UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
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[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 for the Quarterly Period Ended September 30, 2003
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934 for the Transition Period _____ to _____.
Commission File Number: 1-6563
Safeco Corporation
State of Incorporation: Washington
I.R.S. Employer I.D. No.: 91-0742146
Address of Principal Executive Offices: Safeco Plaza, Seattle, Washington 98185
Telephone: 206-545-5000
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
YES [X]. NO [ ].
138,562,607 shares of common stock of Safeco Corporation, no par
value, were outstanding at October 31, 2003.
Safeco Corporation and Subsidiaries
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CONTENTS
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Item Description Page
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Part I Financial Information
1 Financial Statements
Consolidated Statements of Income (Loss)
for the three and nine months ended September 30, 2003 and 2002 3
Consolidated Balance Sheets
September 30, 2003 and December 31, 2002 4
Consolidated Statements of Cash Flows
for the nine months ended September 30, 2003 and 2002 6
Consolidated Statements of Shareholders' Equity
for the nine months ended September 30, 2003 and 2002 8
Consolidated Statements of Comprehensive Income (Loss)
for the three and nine months ended September 30, 2003 and 2002 8
Condensed Notes to Consolidated Financial Statements 9
2 Management's Discussion and Analysis of Financial Condition 21
and Results of Operations
4 Controls and Procedures 45
Part II Other Information
1 Legal Proceedings 46
6 Exhibits and Reports on Form 8-K 46
Signatures 48
Safeco Corporation and Subsidiaries
ITEM 1 - FINANCIAL STATEMENTS PART I - FINANCIAL INFORMATION
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Consolidated Statements of Income (Loss) (Unaudited)
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Three Months Ended Nine Months Ended
September 30 September 30
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(In Millions, Except Per Share Amounts) 2003 2002 2003 2002
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REVENUES
Property & Casualty Earned Premiums $1,250.4 $ 1,135.2 $3,615.3 $ 3,356.7
Life & Investments Premiums and Other Revenues 212.6 223.3 657.6 554.5
Net Investment Income 409.8 420.4 1,255.4 1,247.9
Net Realized Investment Gains (Losses) (95.5) 12.5 (123.1) 138.5
Other 2.7 3.2 8.1 7.9
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Total 1,780.0 1,794.6 5,413.3 5,305.5
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EXPENSES
Losses, Loss Adjustment Expenses and Policy Benefits 1,347.0 1,171.8 3,667.1 3,512.8
Other Underwriting and Operating Expenses 252.9 255.5 775.2 697.1
Amortization of Deferred Policy Acquisition Costs 224.2 220.1 663.1 642.0
Interest Expense (including $17.3 Distributions on
Capital Securities in 2003) 29.9 17.9 60.2 50.3
Intangibles Amortization 4.0 4.2 11.9 12.3
Restructuring Charges -- 3.0 -- 15.1
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Total 1,858.0 1,672.5 5,177.5 4,929.6
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Income (Loss) Before Income Taxes (78.0) 122.1 235.8 375.9
Provision (Benefit) for Income Taxes (49.1) 35.6 40.4 98.2
Distributions on Capital Securities, Net of Taxes -- (11.3) (22.4) (33.7)
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Net Income (Loss) $ (28.9) $ 75.2 $ 173.0 $ 244.0
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Net Income (Loss) Per Share of Common Stock:
Diluted $ (0.21) $ 0.59 $ 1.25 $ 1.91
Basic $ (0.21) $ 0.59 $ 1.25 $ 1.91
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Dividends Declared $ 0.185 $ 0.185 $ 0.555 $ 0.555
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Average Number of Shares Outstanding During the
Period:
Diluted 138.5 128.1 138.9 128.1
Basic 138.5 127.8 138.4 127.8
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See condensed notes to consolidated financial statements.
Safeco Corporation and Subsidiaries
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Consolidated Balance Sheets
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September 30 December 31
2003 2002
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(In Millions) (Unaudited) (Audited)
ASSETS
Investments
Available-for-Sale Securities:
Fixed Maturities, at Fair Value (Cost or amortized cost: $23,544.2;
$22,646.1) $ 25,733.5 $ 24,278.0
Marketable Equity Securities, at Fair Value (Cost: $760.2; $777.2) 1,167.1 1,082.5
Mortgage Loans 937.9 925.9
Other Invested Assets 159.0 173.8
Short-Term Investments 449.2 311.0
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Total Investments 28,446.7 26,771.2
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Cash and Cash Equivalents 267.4 188.5
Accrued Investment Income 358.8 336.3
Premiums and Service Fees Receivable 1,100.0 1,047.1
Other Notes and Accounts Receivable 161.3 162.3
Current Income Taxes Recoverable 36.7 26.2
Deferred Income Taxes -- 124.6
Reinsurance Recoverables 575.2 578.8
Deferred Policy Acquisition Costs 654.0 626.3
Land, Buildings and Equipment for Company Use
(At cost less accumulated depreciation: $329.7; $319.7) 453.2 488.7
Intangibles and Goodwill 186.1 190.0
Other Assets 278.0 259.8
Securities Lending Collateral 2,286.6 2,957.0
Separate Account Assets 1,035.1 899.2
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Total Assets $ 35,839.1 $ 34,656.0
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See condensed notes to consolidated financial statements.
