reinsurance recoverables............................. 8,579 4,730 4,225
------- ------- -------
Balance at December 31 - gross........................... $20,882 $16,932 $17,435
======= ======= =======
The liabilities for claims and claim expenses in the preceding table include
long-term disability claims that are discounted at a 6% rate for all years
presented. As a result of discounting the Company's long-term disability claims,
total liabilities for claims and claim expenses have been reduced by an
estimated 1% at December 31, 2001 and 2000. The accretion of discount is
included in current operating results as part of the development of prior year
liabilities. Discounts amortized as a percentage of claims, claim expenses and
policy benefits were less than 1% for each of the years ended December 31, 2001,
2000 and 1999.
The Company's reconciliation of its property and casualty reserves for unpaid
claims and claim expenses between statutory basis and GAAP basis is summarized
as follows:
December 31,
------------------------------------------------
(In millions) 2001 2000 1999
---------------- --------------- ---------------
Statutory basis reserves for U.S. companies - net......... $ 5,786 $ 6,213 $ 7,204
Adjustments to arrive at GAAP basis (1)................... 664 500 636
------- ------- -------
GAAP basis reserves for U.S. companies - net.............. 6,450 6,713 7,840
GAAP basis reserves for non-U.S. companies - net.......... 5,853 5,489 5,370
------- ------- -------
Total GAAP basis reserves - net........................... 12,303 12,202 13,210
Add reinsurance recoverables.............................. 8,579 4,730 4,225
------- ------- -------
GAAP basis reserves - gross............................... $20,882 $16,932 $17,435
======= ======= =======
(1) Statutory basis reserve offsets and reserves reclassified to contract
deposit assets or liabilities based on risk transfer provisions of SFAS No.
113.
9
Asbestos and Environmental Exposure. Included in the Company's liability for
claims and claim expenses are liabilities for asbestos and environmental
exposures. These claims and claim expenses are primarily related to policies
written prior to 1986 as the policies written since 1986 have tended to
explicitly exclude asbestos and environmental risks from coverage and most of
the asbestos and environmental exposures arise from risks located in the United
States.
The three-year development of claims and claim expense reserves associated with
the Company's asbestos and environmental claims, including case and IBNR
reserves, is summarized as follows:
Year ended December 31,
--------------------------------------------
(In millions) 2001 2000 1999
-------------- -------------- --------------
Balance at January 1 - gross.............................. $829 $800 $995
Less reinsurance recoverables............................. (183) (195) (206)
---- ---- ----
Balance at January 1 - net................................ 646 605 789
Claims and expenses incurred.............................. 23 99 (7)
Claims and expenses paid.................................. (48) (58) (210)
Claim reserves related to acquired companies.............. - - 33
---- ---- ----
Balance at December 31 - net.............................. 621 646 605
Add reinsurance recoverables.............................. 165 183 195
---- ---- ----
Balance at December 31 - gross............................ $786 $829 $800
==== ==== ====
The amounts in the preceding table are management's best estimate, based on
currently available information, of claims and claim expense payments and
recoveries for asbestos and environmental exposures that are expected to develop
in future years.
The Company monitors evolving case law and its effect on asbestos-related
illness and toxic waste cleanup claims. Changing domestic and foreign government
regulations and legislation, including continuing congressional consideration of
federal Superfund legislation, newly reported claims, new contract
interpretations and other factors could significantly affect future claim
development. While the Company has recorded its best estimate of its liabilities
for asbestos-related illness and toxic waste cleanup claims based on currently
available information, it is possible that additional liabilities may arise in
the future. It is not possible to estimate with any certainty the amount of
additional net claims and claim expenses, or the range of net claims and claim
expenses, if any, that is reasonably possible; therefore, there can be no
assurance that future liabilities will not materially affect the Company's
results of operations, financial position or cash flows.
Other Mass Tort Exposures. In addition to asbestos and environmental exposures,
the Company also may have exposures to other mass torts involving primarily
product liability issues such as tobacco products, gun manufacturers and
silicone breast implants. The Company has, in the past, generally avoided the
products liability reinsurance business, and, based on currently available
information, future liabilities resulting from these matters are not expected to
be material to the Company's results of operations, financial position or cash
flows.
Life and Health Reserves for Future Policy Benefits and Accumulated Contract
Values
Future policy benefits for traditional life and health reinsurance contracts
represent the present value of such benefits based on mortality and other
assumptions which were appropriate at the time the policies were issued or, in
the event the policies were acquired by the Company from another insurer, at the
date of acquisition. Interest rate assumptions used in calculating the present
value generally ranged from 3-9% per annum at December 31, 2001. Payments
received from sales of universal life and investment contracts are recognized by
providing liabilities equal to the accumulated contract values of the
policyholders' contracts. Interest rates credited to such universal life and
investment contracts are generally guaranteed for a specified time period with
renewal rates determined by the issuing insurance company. Such crediting
interest rates ranged from 3-9% per annum in 2001.
10
Regulatory Matters
GE Global Insurance and its domestic subsidiaries are subject to regulation
under the insurance statutes, including insurance holding company statutes, of
various states, including Missouri, Kansas, Illinois and Indiana, the
domiciliary states of GE Global Insurance's principal domestic insurance company
subsidiaries. The international subsidiaries of Employers Reinsurance
Corporation (the "GE Frankona Re Group") are subject to regulation under
insurance statutes of various foreign countries.
General. The regulation and supervision to which GE Global Insurance's
subsidiaries are subject relate primarily to licensing requirements of
reinsurers, the standards of solvency that must be met and maintained, the
amount of dividends that may be paid by such subsidiaries, the nature of and
limitations on investments, restrictions on the size of risks that may be
insured or reinsured, deposits of securities for the benefit of ceding
companies, periodic examinations of the financial condition and affairs of
reinsurers, the form and content of financial statements required to be filed
with regulatory authorities and reserves for unearned premiums, losses and other
purposes. In general, such regulation is for the protection of the ceding
companies and, ultimately, their policyholders, rather than security holders of
the regulated reinsurer. GE Global Insurance believes it is, and that its
subsidiaries are, in material compliance with all applicable laws and
regulations pertaining to their business and operations.