Safeco Corporation and Subsidiaries
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Consolidated Balance Sheets
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September 30 December 31
2003 2002
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(In Millions) (Unaudited) (Audited)
LIABILITIES AND SHAREHOLDERS' EQUITY
Property & Casualty Loss and Loss Adjustment Expense Reserves $ 5,096.6 $ 4,998.5
Accident and Health Reserves 148.1 170.0
Life Policy Liabilities 330.8 339.9
Unearned Premiums 2,075.5 1,847.5
Funds Held Under Deposit Contracts 16,422.0 15,655.4
Debt (including $850.0 of Capital Securities at September 30, 2003) 1,952.7 1,123.8
Deferred Income Taxes 98.0 --
Other Liabilities 1,460.3 1,389.3
Securities Lending Payable 2,286.6 2,957.0
Separate Account Liabilities 1,035.1 899.2
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Total Liabilities 30,905.7 29,380.6
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Commitments and Contingencies -- --
Corporation-Obligated, Mandatorily Redeemable Capital Securities of
Subsidiary Trust Holding Solely Junior Subordinated Debentures of the
Corporation (Capital Securities) -- 843.8
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Preferred Stock, No Par value
Shares Authorized: 10
Shares Issued and Outstanding: None -- --
Common Stock, No Par Value
Shares Authorized: 300
Shares Reserved for Options: 11.7, 12.0
Shares Issued and Outstanding: 138.5; 138.2 1,185.8 1,178.1
Retained Earnings 2,168.1 2,072.2
Accumulated Other Comprehensive Income, Net of Taxes:
Unrealized Gains and Losses on Available-for-Sale Securities and 1,652.3 1,241.2
Derivative Financial Instruments
Unrealized Foreign Currency Translation Adjustments (14.6) (15.7)
Deferred Policy Acquisition Costs Valuation Allowance (49.4) (35.4)
Minimum Pension Liability Adjustment (8.8) (8.8)
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Total Accumulated Other Comprehensive Income 1,579.5 1,181.3
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Total Shareholders' Equity 4,933.4 4,431.6
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Total Liabilities and Shareholders' Equity $ 35,839.1 $ 34,656.0
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See condensed notes to consolidated financial statements.
Safeco Corporation and Subsidiaries
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Consolidated Statements of Cash Flows (Unaudited)
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Nine Months Ended
September 30
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(In Millions) 2003 2002
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OPERATING ACTIVITIES
Insurance Premiums Received $ 4,230.4 $ 3,679.6
Dividends and Interest Received 1,186.0 1,152.3
Other Operating Receipts 164.1 148.8
Insurance Claims and Policy Benefits Paid (2,901.6) (2,857.5)
Underwriting, Acquisition and Insurance Operating Costs Paid (1,487.6) (1,339.1)
Interest Paid and Distributions on Capital Securities (125.9) (120.3)
Income Taxes Paid (34.1) (74.9)
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Net Cash Provided by Operating Activities 1,031.3 588.9
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INVESTING ACTIVITIES
Purchases of
Fixed Maturities Available-for-Sale (4,962.4) (4,798.3)
Equity Securities Available-for-Sale (153.2) (246.9)
Other Invested Assets (9.1) (105.1)
Issuance of Mortgage Loans (88.5) (64.2)
Issuance of Policy Loans (17.3) (18.5)
Maturities of Fixed Maturities Available-for-Sale 2,381.3 1,236.9
Sales of
Fixed Maturities Available-for-Sale 1,672.4 2,289.4
Equity Securities Available-for-Sale 181.6 537.5
Other Invested Assets 6.3 24.7
Repayment of Mortgage Loans 83.1 69.3
Repayment of Policy Loans 17.9 19.7
Net (Increase) Decrease in Short-Term Investments (138.2) 161.9
Other, Net 1.0 30.5
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Net Cash Used in Investing Activities (1,025.1) (863.1)
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FINANCING ACTIVITIES
Funds Received Under Deposit Contracts 987.5 1,010.1
Return of Funds Held Under Deposit Contracts (824.3) (778.8)
Proceeds from Notes 495.9 371.8
Repayment of Notes (515.9) (46.2)
Net Repayment of Commercial Paper -- (299.0)
Common Stock Reacquired -- (7.5)
Dividends Paid to Shareholders (76.8) (70.9)
Other, Net 6.3 6.7
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Net Cash Provided by Financing Activities 72.7 186.2
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Net Increase (Decrease) in Cash and Cash Equivalents 78.9 (88.0)
Cash and Cash Equivalents, Beginning of Period 188.5 269.3
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Cash and Cash Equivalents, End of Period $ 267.4 $ 181.3
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See condensed notes to consolidated financial statements.