U.S. Insurance Regulation. U.S. domestic property and casualty and life
insurers, including reinsurers, are subject to regulation by their states of
domicile and by those states in which they are licensed. The rates and policy
terms of primary insurance policies generally are closely regulated by state
insurance departments. While reinsurance is not regulated as closely as primary
insurance, some states do impose control over certain terms and conditions of
reinsurance agreements by virtue of their authority to grant or deny credit for
ceded reinsurance by its domiciled primary insurers. In addition, as a practical
matter, the rates permitted to be charged by primary insurers can have an effect
on the rates that are charged by reinsurers.
Effective January 1, 2001, the National Association of Insurance Commissioners
("NAIC") required that insurance companies prepare their statutory basis
financial statements in accordance with the NAIC Accounting Practices and
Procedures Manual subject to any deviations prescribed or permitted by the
domiciliary state insurance departments. Statutory accounting practices
determine, among other things, the statutory surplus of an insurance company
and, therefore, the amount of funds that can be paid as dividends. For statutory
reporting purposes, accounting changes adopted to conform to these accounting
practices are reported as changes in accounting principles, with the cumulative
effect reported as an adjustment to 2001 unassigned funds (surplus). The
cumulative effect is the difference between the amount of capital and surplus at
the beginning of the year and the amount of capital and surplus that would have
been reported at that date if the new accounting principles had been applied
retroactively for all periods. As a result of adoption of the model statutory
accounting practices, aggregate cumulative adjustments totaling $234 million
were recorded by Employers Reinsurance Corporation ("ERC"), GE Reinsurance
Corporation ("GE Re") and Medical Protective as an increase to unassigned funds
(surplus) at January 1, 2001, primarily related to the recording of deferred tax
assets.
Risk-Based Capital. The NAIC has adopted minimum risk-based capital requirements
to evaluate the adequacy of statutory capital and surplus in relation to an
insurance company's risks. Regulatory compliance with risk-based capital
requirements is defined by a ratio of a company's regulatory total adjusted
capital to its authorized control level risk-based capital, as defined by the
NAIC. At December 31, 2001, each of GE Global Insurance's domestic insurance
company subsidiaries exceeded the minimum risk-based capital requirements.
Insurance Holding Company Regulations. The insurance holding company laws and
regulations vary from state to state, but generally require an insurance holding
company to register with its domiciliary state insurance regulatory agency and
file certain reports that include current information concerning the capital
structure, ownership, management, financial condition and general business
operations of the insurance holding company and its subsidiary insurers that are
licensed in the state. State insurance holding company laws and regulations,
with respect to domestic insurers, also require prior notice or regulatory
approval of changes in control of an insurer or its holding company and of
material inter-affiliate transactions within the holding company structure.
11
Dividends by Subsidiaries. Because the operations of GE Global Insurance are
conducted primarily through ERC, GE Re and Medical Protective, GE Global
Insurance is dependent upon dividends, tax allocation and other payments
primarily from ERC, GE Re and Medical Protective to service its debt and meet
its other obligations. The payment of dividends and other payments to GE Global
Insurance by ERC, GE Re and Medical Protective are subject to limitations
imposed by the Missouri, Illinois and Indiana Insurance Codes, respectively. The
payment of dividends to ERC by its principal life reinsurance subsidiaries,
Employers Reassurance Corporation and ERC Life Reinsurance Corporation, are
subject to limitations imposed by the Kansas and Missouri Insurance Codes,
respectively. No prediction can be made as to whether any legislative proposals
relating to dividend rules in Kansas, Missouri, Illinois or Indiana will be
made, whether any such legislative proposal will be adopted in the future, or
the effect, if any, any such proposal would have on the Company.
The maximum amount available for the payment of dividends by ERC without prior
regulatory approval is $273 million at December 31, 2001. Such amount will
increase to $341 million by December 31, 2002. Of this amount, $88 million is
committed to pay dividends on the preferred stock issued by ERC to GE Capital
Corporation. GE Re will not be able to make any dividend payments during 2002
without the prior approval of the Director of Insurance for the State of
Illinois. The maximum amount available for the payment of dividends during 2002
by Medical Protective without prior regulatory approval is $74 million after
December 27, 2002.
International Regulations. Based on 2001 net premiums written, approximately 39%
of the Company's business is carried on outside of the United States. The degree
of regulation and supervision in foreign jurisdictions varies from minimal in
some to stringent in others. Licenses issued by foreign authorities to the GE
Frankona Re Group are subject to modification or revocation by such authorities,
and such subsidiaries could be prevented from conducting business in certain of
the jurisdictions where they currently operate. In the past, the GE Frankona Re
Group has been allowed to modify their operations to conform with new licensing
requirements in all jurisdictions that are material to the Company's
international operations.
In addition to licensing requirements, the GE Frankona Re Group is regulated in
various jurisdictions with respect to, among other things, currency, policy
language and terms, methods of accounting and auditing, amount and type of
security deposits, amount and type of reserves, amount and type of local
investment and the share of profits to be returned to policyholders on
participating policies. Regulations governing constitution of technical reserves
(including equalization reserves) in some countries could hinder the remittance
of profits and repatriation of assets and the payment of dividends; however, the
Company does not believe that these regulations will have a material impact on
the GE Frankona Re Group's operations.
Effective January 1, 2001, certain of the Company's international operations
(licensed in the European Union ("EU") member states) are required to comply
with the EU Directive on Supplementary Supervision of Insurance Undertakings in
an Insurance Group. This directive is designed to address solvency issues for
groups of insurance companies and supplements the solvency tests historically
performed on individual insurance companies. The main goal of this directive is
to assess the overall capital available to the group, rather than on an
individual company basis, and identify potential risks. The Company is currently
in the process of performing such required solvency tests in anticipation of the
first filing in 2002.
Item 2. Properties.
The Company conducts business from various facilities, most of which are leased.
In addition, the Company owns its administrative offices in Overland Park,
Kansas, Fort Wayne, Indiana and Munich, Germany.
12
Item 3. Legal Proceedings.
There are no pending legal proceedings beyond the ordinary course of business
that in the opinion of the Company's management, based on information available
at the date of this report, would have a material adverse effect on the
Company's consolidated results of operation or financial condition, except as
noted in the following paragraph.
As a result of the September 11, 2001 terrorist attacks, both towers of the
World Trade Center in New York City ("WTC") were completely destroyed.
Industrial Risk Insurers ("IRI"), an affiliate of ERC, was one of the primary
insurers of the WTC with an occurrence policy limit of $237 million. In
addition, ERC reinsured part of the various other primary insurers of the WTC,
limits of which are also written on a per occurrence basis. The principal lessee
of the WTC is alleging that the damage to (i.e., the loss of) each tower was a
separate occurrence. It is the contention of all insurers of the WTC that the
policies were written in such a way that the loss of both towers in this
instance constituted one occurrence. Suit has been filed in the United States
District Court in New York seeking a declaratory judgment on this question. IRI
is a party to this suit, as are several of ERC's reinsureds. Discovery in the
suit(s) is underway. Both IRI and ERC have retrocessional coverage on their
exposure to WTC losses covering a portion of losses incurred. Management
believes that there is compelling evidence supporting their contention that the
loss of both towers constituted a single occurrence of loss and is prepared to
defend this position vigorously (including litigation if required) and,
accordingly, has established claim reserves on this basis.
Item 4. Submission of Matters to a Vote of Security Holders.
Omitted
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
Matters.
All of the common stock of GE Global Insurance, its sole class of common equity
on the date hereof, is owned by GE Capital Services. Accordingly, there is no
public trading market for the Company's common equity.
Item 6. Selected Financial Data.
Consolidated Financial Data
Year ended December 31,
-----------------------------------------------------------------
(In millions) 2001 2000 1999 1998 1997
-----------------------------------------------------------------
Total revenues............................... $9,191 $10,131 $ 9,031 $ 7,203 $ 5,784
Net Premiums Written......................... 7,392 8,191 7,147 5,984 4,545
Net investment income........................ 1,202 1,315 1,151 985 910
Net realized gains on investments............ 436 522 699 432 303
Earnings (loss) before income taxes and
cumulative effect of change in
accounting principle ..................... (466) 605 988 1,070 882
Net earnings (loss).......................... (195) 581 720 779 648
Total investments............................ 22,495 21,191 21,539 21,987 18,343
Total assets................................. 45,118 38,564 37,561 35,047 27,532
Stockholder's equity......................... $ 6,362 $ 6,025 $ 5,575 $ 6,020 $ 5,374
Return on equity (average)................... (3.1%) 10.0% 12.4% 13.7% 12.8%
Stockholder's equity, excluding unrealized
gains (losses) on investment securities... $ 6,339 $ 5,882 $ 5,524 $ 5,088 $ 4,628
Return on equity (average), excluding
unrealized gains (losses) on investment
securities................................ (3.2%) 10.2% 13.6% 16.0% 14.6%
13
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Overview
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Net premiums written and net premiums earned decreased $798 million (or 10%) and
$816 million (also 10%), respectively, in 2001. The majority of this decrease is
attributable to the $698 million of premiums ceded in connection with the events
of September 11 as discussed below. The remaining decrease in premiums is
attributable to (1) the decision to exit certain lines of business and customer
relationships as part of a reunderwriting initiative undertaken in 2000/2001 and
(2) additional ceded premiums resulting from claims made on prior year
retrocession coverages in place as a result of the adverse development on prior
year losses recognized in 2001, somewhat offset by general growth in premiums
due to the combination of recent hardening of pricing within the overall
property and casualty insurance/reinsurance industry and a focus on growth
within certain niche markets.
Excluding the decrease in net premiums earned, the remaining revenue categories
decreased $124 million, principally as a result of lower levels of investment
income resulting from the general decline in interest rates in 2001 and a
reduction in net realized gains on investments, somewhat offset by an increase
in other revenues.
GE Global Insurance incurred a loss before cumulative effect of change in
accounting principle (see further discussion of this accounting change in note 2
to the accompanying consolidated financial statements) of $184 million in 2001,
as compared to earnings of $581 million in 2000. Operating results for 2001 as
compared to 2000 were adversely impacted by approximately $575 million related
to the insurance losses arising from the events of September 11. This amount,
which primarily resulted from contingent premium payments contained in certain
retrocession agreements, comprises $698 million recorded as a reduction in net
premiums earned, and $78 million reflecting additional claims, claim expenses
and policy benefits, partially offset by $201 million reflecting a reduction in
insurance acquisition costs. The gross losses arising from the events of
September 11 (estimated to be $3.3 billion) relate to underlying insurance
policies and reinsurance contracts providing general property, general
liability, aviation, business interruption, workers compensation and life and
health-related coverages. Historical experience related to large catastrophic
events has shown that a broad range of total insurance industry loss estimates
often exists following such an event and it is not unusual for there to be
significant subsequent revisions in such estimates. $575 million is management's
best estimate of its existing net liability based on the information currently
available, and is net of estimated recoveries under retrocession arrangements,
under which a portion of losses is routinely ceded to other reinsurance
entities. Further information regarding potential litigation associated with the
events of September 11 is discussed in note 13 to the consolidated financial
statements.
The Company's retrocession program includes aggregate excess of loss coverages
in which accident year losses exceeding a specified loss ratio are ceded to
retrocessionaires. These contracts also contain contingent premium provisions
whereby the Company is required to cede additional premiums equal to a specified
portion of the covered losses. As described in the preceding paragraph, the
accident year losses incurred in 2001, primarily as a result of the insurance
losses arising from the events of September 11, exceeded the specified loss
ratio and, accordingly, accruals for reinsurance recoverables and ceded premium
payables were reflected in the accompanying consolidated financial statements in
accordance with the terms of the underlying retrocession contracts. The
associated accrued reinsurance recoverables will be collected when the
underlying paid losses exceed the specified loss ratios.
Substantially all of the Company's retrocessionaires are large, highly rated
reinsurance entities. At this time, management does not anticipate that any
significant portion of its estimated recoveries will be uncollectible.
Operating results in 2001 were also adversely affected by the continued
deterioration of underwriting results, reflecting higher property and
casualty-related losses (principally as a result of adverse development relating
to prior-year loss events) and the continued effects of low premiums in the
property and casualty insurance/reinsurance industry in recent years. As the
Company's underwriting results in 2001, typical of the global property and
casualty industry, were realized, management began underwriting initiatives that
increased premium prices for given levels of coverage. These initiatives
resulted in management reconsidering and clarifying the product lines, policies,
contracts and specific customers for which, given the risk, acceptable future
levels of profit seem achievable. For these businesses, the Company has sought
to retain or even expand its business. On the other hand, management has
identified particular property and casualty business channels from which returns
do not appear to justify the risks. For these channels, new business will be
significantly curtailed or exited.