Safeco Corporation and Subsidiaries
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Consolidated Statements of Cash Flows --
Reconciliation of Net Income to Net Cash Provided by Operating Activities (Unaudited)
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Nine Months Ended
September 30
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(In Millions) 2003 2002
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Net Income $ 173.0 $ 244.0
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ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED
BY OPERATING ACTIVITIES
Net Realized Investment (Gains) Losses 123.1 (138.5)
Amortization of Fixed Maturity Investments (9.8) (39.5)
Amortization and Depreciation 50.3 64.7
Deferred Income Tax Provision 3.2 16.0
Interest Expense on Deposit Contracts 618.1 566.6
Other, Net 0.5 6.0
Changes in
Accrued Interest on Accrual Bonds (34.1) (33.5)
Accrued Investment Income (22.5) (26.4)
Deferred Policy Acquisition Costs (27.7) (37.4)
Property & Casualty Loss and Loss Adjustment Expense Reserves 98.1 8.7
Accident and Health Reserves (21.9) (1.7)
Life Policy Liabilities (9.1) 12.8
Unearned Premiums 228.0 101.4
Current Income Taxes Recoverable (10.5) (53.9)
Other Assets and Liabilities (127.4) (100.4)
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Total Adjustments 858.3 344.9
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Net Cash Provided by Operating Activities $ 1,031.3 $ 588.9
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There were no significant non-cash financing or investing activities for the
nine months ended September 30, 2003 and 2002.
See condensed notes to consolidated financial statements.
Safeco Corporation and Subsidiaries
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Consolidated Statements of Shareholders' Equity (Unaudited)
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Nine Months Ended
September 30
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(In Millions) 2003 2002
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COMMON STOCK
Balance at Beginning of Period $ 1,178.1 $ 841.9
Stock Issued for Options and Rights 7.7 6.7
Common Stock Reacquired -- (1.0)
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Balance at End of Period 1,185.8 847.6
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RETAINED EARNINGS
Balance at Beginning of Period 2,072.2 1,875.9
Net Income 173.0 244.0
Amortization of Underwriting Compensation on Capital Securities (0.2) (0.3)
Dividends Declared (76.9) (70.9)
Common Stock Reacquired -- (6.0)
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Balance at End of Period 2,168.1 2,042.7
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ACCUMULATED OTHER COMPREHENSIVE INCOME, NET OF TAXES
Balance at Beginning of Period 1,181.3 916.8
Other Comprehensive Income 398.2 251.1
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Balance at End of Period 1,579.5 1,167.9
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Shareholders' Equity $ 4,933.4 $ 4,058.2
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Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
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Three Months Ended Nine Months Ended
September 30 September 30
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(In Millions) 2003 2002 2003 2002
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Net Income (Loss) $ (28.9) $ 75.2 $ 173.0 $ 244.0
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Other Comprehensive Income, Net of Taxes:
Change in Unrealized Gains and Losses on
Available-for-Sale Securities (230.6) 327.2 339.5 349.7
Reclassification Adjustment for Net
Realized Investment (Gains) Losses
Included in Net Income (Loss) 62.5 (7.8) 80.2 (89.9)
Derivatives Qualifying as Hedges -
Net Change in Fair Value (4.4) 7.2 (8.6) 11.1
Adjustment for Deferred Policy Acquisition
Costs 7.3 (10.9) (14.0) (15.4)
Foreign Currency Translation Adjustments (4.1) (1.2) 1.1 (4.4)
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Other Comprehensive Income (Loss) (169.3) 314.5 398.2 251.1
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Comprehensive Income (Loss) $ (198.2) $ 389.7 $ 571.2 $ 495.1
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See condensed notes to consolidated financial statements.
Safeco Corporation and Subsidiaries
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Condensed Notes to Consolidated Financial Statements (Unaudited)
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(Dollar amounts in millions except per share data, unless noted otherwise)
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
Safeco Corporation is a Washington corporation that has been in the insurance
business since 1923. We operate subsidiaries on a nationwide basis in segments
of the insurance industry and other financial services-related businesses. Our
two principal businesses are (1) property and casualty insurance, including
surety, and (2) life and stop-loss medical insurance and asset management. These
activities generated nearly all of our revenues for the interim periods
presented in this report.
Throughout our unaudited consolidated financial statements and condensed notes
and management's discussion and analysis, Safeco Corporation and its
subsidiaries are referred to as "Safeco," "we" and "our." The property and
casualty businesses including surety, are referred to as "Property & Casualty."
The life and stop-loss medical insurance and asset management businesses are
referred to as "Life & Investments." All other activities, primarily the
financing of our business activities, are collectively referred to as
"Corporate."
On September 29, 2003, we announced our intent to sell our Life & Investments
business. As of September 30, 2003, we have not met all of the "held-for-sale"
criteria under Financial Accounting Standards Board (FASB) Statement of
Financial Accounting Standards 144, "Accounting for the Impairment & Disposal of
Long-lived Assets" (SFAS 144) and therefore we have not presented Life &
Investments as a discontinued operation in these unaudited financial statements.