14
The majority of the adverse development in 2001 related to higher projected
ultimate losses for liability coverages, especially in the hospital liability,
nonstandard automobile (automobile insurance extended to higher-risk drivers)
and commercial general liability lines of business.
Income tax benefits partially offset the significant pre-tax operating loss
generated in 2001. Such recorded tax benefits include the impact of the Company
holding a significant portion of its overall investment portfolio in securities
that are substantially exempt from U.S. taxation and the treatment of certain
proceeds received in connection with the resolution of issues involving a
previous acquisition as a purchase price adjustment for tax purposes.
Year Ended December 31, 2000 Compared to Year Ended December 31, 1999
Net premiums written increased $1,044 million or 15% in 2000, primarily
attributable to the combination of hardening pricing within the overall property
and casualty insurance/reinsurance industry, a focus on growth within the niche
direct commercial market and the impact of a full year of operating activity for
the March 1999 acquisition of Eagle Star Re. This growth was somewhat offset by
the 2000 decisions to exit certain lines of business and customer relationships
as part of a reunderwriting initiative undertaken during the year, an increase
in contingently payable ceded premiums related to recorded recoveries under
aggregate excess retrocession programs and the impact of foreign currency
translation in connection with the continued strengthening of the U.S. dollar
compared to most major European currencies.
Net earnings decreased $139 million or 19% in 2000, including a decrease in
after-tax net realized gains on investments of $100 million. Excluding after-tax
net realized gains on investments, net earnings decreased $39 million or 14% in
2000. This decrease reflects deterioration of underwriting results, including
adverse development on prior year recorded losses. The significant level of
adverse development on prior year recorded losses is primarily attributable to
the combination of the effects of continued insufficient pricing within the
overall property and casualty insurance/reinsurance industry and the insurance
industry's undervaluing the initial loss estimates for certain European
windstorms occurring late in December 1999. Based on the continued escalation in
reported losses relative to associated premiums, it became more apparent during
2000 that the level of general price erosion that occurred in the primary
property and casualty insurance industry in recent years was significantly
greater than had been previously contemplated. In response to this new
information, it became necessary for the Company to increase claim reserves to
reflect the higher ultimate loss projections resulting from this increasing
trend of claim development on these more recent underwriting years.
Partially offsetting these reductions in net earnings were: (1) an increase in
net investment income due to the combination of higher average investment yields
(as a result of the increasing U.S. interest rate environment throughout most of
2000) and repositioning of the investment portfolio to include a higher
proportion of fixed maturity securities and (2) tax benefits attributable to a
step-up in the tax basis of certain assets following the conversion of a
corporate subsidiary to a partnership for German tax purposes.
15
Domestic Property and Casualty Business
Year ended December 31,
-------------------------------
(In millions) 2001 2000 1999
-------------------------------
Net premiums written........................... $3,687 $3,801 $3,370
Net underwriting loss.......................... (1,305) (419) (423)
Net investment income.......................... 530 606 513
Earnings (loss) before income taxes and
cumulative effect of change in accounting
principle.................................. (586) 250 533
Net realized gains on investments.............. 268 128 516
Earnings (loss) before income taxes and
cumulative effect of change in accounting
principle, excluding net realized gains
on investments............................. (854) 122 17
GAAP ratios (1):
GAAP claims and claim expense ratio......... 102.2% 77.4% 79.5%
GAAP underwriting expense ratio............. 33.1% 34.4% 33.6%
----- ----- -----
GAAP combined ratio......................... 135.3% 111.8% 113.1%
===== ===== =====
(1) Represents data for the applicable periods calculated in accordance with
GAAP. Claims and claim expense ratio represents incurred claims and
claim expenses as a percentage of net premiums earned. Underwriting
expense ratio represents acquisition costs and other underwriting
expenses (excluding amortization of intangibles, interest expense and
minority interest in net earnings of consolidated subsidiaries) as a
percentage of net premiums earned. The combined ratio represents the sum
of the claims and claim expense ratio and the underwriting expense ratio.
Net premiums written decreased $114 million or 3% in 2001, primarily
attributable to (1) higher levels of ceded losses under aggregate excess
retrocession programs (both current year principally as a result of the events
of September 11 and prior years due to continued adverse claim development) and
(2) the decision to exit certain lines of business and customer relationships as
part of a reunderwriting initiative undertaken in 2000/2001, somewhat offset by
general growth in premiums due to the combination of recent hardening of pricing
within the overall property and casualty insurance/reinsurance industry and a
focus on growth within certain niche markets. Net premiums written increased
$431 million or 13% in 2000, primarily attributable to the combination of
hardening pricing within the overall property and casualty insurance/reinsurance
industry and a focus on growth within the niche direct commercial market. This
increase was partially offset by the 2000 decision to exit certain lines of
business and customer relationships as part of a reunderwriting initiative
undertaken during the year and higher levels of ceded premiums under aggregate
excess retrocession programs.
Typically, the underwriting performance of property and casualty business is
measured in terms of a combined ratio. The combined ratio is the sum of the loss
ratio and the underwriting expense ratio, with a ratio lower than 100%
indicating an underwriting profit and a ratio greater than 100% indicating an
underwriting loss. Although the combined ratio has been greater than 100% for
the three years presented above, the operating results of insurance/reinsurance
companies include net investment income which generally yields an overall
operating profit.
The significant increase in the 2001 combined ratio is partially attributable to
higher levels of ceded premiums and incurred losses resulting from the events of
September 11. Excluding this impact, the 2001 combined ratio would have been
126.6%. The relatively high combined ratios in 2001 (excluding the impact of the
events of September 11), 2000 and 1999 primarily reflect the effects of
continued insufficient pricing within the overall property and casualty
insurance/reinsurance industry in recent years and adverse development on prior
year recorded losses. The majority of the adverse development in 2001 related to
higher projected ultimate losses for liability coverages, especially in the
hospital liability, nonstandard automobile (automobile insurance extended to
higher-risk drivers) and commercial general liability lines of business.
Net investment income decreased $76 million or 13% in 2001, primarily
attributable to the general decline in interest rates during 2001. Net
investment income increased $93 million or 18% in 2000, primarily attributable
to the combination of higher average investment yields (as a result of the
increasing U.S. interest rate environment throughout most of 2000) and
repositioning of the investment portfolio to include a higher proportion of
fixed maturity securities.
16
Earnings (loss) before income taxes and cumulative effect of change in
accounting principle, excluding net realized gains on investments, decreased
$976 million in 2001, primarily attributable to the increase in the combined
ratio (including the significant impact of the events of September 11) and the
decrease in net investment income discussed above. Earnings before income taxes
and cumulative effect of change in accounting principle, excluding net realized
gains on investments, increased $105 million in 2000, primarily attributable to
the decrease in the combined ratio and the increase in net investment income
discussed above.
International Property and Casualty Business
Year ended December 31,
------------------------------
(In millions) 2001 2000 1999
------------------------------
Net premiums written............................ $1,864 $2,754 $2,513
Net underwriting loss........................... (618) (509) (238)
Net investment income........................... 303 347 340
Earnings (loss) before income taxes
and cumulative effect of change in
accounting principle....................... (140) 117 211
Net realized gains on investments............... 112 297 101
Earnings (loss) before income taxes and
cumulative effect of change in accounting
principle, excluding net realized gains
on investments............................... (252) (180) 110
GAAP ratios (1):
GAAP claims and claim expense ratio.......... 100.5% 91.6% 76.3%
GAAP underwriting expense ratio.............. 38.1% 26.4% 33.6%
----- ----- -----
GAAP combined ratio............................ 138.6% 118.0% 109.9%
===== ===== =====
(1) Represents data for the applicable periods calculated in accordance with
GAAP. Claims and claim expense ratio represents incurred claims and
claim expenses as a percentage of net premiums earned. Underwriting expense
ratio represents acquisition costs and other underwriting expenses
(excluding amortization of intangibles, interest expense and minority
interest in net earnings of consolidated subsidiaries) as a percentage of
net premiums earned. The combined ratio represents the sum of the claims
and claim expense ratio and the underwriting expense ratio.
Net premiums written decreased $890 million or 32% in 2001, primarily
attributable to (1) higher levels of ceded losses under the aggregate excess
retrocession program principally as a result of the events of September 11 and
(2) the decision to exit certain lines of business and customer relationships as
part of a reunderwriting initiative undertaken in 2000/2001, somewhat offset by
general growth in premiums due to the combination of recent hardening of pricing
within the overall property and casualty insurance/reinsurance industry. Net
premiums written increased $241 million or 10% in 2000, primarily attributable
to the combination of hardening pricing within the overall property and casualty
insurance/reinsurance industry and the impact of a full year of operating
activity for the March 1999 acquisition of Eagle Star Re. This increase was
somewhat offset by the 2000 decision to exit certain lines of business and
customer relationships as part of a reunderwriting initiative undertaken during
the year.
Consistent with experience in the domestic property and casualty business, the
significant increase in the 2001 combined ratio is primarily attributable to
higher levels of ceded premiums and incurred losses resulting from the events of
September 11. Excluding this impact, the 2001 combined ratio would have been
114.8%. The relatively high combined ratios in 2001 (excluding the impact of the
events of September 11), 2000 and 1999 primarily reflect the effects of
continued insufficient pricing within the overall property and casualty
insurance/reinsurance industry in recent years and adverse development on prior
year recorded losses. The increase in the combined ratio in 2000 includes the
impact of significant adverse development relating to certain European
windstorms occurring late in 1999.
Net investment income decreased $44 million or 13% in 2001, primarily
attributable to the general decline in interest rates during 2001. Net
investment income increased $7 million or 2% in 2000, primarily attributable to
the repositioning of the investment portfolio to include a higher proportion of
fixed maturity securities.
17
Earnings (loss) before income taxes and cumulative effect of change in
accounting principle, excluding net realized gains on investments, decreased $72
million in 2001, primarily attributable to the increase in the combined ratio
(including the significant impact of the events of September 11) and the
decrease in net investment income discussed above. Earnings before income taxes
and cumulative effect of change in accounting principle, excluding net realized
gains on investments, decreased $290 million in 2000, primarily attributable to
the significant increase in the combined ratio discussed above.
Life Reinsurance Business
Year ended December 31,
-------------------------
(In millions) 2001 2000 1999
-------------------------
Revenues....................................... $2,466 $2,207 $1,789
Earnings before income taxes and cumulative
effect of change in accounting
accounting principle ....................... 260 238 244
Revenues, which consist of net premiums earned, net investment income, net
realized gains on investments and other revenues, including fees generated from
investment-related life reinsurance products and financial reinsurance
transactions, increased $259 million or 12% in 2001. This increase was primarily
attributable to growth in the international traditional life and health business
(principally in Europe and Latin America), somewhat offset by a decrease in net
realized gains on investments. Revenues increased $418 million or 23% in 2000.
This increase was primarily attributable to growth in the domestic traditional
life and credit life business and an increase in net realized gains on
investments.
Earnings before income taxes and cumulative effect of change in accounting
principle increased $22 million or 9% in 2001, including a $41 million decrease
in net realized gains on investments. Excluding net realized gains on
investments, earnings before income taxes and cumulative effect of change in
accounting principle increased $63 million or 45% in 2001, primarily
attributable to the increase in revenues discussed above and more favorable
claim experience as compared to 2000 (particularly in the international
individual disability line of business). Earnings before income taxes and
cumulative effect of change in accounting principle decreased $6 million or 2%
in 2000, including a $15 million increase in net realized gains on investments.
Excluding net realized gains on investments, earnings before income taxes and
cumulative effect of change in accounting principle decreased $21 million or 13%
in 2000, primarily attributable to an increase in claims experience.
Liquidity and Capital Resources
GE Global Insurance's ability to meet its obligations, including debt service
and operating expenses, and pay dividends to its shareholder depends primarily
upon the receipt of sufficient funds from its insurance subsidiaries. The
payment of dividends by ERC, GE Re and Medical Protective are subject to
restrictions set forth in the insurance laws of Missouri, Illinois and Indiana,
respectively, as well as other restrictions. Historically, the Company's
liquidity requirements have been met by funds provided from operations and from
the maturity and sales of investments.