Basis of Consolidation and Reporting and Use of Estimates
These unaudited consolidated financial statements and condensed notes have been
prepared in conformity with accounting principles generally accepted in the
United States (GAAP) for interim financial information and with the instructions
to Form 10-Q. Certain financial information, which is required in the annual
financial statements prepared in conformity with GAAP, may not be required for
interim financial reporting purposes and has been condensed or omitted. In the
opinion of management, all adjustments (consisting of normal and recurring
adjustments) considered necessary for a fair presentation of results for the
interim periods have been included. Operating results for the nine month period
ended September 30, 2003 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2003.
These unaudited consolidated financial statements and condensed notes should be
read in conjunction with the financial statements and notes included in Safeco's
2002 Annual Report on Form 10-K that was previously filed with the Securities
and Exchange Commission.
The preparation of these interim consolidated financial statements in conformity
with GAAP requires management to make estimates and assumptions that affect
amounts reported in these consolidated financial statements. Actual results
could differ from those estimates.
The unaudited consolidated financial statements include Safeco Corporation and
its subsidiaries. All significant intercompany transactions and accounts have
been eliminated in the consolidated financial statements.
Certain reclassifications have been made to the prior year amounts to conform to
the current year presentation.
Earnings Per Share
Basic earnings per share is calculated by dividing net income by the
weighted-average number of common shares outstanding. Diluted earnings per share
reflects the potential dilution that could occur if options or other dilutive
instruments outstanding under Safeco's stock-based compensation plans were
exercised.
The computation of net income per share is presented below, based upon
weighted-average basic and diluted shares outstanding:
Three Months Ended Nine Months Ended
September 30 September 30
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(In Millions, Except Per Share Amounts) 2003 2002 2003 2002
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Net Income (Loss) $ (28.9) $ 75.2 $ 173.0 $ 244.0
Average Number of Common Shares Outstanding 138.5 127.8 138.4 127.8
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Basic Net Income (Loss) Per Share $ (0.21) $ 0.59 $ 1.25 $ 1.91
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Net Income (Loss) $ (28.9) $ 75.2 $ 173.0 $ 244.0
Average Number of Common Shares Outstanding 138.5 127.8 138.4 127.8
Additional Common Shares Assumed Issued Under
Treasury Stock Method -- 0.3 0.5 0.3
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Average Number of Common Shares Outstanding -
Diluted 138.5 128.1 138.9 128.1
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Diluted Net Income (Loss) Per Share $ (0.21) $ 0.59 $ 1.25 $ 1.91
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Due to the net loss in the third quarter of 2003, we used basic weighted-average
shares outstanding to calculate diluted net income (loss) per share of common
stock. Using diluted weighted-average shares outstanding would have resulted in
a lower net loss per share of common stock.
Stock Compensation Expense
Prior to 2003, Safeco applied Accounting Principles Board (APB) Opinion 25 in
accounting for its stock options, as allowed under SFAS 123, as amended. Under
APB 25, no compensation expense related to options was recognized because the
exercise price of Safeco's employee stock options equaled the fair market value
of the underlying stock on the date of grant.
In December 2002, the FASB issued SFAS 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," amending SFAS 123, to provide
alternative methods of transition to the fair value method of accounting for
stock-based employee compensation under SFAS 123. Effective January 1, 2003,
Safeco adopted the fair value method for accounting for stock options as defined
in SFAS 123, using the prospective basis transition method provided for under
SFAS 148. Under the prospective basis transition method, Safeco will recognize
stock-based compensation expense for options granted, modified or settled after
January 1, 2003. Safeco typically grants options to employees in the second
quarter. Stock-based compensation expense was $2.2 and $3.6 after tax for the
three and nine months ended September 30, 2003, respectively.
The following table illustrates the pro forma effect on net income and net
income per share as if the fair value method had been applied to all outstanding
and unvested awards in each period.
Three Months Ended Nine Months Ended
September 30 September 30
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(In Millions, Except Per Share Amounts) 2003 2002 2003 2002
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Net Income (Loss), as Reported $ (28.9) $ 75.2 $ 173.0 $ 244.0
Add: Stock-based Compensation Expense
Included in Reported Net Income (Loss), After
tax 2.2 -- 3.6 --
Deduct: Total Stock-based Compensation
Expense Determined Under Fair Value Based
Method for All Awards, Net of Related Tax
Effects (4.1) (4.8) (9.4) (9.2)
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Pro Forma Net Income (Loss) $ (30.8) $ 70.4 $ 167.2 $ 234.8
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Net Income (Loss) Per Share
Basic - as Reported $ (0.21) $ 0.59 $ 1.25 $ 1.91
Basic - Pro Forma (0.22) 0.55 1.21 1.84
Diluted - as Reported $ (0.21) $ 0.59 $ 1.25 $ 1.91
Diluted - Pro Forma (0.22) 0.55 1.20 1.83
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New Accounting Standards
SFAS 150, "Accounting for Financial Instruments with Characteristics of
Liabilities, Equity or Both"
SFAS 150 was issued in May 2003 and is effective for all financial instruments
created or modified after May 31, 2003, or otherwise effective July 1, 2003.