Cash flows from operating activities, which primarily consists of premiums
collected during the period and payments made for claims and claim expenses,
increased $74 million in 2001, primarily attributable to a decrease in claim
settlements relative to the collection of premiums, somewhat offset by an
increase in reinsurance recoverables under the Company's aggregate excess
retrocession programs. Cash flows from operating activities decreased $1,030
million in 2000, primarily as a result of an escalation in claim-related
payments attributable to higher levels of incurred claims and claim expenses in
recent years.
Cash flows from investing activities decreased $1,307 million in 2001, primarily
attributable to a net increase in the purchase of investment securities as a
result of the cash inflows from higher volumes of contract deposits within the
life reinsurance operations and the capital contributions discussed below under
cash flows from financing activities. Cash flows from investing activities
increased $447 million in 2000, primarily attributable to a net decrease in the
purchases of investment securities as a result of the decrease in operating cash
flows discussed above.
18
Cash flows from financing activities increased $944 million in 2001, primarily
attributable to an increase in contract deposit liabilities resulting from
growth within the life reinsurance business segment and capital contributions
received to replenish capital sufficient to cover losses associated with the
events of September 11, somewhat offset by a decrease in short-term borrowings.
Cash flows from financing activities increased $520 million in 2000, primarily
attributable to the following factors: (1) an increase in short-term borrowings,
(2) a reduction in dividends paid on common stock and (3) an increase in
contract deposit liabilities resulting from growth in financial reinsurance
business volumes. The $691 million of proceeds from long-term borrowings in 2000
were substantially all used to repay outstanding borrowings under an interim
loan agreement with GE Capital Corporation used to fund the Company's 1998
acquisition of Medical Protective.
The Company has a one-year $600 million revolving credit agreement with GE
Capital Services which enables the Company to borrow from GE Capital Services at
an interest rate per annum equal to GE Capital Services' cost of funds for a one
year period. The agreement is automatically extended for successive terms of one
year each unless terminated in accordance with terms of the agreement. The total
amount outstanding on this credit facility, including accrued interest payable,
was $108 million and $129 million as of December 31, 2001 and 2000,
respectively.
Off-Balance Sheet Arrangements
The Company has not utilized forms of off-balance sheet arrangements, such as
asset securitizations, involving special purpose entities to facilitate improved
share owner returns and securities transactions, transfer selected credit risk,
or engage in speculative activities and has not provided financial support to
special purpose entities under any liquidity or credit support agreements.
Investments
General. The Company follows a conservative investment strategy that emphasizes
maintaining a high quality investment portfolio. The primary goals include a
growing stream of investment income and improving total investment returns. All
investments are administered under guidelines established and approved by the
Company's Board of Directors. The Company's guidelines specify credit quality
and concentration limits with respect to both fixed maturity and equity
securities.
In structuring its fixed maturity portfolios, the Company considers the duration
of its assets and claims and claim expense reserves. Most fixed maturity
portfolios have total return benchmarks against which relative performance is
measured. The total return benchmarks include investment income and realized and
unrealized gains and losses on investments. Equity portfolios are managed for
total return and performance is measured against equity benchmarks.
On a worldwide basis, based on data as of December 31, 2001, the Company manages
73% of its investments internally. GE Asset Management Incorporated, an
affiliate of the Company, manages an additional 8% of the Company's investments,
and the balance is managed by unaffiliated outside managers.
The Company's investment results are summarized as follows:
Year ended December 31,
-----------------------------------------------------------
(In millions) 2001 2000 1999 1998 1997
-----------------------------------------------------------
Average invested assets (at cost)............. $21,697 $21,197 $20,940 $18,794 $16,417
Net investment income....................... 1,202 1,315 1,151 985 910
Net effective yield......................... 5.5% 6.2% 5.5% 5.2% 5.5%
Net realized gains on investments........... $ 436 $ 522 $ 699 $ 432 $ 303
Net unrealized gains on investment securities,
before deferred income taxes............. 49 244 92 1,554 1,189
The decrease in unrealized gains on investment securities before deferred income
taxes in 2001 is primarily due to the impact of realized gains recognized,
somewhat offset by the concentration of fixed maturity debt securities held in
the investment portfolio and the effects of a general decrease in interest rates
which occurred in 2001.
19
The Company continues to seek opportunities to enhance investment yield through
a conservative, primarily fixed maturity investment strategy. Its current
investment strategy does not contemplate material additional investments in
non-investment grade debt securities, commercial real estate, commercial
mortgages or derivatives.
Domestic Investment Operations. The Company's domestic property and casualty
investment portfolios are principally invested in tax-exempt state and municipal
bonds, which the Company believes provide the most attractive after-tax yield.
The Company's domestic life investment portfolios are largely invested in
taxable debt securities.
The Company's domestic fixed maturity portfolios, categorized by rating based on
market values, are summarized as follows:
Domestic Property
and Casualty Domestic Life
-----------------------------------------------
December 31,
-----------------------------------------------
2001 2000 2001 2000
-----------------------------------------------
U.S. government and government agency securities..... 1.0% 0.5% 2.0% 2.6%
Aaa.................................................. 40.5 45.2 2.1 1.7
Aa................................................... 26.0 29.4 9.1 9.0
A.................................................... 12.0 10.8 29.3 27.9
Baa.................................................. 2.0 1.5 13.1 13.1
Ba................................................... 0.5 0.5 1.1 0.8
Canadian securities.................................. 4.1 3.6 10.1 7.2
Mortgage-backed and other asset-backed securities.... 11.1 6.7 32.0 36.0
Other................................................ 2.8 1.8 1.2 1.7
----- ----- ----- -----
Total............................................. 100.0% 100.0% 100.0% 100.0%
===== ===== ===== =====
Ratings are as assigned by Moody's when available, or by S&P and converted to
the generally comparable Moody's rating.
The Company's emphasis on investment quality is evidenced by the preceding
table, which indicates that the bonds in the Company's investment portfolios are
principally invested in either U.S. government and government agency securities
or issues rated "Baa" or above. The Canadian securities held by the Company are
similar in quality to the other securities held in its domestic portfolio. Fixed
maturity securities held by the Company in its domestic life portfolios include
mortgage-backed and other asset-backed securities that are matched to the
liability profile of specific life reinsurance contracts. Investments in
mortgage-backed and other asset-backed securities are limited to lower risk
tranches and do not include any interest only or principal only securities.
Mortgage-backed and other asset-backed securities in the Company's investment
portfolio were principally issued by Federal agencies. The majority of the
balance of other securities held in both the domestic property and casualty and
domestic life portfolios represent investments in non-rated debt securities. The
Company does not contemplate significant additional investment in non-investment
grade securities in either the property and casualty or life portfolios.
International Investment Operations. The investment portfolios of the Company's
international operations (other than certain equity portfolios, which are
managed by outside managers) are managed by the GE Frankona Re Group's
investment personnel based in Munich, within guidelines established by the
management of the GE Frankona Re Group and under the overall supervision and
review of ERC's investment department.
The principal objective of the GE Frankona Re Group's investment policy is to
manage the investment portfolios on a total return basis taking into
consideration the duration and currency structure of the GE Frankona Re Group's
reinsurance liabilities. The GE Frankona Re Group's investment portfolios are
geographically diversified with investments principally from the major European
markets and the United States.
20
As of December 31, 2001, the fair value of the GE Frankona Re Group's
investments totaled $6,597 million, a decrease of $143 million from December 31,
2000. The composition of GE Frankona Re Group's investments is summarized as
follows:
December 31,
----------------
2001 2000
----------------
Fixed maturity securities............................ 89.1% 89.5%
Equity securities.................................... 8.1 7.5
Other invested assets................................ 2.8 3.0
----- -----
Total................................................ 100.0% 100.0%
===== =====
Most fixed maturity securities within the GE Frankona Re Group's investment
portfolios have a term of less than ten years. The fixed maturity securities
consist of high credit quality securities, and almost all bonds are investment
grade securities with a comparable average rating equal to or above a Moody's or
S&P "AA" rating. Fixed maturity securities include German and Danish
mortgage-backed securities, although these mortgage-backed securities have
significantly less prepayment risk than typical U.S. mortgage-backed securities,
as the German and Danish tax and social environments are not conducive to risks
of prepayment of interest and principal. Equity securities and other invested
assets were internationally diversified with principal holdings in Germany, the
United Kingdom and the United States.
Interest Rate and Currency Risk Management
Interest rate and currency risk management is important in the normal business
activities of GE Global Insurance. The Company uses derivative financial
instruments to mitigate or eliminate certain financial and market risks,
including those related to changes in interest rates and currency exchange
rates. As a matter of policy, the Company does not engage in derivatives
trading, derivatives market-making or other speculative activities. More
detailed information regarding these financial instruments, as well as
strategies and policies for their use, is contained in notes 2 and 14 to the
consolidated financial statements.
The Company manages its exposure to currency principally by matching investment
assets with the underlying reinsurance liabilities. Any remaining significant
net asset/liability positions in a given currency are hedged with forward
currency purchase or sale contracts to further mitigate currency exposures. The
Company also hedges its currency risk by utilizing cross currency swaps and
currency forwards. The Company manages its exposure to interest rates
principally by matching floating rate liabilities with corresponding floating
rate assets and by matching fixed rate liabilities with corresponding fixed rate
assets. Certain of the products reinsured within the life segment include fixed
rate interest rate features that are matched with fixed rate investments of a
similar duration.
On a limited basis, and as part of ongoing customer activities, the Company uses
equity options to minimize its exposure to movements in equity markets that have
a direct correlation with certain of its reinsurance products. Additionally, the
Company has entered into a limited number of credit default swaps to lessen its
exposure on certain financial guarantee reinsurance business.
Substantially all derivative transactions are executed by the Company's Treasury
Department, which works closely with GE Capital Treasury personnel to maintain
controls on all exposures, adhere to stringent counterparty credit standards and
actively monitor marketplace exposures. Although the Company is exposed to
credit risk that the counterparty may not be able to comply with the terms and
conditions of the contracts, the Company uses only highly rated institutions as
counterparties to the derivative transactions.
The U.S. Securities and Exchange Commission requires that registrants provide
information about potential effects of changes in interest rates and currency
exchange. Although the rules offer alternatives for presenting this information,
none of the alternatives is without limitations. The following discussion is
based on so-called "shock tests," which model effects of interest rate and
currency shifts on the reporting company. Shock tests, while probably the most
meaningful analysis permitted, are constrained by several factors, including the
necessity to conduct the analysis based on a single point in time and by their
inability to include the complex market reactions that normally would arise from
the market shifts modeled. While the following results of shock tests for
interest rates and currencies may have some limited use as benchmarks, they
should not be viewed as forecasts.
21
One means of assessing exposure to interest rate changes is a
duration-based analysis that measures the potential loss in net earnings
resulting from a hypothetical decrease in interest rates of 100 basis
points across all maturities (sometimes referred to as a "parallel shift in
the yield curve"). Under this model with all else constant, it is estimated
that such a decrease, including repricing in the securities portfolio,
would reduce the 2002 net earnings of the Company based on year-end 2001
positions by an insignificant amount. Based on positions at year-end 2000,
the pro forma effect on 2001 net earnings of such a decrease in interest
rates was also estimated to be an insignificant amount.
The geographic distribution of the Company's operations is diverse. One
means of assessing exposure to changes in currency exchange rates is to
model effects on reported earnings using a sensitivity analysis. Year-end
2001 consolidated currency exposures, including financial instruments
designated and effective as hedges, were analyzed to identify Company
assets and liabilities denominated in other than their relevant functional
currencies. Net unhedged exposures in each currency were then remeasured
assuming a 10 percent decrease (substantially greater decreases for
hyperinflationary currencies) in currency exchange rates compared with the
U.S. dollar. Under this model, management estimated at year-end 2001 that
such a decrease would have an insignificant effect on 2002 earnings of the
Company.
Cyclicality
The property and casualty reinsurance industry has been highly cyclical.
Underwriting results of primary property and casualty insurance companies and
prevailing general economic and reinsurance premium rates significantly
influences demand for reinsurance. The cyclical trends in the industry and the
industry's profitability can also be affected significantly by volatile and
unpredictable developments, including changes in what the Company believes to be
the propensity of courts to grant large awards, natural disasters and other
catastrophic events (such as hurricanes, windstorms, earthquakes, floods, fires
and, as experienced in 2001, intentional events such as terrorist acts),
fluctuations in interest rates and other changes in the investment environment
which affect inflationary pressures that may tend to affect the size of losses
experienced by ceding primary insurance companies.