This statement establishes standards for how we classify and measure our
Corporation-Obligated, Mandatorily Redeemable Capital Securities of Subsidiary
Trust Holding Solely Junior Subordinated Debentures of the Corporation (Capital
Securities). In accordance with SFAS 150 we reclassified our Capital Securities
to debt on the September 30, 2003 Consolidated Balance Sheet. SFAS 150 does not
allow prior periods to be restated to reflect our current presentation. Deferred
issuance costs, previously netted against the balance of the capital securities,
were reclassified to other assets on the September 30, 2003 Consolidated Balance
Sheet and are amortized into interest expense. Effective July 1, 2003, amounts
paid or accrued on the Capital Securities are reported pretax with interest
expense on the Consolidated Statements of Income (Loss). Prior to July 1, 2003
these amounts were reported after tax as Distributions on Capital Securities.
FIN 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others"
FASB Interpretation 45 (FIN 45) was issued in November 2002. FIN 45 elaborates
on the disclosures required to be made by a guarantor in its financial
statements and clarifies that a guarantor is required to recognize, at the
inception of certain guarantees, a liability for the fair value of the
obligation undertaken in issuing the guarantee. The recognition provisions are
effective prospectively for guarantees issued or modified after December 15,
2002. The disclosure requirements are effective for periods ending after
December 15, 2002. We do not have any guarantees subject to the recognition
provisions of FIN 45. In accordance with the disclosure provisions under FIN 45,
the following guarantees were in effect at September 30, 2003:
o In April 2003, Safeco Corporation issued a letter of credit to Citibank on
behalf of Safeco UK, Ltd. (Safeco UK), a wholly-owned subsidiary. Safeco UK
conducted our London operations which were put into runoff in the third
quarter of 2002. The letter of credit guarantees payment of Safeco UK's
share of potential losses up to $19.6, arising from prior participation in
a Lloyds' of London reinsurance syndicate. Prior to April 2003, this
guarantee was provided by Safeco Insurance Company of America (SICA), a
wholly-owned subsidiary of Safeco Corporation.
o In June 2000, Safeco Life Insurance Company (Safeco Life), a wholly-owned
subsidiary, issued a guarantee to General America Corporation (GAC), a
wholly-owned subsidiary. Under the guarantee, Safeco Life guarantees
repayment of a loan made by GAC to Investar Holdings (Investar), an
insurance agency. The loan was made in June 2000 and matures in June 2017.
The principal balance of $18.4 is included with Other Notes and Accounts
Receivable on the Consolidated Balance Sheets.
o In 1993, SICA issued a guarantee to the Bank of New York on behalf of
Market Square Real Estate, Inc. (Market Square), a limited liability
company in which SICA was an investor. The guarantee covers the repayment
of $10.0 of municipal bonds issued by the City of Minneapolis. The proceeds
from the 1993 bond issuance were then loaned to Market Square. In 1997,
SICA sold its interest in Market Square but remained a guarantor for the
repayment of the bonds. As a condition to the sale, Market Square granted
SICA a first mortgage on its assets, as security, for any payments SICA may
make pursuant to the guarantee. The scheduled repayment of the bonds in
2006 will be funded by the repayment of the loan made to Market Square by
the City of Minneapolis. SICA has not made any payments pursuant to the
guarantee.
o Safeco Corporation issued guarantees to the counterparties of the
International Swaps and Derivatives Association (ISDA) Master Agreements
entered into by Safeco Financial Products, Inc. (SFP), a wholly-owned
subsidiary. SFP was organized in 2000 to write S&P 500 index options to
mitigate the risk associated with Life & Investments' Equity Indexed
Annuity product. SFP also engages in limited activity for its own account
by selling single-name credit default swaps, writing and hedging S&P 500
Index options and investing in and hedging convertible bonds. Safeco
Corporation guarantees the payment of any obligation owed by SFP to the
counterparties under the terms of the ISDA Master Agreements. This
obligation totaled $30.8 at September 30, 2003, representing SFP's
derivative liability position net of posted collateral.
FIN 46, "Consolidation of Variable Interest Entities"
FIN 46, "Consolidation of Variable Interest Entities," was issued in January
2003. FIN 46 requires existing unconsolidated variable interest entities (VIEs)
to be consolidated by their primary beneficiary if such entities do not
effectively disperse risks among parties involved. The interpretation explains
criteria to identify VIEs and how to assess interest in a VIE in order to
determine whether to consolidate a particular entity. FIN 46 is effective
immediately for variable interests created or obtained after January 31, 2003,
and in the first period ending after December 15, 2003 for variable interests
acquired before February 1, 2003.
We have identified certain interests in VIEs as defined by FIN 46. Based on our
analysis of these interests, Safeco does not meet the FIN 46 definition of
"primary beneficiary" of any of these entities and therefore will not
consolidate the entities. Even though consolidation is not required, FIN 46
requires disclosure of the nature of any significant interests in a VIE, a
description of the VIE's activities and the maximum exposure to potential losses
due to our involvement.
In June 2000, we extended a loan to Investar, whose equity at risk was not
sufficient to finance its activities and is therefore considered a VIE under FIN
46. The loan is secured by the assets of Investar and personally guaranteed by
its equity holders. Based on our analysis of Investar's expected losses and
expected residual returns, we are not the primary beneficiary. Our potential
exposure to losses due to our interest in Investar is limited to our senior debt
holding, which was $18.4 as of September 30, 2003, excluding the value of our
rights to the assets of the agency and guarantees provided by the equity
holders.
AcSEC Statement of Position (SOP), "Accounting and Reporting by Insurance
Enterprises for Certain Nontraditional Long-Duration Contracts and for Separate
Accounts"
The provisions of the SOP are effective for fiscal years beginning after
December 15, 2003, with earlier adoption encouraged. This SOP provides guidance
in three areas: separate account presentation and valuation; the accounting
recognition given sales inducements; and the classification and valuation of
long-duration contract liabilities. We do not anticipate a material impact to
our financial statements upon adoption.
NOTE 2 - DERIVATIVE FINANCIAL INSTRUMENTS
See Note 3 of Safeco's 2002 Annual Report on Form 10-K for a discussion of
Safeco's use of derivative financial instruments.
Fair Value Hedges
Safeco uses interest rate swaps to offset the change in value of certain fixed
rate assets and liabilities. In calculating the effective portion of the fair
value hedge, the changes in the fair value of the hedge and the hedged item are
recognized in net realized investment gains and losses in the Consolidated
Statements of Income (Loss). There was no fair value hedge ineffectiveness for
the three and nine months ended September 30, 2003 or the three months ended
September 30, 2002. Fair value hedge ineffectiveness for the nine months ended
September 30, 2002 resulted in a $0.9 net realized investment gain.
Cash Flow Hedges
Safeco also uses interest rate swaps to hedge the variability of future cash
flows arising from changes in interest rates associated with certain variable
rate assets and forecasted transactions. The changes in the fair value of the
hedge are recognized in the Consolidated Statements of Comprehensive Income
(Loss). Differences between the changes in the fair value of the hedge and the
hedged item represent hedge ineffectiveness and are recognized as interest
expense in the Consolidated Statements of Income (Loss). There was no cash flow
hedge ineffectiveness for the three and nine months ended September 30, 2003, or
the three months ended September 30, 2002. Cash flow ineffectiveness resulted in
a decrease of $0.5 to interest expense for the nine months ended September 30,
2002.
At September 30, 2003 the maximum length of time over which Safeco was hedging
its exposure to future cash flows for forecasted transactions was approximately
33 months.
Amounts related to derivatives qualifying as cash flow hedges are recorded in
Accumulated Other Comprehensive Income (AOCI) and recognized in earnings
contemporaneously with the effect of the hedged item. SFAS 133 requires amounts
recorded in AOCI that relate to forecasted transactions that are no longer
probable of occurring within a specified time period to be recognized in
earnings immediately. For the nine months ended September 30, 2003, $15.2 was
reclassified from AOCI on the Consolidated Balance Sheets to Net Realized
Investment Gains (Losses) on the Consolidated Statements of Income (Loss),
related to interest rate hedges on forecasted transactions not probable of
occurring. No such amounts were reclassified from AOCI into earnings during the
three months ended September 30, 2003 or the three and nine months ended
September 30, 2002. At September 30, 2003, we deferred $18.7 in AOCI related to
forecasted transactions that are reasonably possible of occurring. Amounts
deferred in AOCI will be reclassified into earnings at the sooner of the
determination that the forecasted transaction is not probable of occurring or
the forecasted transaction occurs. No such amounts were deferred in AOCI at
September 30, 2002 or December 31, 2002.
NOTE 3 - DEBT
The total amount, current portions and maturities of debt and capital securities
at September 30, 2003 and December 31, 2002 are as follows:
September 30, 2003 December 31, 2002
- ------------------------------------------------------------------------------------------------------
Total Current Long-Term Total Current Long-Term
----------------------------------------------------------------
7.875% Medium-Term Notes Due 2003 $ -- $ -- $ -- $ 303.5 $ 303.5 $ --
7.875% Notes Due 2005 -- -- -- 200.0 200.0 --
6.875% Notes Due 2007 195.8 -- 195.8 200.0 -- 200.0
4.200% Senior Notes Due 2008 200.0 -- 200.0 -- -- --
4.875% Senior Notes Due 2010 300.0 -- 300.0 -- -- --
7.250% Senior Notes Due 2012 387.7 -- 387.7 390.6 -- 390.6
8.072% Capital Securities Due 2037 850.0 -- 850.0 -- -- --
Other Notes and Loans Payable Due
Through 2008 19.2 4.3 14.9 29.7 12.3 17.4
----------------------------------------------------------------
Total Debt 1,952.7 4.3 1,948.4 1,123.8 515.8 608.0
8.072% Capital Securities Due 2037 -- -- -- 843.8 -- 843.8
----------------------------------------------------------------
Total Debt and Capital Securities $ 1,952.7 $ 4.3 $1,948.4 $1,967.6 $ 515.8 $1,451.8
- ------------------------------------------------------------------------------------------------------
SFAS 150 was issued in May 2003 and is effective for all financial instruments
created or modified after May 31, 2003, or otherwise effective July 1, 2003.