Effects of Inflation
The Company's ultimate claims and claim expense costs on claims not yet settled
is increased by the effects of inflation, and changes in the inflation rate
therefore could become a significant factor in determining appropriate claims
and claim expense reserves, as well as reinsurance premium rates. Generally, the
Company's methods used to estimate claims and claim expense reserves and to
calculate reinsurance premium rates take into account the anticipated effects of
inflation in estimating the ultimate claims and claim expense costs. The Company
uses both insurance industry data and government economic indices in estimating
the effects of inflation on reinsurance premium rates and claims and claim
expense reserves. However, until claims are ultimately settled, the full effect
of inflation on the Company's results cannot be known.
Critical Accounting Policies
High quality financial statements require rigorous application of high quality
accounting policies. The policies discussed below are considered by management
critical to an understanding of the Company's financial statements because their
application places the most significant demands on management's judgment, with
reporting results relying on estimation about the effect of matters that are
inherently uncertain. Specific risks for these critical accounting policies are
described in the following paragraphs. For all of these policies, management
cautions that future events rarely develop exactly as forecast, and the best
estimates routinely require adjustment.
Insurance related liabilities and reserves differ for short and long duration
insurance contracts. Short-duration contracts such as property and casualty
policies are accounted for based on actuarial estimates of the amount of loss
inherent in that period's claims, including losses for which claims have not yet
been reported. Short-duration contract loss estimates rely on actuarial
observations of ultimate loss experience for similar historical events.
Measurement of long-duration insurance liabilities (such as term and whole life
insurance policies) also is based on approved actuarial techniques, but
necessarily includes assumptions about mortality, lapse rates and future yield
on related investments. The Company's insurance related liabilities and reserves
totaled $31 billion at year-end 2001. Of that total, approximately $20 billion
related to unpaid claims and claims adjustment expenses for short-duration
insurance coverage. As discussed on page 14, there has been a recent shift in
the source of adverse loss development away from property to liability coverage.
Management continually evaluates the potential for changes in loss estimates,
both positive and negative, and uses the results of these evaluations both to
adjust recorded provisions and to adjust underwriting criteria and product
offerings. The potential for further adverse loss
22
development in these areas is highly uncertain. Further information about
insurance liabilities is provided in note 6 to the consolidated financial
statements.
Impairment of investment securities results in a charge to operations when a
market decline below cost is other than temporary. Management regularly reviews
each investment security for impairment based on criteria that include the
extent to which cost exceeds market value, the duration of that market decline
and the financial health of and specific prospects for the issuer. The Company's
investment securities amounted to approximately $22 billion at year-end 2001.
Gross unrealized gains and losses included in that carrying amount related to
debt securities were $317 million and $249 million, respectively. Gross
unrealized gains and losses of equity securities were $19 million and $38
million, respectively. Of thoses securities whose carrying amount exceeds fair
value at year-end 2001, and based on application of the Company's accounting
policy for impairment, approximately $30 million of portfolio value is at risk
of being charged to earnings in 2002. The Company actively performs
comprehensive market research, monitors market conditions and segments its
investments by credit risk in order to minimize impairment risks. Further
information is provided in notes 2 and 4 to the consolidated financial
statements and pages 19-21, which discusses the investment securities portfolio.
Provision for uncollectible premium receivables and reinsurance recoverables are
recognized when they are incurred. Measurement of such losses requires
consideration of historical loss experience, including the need to adjust for
current conditions, and judgments about the probable effects of relevant
observable data, including present economic conditions such as delinquency
rates, financial health of specific customers, collateral value (such as letters
of credit and funds held balances) and legal right-of-offset of related claim
liabilities. The Company's exposure to uncollectible premium receivables and
reinsurance recoverables was approximately $15 billion at year-end 2001, against
which an allowance for losses of approximately $159 million was provided. While
collection prospects depend to a large degree on future economic conditions
(including the impact of future claims experience), management does not forecast
significant receivable write-offs in 2002. Further information is provided in
notes 2 and 6 to the consolidated financial statements.
Other significant accounting policies, not involving the same level of
measurement uncertainties as those discussed above, are nevertheless important
to an understanding of the financial statements. Policies related to revenue
recognition, financial instruments and consolidation policy require difficult
judgments on complex matters that are often subject to multiple sources of
authoritative guidance. Certain of these matters are among topics currently
under reexamination by accounting standards setters and regulators. Although no
specific conclusions reached by these standard setters appear likely to cause a
material change in the Corporation's accounting policies, outcomes cannot be
predicted with confidence. Also see note 2, Summary of Significant Accounting
Policies, which discusses accounting policies that must be selected by
management when there are acceptable alternatives.
New Accounting Standards
Major provisions of new accounting standards that may be significant to the
Company's financial statements in the future are described in the following
paragraphs.
Statement of Financial Accounting Standards ("SFAS") 141, Business Combinations,
and SFAS 142, Goodwill and Other Intangible Assets, modify the accounting for
business combinations, goodwill and identifiable intangible assets. As of
January 1, 2002, all goodwill and indefinite-lived intangible assets must be
tested for impairment and a transition adjustment will be recognized. Management
believes no goodwill impairment will be recognized under these new standards.
Amortization of goodwill will cease as of January 1, 2002, and, thereafter, all
goodwill and any indefinite-lived intangible assets must be tested at least
annually for impairment. The effect of the non-amortization provisions on 2002
operations will be affected by 2002 acquisitions and cannot be forecast, but if
these rules had applied to goodwill in 2001, management believes that full year
2001 net earnings would have increased by approximately $81 million.
SFAS 143, Accounting for Asset Retirement Obligations, requires recognition of
the fair value of obligations associated with the retirement of long-lived
assets when there is a legal obligation to incur such costs. This amount is
accounted for like an additional element of the corresponding asset's cost, and
is depreciated over that asset's useful life. SFAS 143 will be effective for the
Company on January 1, 2003. Management has not yet determined the effects of
adopting this standard on the Company's financial position and results of
operations.
23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Information about potential effects of changes in interest rates and currency
exchange on the Company is discussed on pages 21-22.
Item 8. Financial Statements and Supplementary Data.
The Company's Consolidated Financial Statements and the Independent Auditors'
Report thereon and the Supplementary Financial Statement Schedules listed on the
accompanying Index to Financial Statements and Financial Statement Schedules are
filed as part of this report.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
Not applicable.
PART III
Item 10. Directors and Executive Officers of t