This statement establishes standards for how we classify and measure our Capital
Securities. In accordance with SFAS 150 we reclassified Capital Securities to
debt on the September 30, 2003 Consolidated Balance Sheet. SFAS 150 does not
allow prior periods to be restated to reflect our current presentation. Deferred
issuance costs, previously netted against the balance of the capital securities,
were reclassified to other assets on the September 30, 2003 Consolidated Balance
Sheet.
On January 27, 2003, Safeco issued $200.0 of senior notes with a coupon of
4.200% that mature in 2008 and $300.0 of senior notes with a coupon of 4.875%
that mature in 2010. The notes are unsecured and rank equally with all other
unsecured senior indebtedness of Safeco. The proceeds from the notes were used
to repay $300.0 principal amount of 7.875% medium term notes due in March 2003
and to call and repay $200.0 principal amount of 7.875% notes maturing in 2005
that were callable at par on April 1, 2003.
Safeco maintains a bank credit facility with $500.0 available through September
2005. Safeco pays a fee to have the facility available and does not maintain
deposits as compensating balances. The facility carries certain covenants that
require Safeco to maintain a specified minimum level of shareholders' equity and
a maximum debt-to-capitalization ratio. There were no borrowings under the
facility as of September 30, 2003 and December 31, 2002, and Safeco was in
compliance with all covenants.
NOTE 4 - RESTRUCTURING CHARGES
On September 29, 2003, Safeco announced that it would eliminate at least 500
positions by the end of 2004. Positions will be eliminated primarily in our
corporate departments. We expect to record a restructuring charge of
approximately $10.0 after tax in the fourth quarter of this year.
In July 2001, Safeco announced that it would eliminate approximately 1,200 jobs
by the end of 2003. Since the beginning of 2001 through the end of 2002,
Safeco's total employment decreased by approximately 1,200, excluding the
reduction due to the sale of Safeco Credit and the increase associated with the
acquisition of Swiss Re's stop-loss medical business. Positions eliminated were
in the corporate headquarters and regional Property & Casualty operations, and
these actions were completed in 2002. Total restructuring charges and period
costs associated with this restructuring were $66.1. For the three and nine
months ended September 30, 2002, period costs associated with the restructuring
totaled $3.0 and $15.1, respectively. These period costs included stay bonuses,
employee transfer costs, recruiting and training expenses, related consulting
fees and certain office closure costs.
NOTE 5 - COMPREHENSIVE INCOME
Comprehensive income is defined as all changes in shareholders' equity, except
those arising from transactions with shareholders. Comprehensive income includes
net income and other comprehensive income, which for Safeco consists of changes
in net unrealized gains or losses on available-for-sale securities, net
unrealized gains or losses on derivatives, deferred policy acquisition costs
valuation allowance, foreign currency translation adjustments, minimum pension
liability and the deferred taxes applicable to these items.
The components of other comprehensive income or loss were as follows:
NINE MONTHS ENDED SEPTEMBER 30 2003 2002
- -------------------------------------------------------------------------------------------------------------
Pretax Tax After tax Pretax Tax After tax
------------------------------------------------------------------
Change in Unrealized Gains and Losses of
Available-for-Sale Securities $ 522.6 $ (183.1) $ 339.5 $ 538.1 $ (188.4) $ 349.7
Reclassification adjustment for
Net Realized Investment (Gains) Losses
included in Net Income (Loss) 123.1 (42.9) 80.2 (138.4) 48.5 (89.9)
Derivatives Qualifying as Cash Flow Hedges-
Net Changes in Fair Value (13.3) 4.7 (8.6) 17.1 (6.0) 11.1
Deferred Policy Acquisition Costs
Valuation Allowance (21.5) 7.5 (14.0) (23.7) 8.3 (15.4)
Foreign Currency Translation Adjustments 1.7 (0.6) 1.1 (6.7) 2.3 (4.4)
------------------------------------------------------------------
Other Comprehensive Income $ 612.6 $ (214.4) $ 398.2 $ 386.4 $ (135.3) $ 251.1
- -------------------------------------------------------------------------------------------------------------
NOTE 6 - PROPERTY & CASUALTY LOSS RESERVES
During the third quarter, we strengthened loss and allocated loss adjustment
expense (LAE) reserves for losses occurring in prior years by $180.0 in the
third quarter of 2003. Of the $180.0, $130.0 was recorded in SBI Runoff, $48.0
in SBI Regular and $2.0 in SBI Special Accounts Facility. These reserve
increases reflect the impact of rising medical costs and longer payout periods.
In connection with this reserve strengthening, we also increased unallocated LAE
reserves by $25.0 for the costs of servicing the increasingly long payout period
of our workers compensation claims. Of the $25.0 increase, $14.9 was recorded in
SBI Runoff, $9.6 in SBI Regular and $0.5 in SBI Special Accounts Facility.
NOTE 7 - SEGMENT INFORMATION
Safeco operates on a nationwide basis in two principal businesses: (1) property
and casualty insurance including surety (Property & Casualty), and (2) life and
stop-loss medical insurance and asset management (Life & Investments).
Property & Casualty
Safeco's Property & Casualty insurance operations are organized around our four
operating segments: Safeco Personal Insurance (SPI), Safeco Business Insurance
(SBI), Surety and Property & Casualty Other (P&C Other). These operations
contain our reportable segments, which are managed separately as described
below.
Safeco Personal Insurance
SPI writes automobile, homeowners and other insurance coverages for individuals,
and the SPI operations are organized around three reportable segments--Personal
Auto, Homeowners and Specialty, which are managed separately by these product
groupings.
The Personal Auto segment provides coverage for liability to others for both
bodily injury and property damage, for injury to an insured, and for physical
damage to an insured's own vehicle from collision and other hazards.
The Homeowners segment provides protection against losses to dwellings and
contents from a wide variety of hazards, as well as coverage for liability
arising from ownership or occupancy. Homeowners policies insure dwellings,
condominiums, and rental property contents.
The Specialty segment provides coverages for earthquake, dwelling fire, inland
marine, motorcycles and boat insurance for individuals.
Safeco Business Insurance
SBI writes various commercial coverages including commercial multi-peril,
workers compensation, general liability and auto. SBI's operations are organized
around three reportable segments: SBI Regular, SBI Special Accounts Facility and
SBI Runoff, which are managed separately based on the nature of the underlying
insured.
SBI Regular is Safeco's core commercial segment writing commercial lines
insurance for small- to medium-sized businesses. The principal coverages offered
by SBI Regular are commercial multi-peril, general liability, workers
compensation and auto.
SBI Special Accounts Facility writes larger commercial accounts for key Safeco
agents and our four continuing specialty commercial programs.
SBI Runoff includes results for the larger commercial business accounts and 15
specialty programs that Safeco has been exiting since late 2001.
Surety
Surety provides an insured with a third party guarantee of a statutory or
contractual obligation of the insured. Safeco offers surety bonds primarily for
construction, performance and for legal matters such as appeals, probate and
bankruptcies.
Property & Casualty Other
P&C Other includes discontinued assumed reinsurance business, non-voluntary
property and casualty business for personal lines, results from Safeco's Lloyds'
of London operations that are in runoff and certain other discontinued product
lines.
Life & Investments
On September 29, 2003, we announced our intent to sell our Life & Investments
business. As of September 30, 2003, we have not met all of the "held-for-sale"
criteria under SFAS 144, "Accounting for the Impairment & Disposal of Long-lived
Assets" and therefore we have not presented Life & Investments as a discontinued
operation in these unaudited financial statements.
Life & Investments provides a broad range of products and services that include
individual and group insurance products, annuity products, mutual funds and
investment advisory services. These operations are managed separately as six
reportable segments: Group, Income Annuities, Retirement Services, Individual,
Asset Management and Life & Investments Other (L&I Other) based on product
groupings.
Group's principal product is stop-loss medical insurance sold to employers with
self-insured medical plans. Also included in this segment are group life,
accidental death and dismemberment and disability products.
Income Annuities' principal product is the structured settlement annuity that is
sold to fund third party personal injury settlements, providing a reliable
income stream to the injured party.
Retirement Services' products are primarily fixed and variable deferred
annuities (both qualified and non-qualified), tax-sheltered annuities (marketed
to teachers and not-for-profit organizations), guaranteed investment contracts
and corporate retirement funds.
Individual's products include term, universal and variable universal life and
bank-owned life insurance (BOLI).
Asset Management provides investment advisory and administrative services for
Safeco Mutual Funds, variable insurance portfolios, institutional and trust
accounts.
L&I Other is comprised mainly of investment income resulting from the investment
of capital and accumulated earnings of the operating lines of business. L&I
Other also includes the results of a wholly-owned subsidiary, Talbot Financial
Corporation (Talbot), an insurance agency and financial services organization.
Corporate
In addition to these operating segments, certain activities are reported in the
Corporate segment and not allocated to individual segments. The Corporate
segment includes operating results for the parent company, which primarily
includes interest expense for Safeco's debt; SFP; Safeco Properties, Inc., which
owns real estate held for sale; net investment income; and intercompany
eliminations.
Segment Performance Measures
Safeco's management measures segment profit or loss for Property & Casualty
based upon underwriting profit (loss), a non-GAAP measure. Underwriting profit
(loss) represents the net amount of earned premiums less underwriting losses and
expenses on a pretax basis. Management views underwriting profit (loss) as a
critical measure to assess underwriting effectiveness and to evaluate the
results of the Property & Casualty operations.
Life & Investments' results are evaluated based on pretax operating earnings, a
non-GAAP measure, which excludes net realized investment gains and losses.
Management believes the presentation of pretax operating earnings enhances the
understanding of our Life & Investments results of operations by excluding net
realized investment gains and losses, which can fluctuate significantly and
distort the comparison between periods.
Underwriting profit (loss) and pretax operating earnings are not a substitute
for net income determined in accordance with GAAP.
The following tables present selected financial information by segment and
reconcile segment revenues, underwriting profit (loss) and pretax operating
earnings to amounts reported in the Consolidated Statements of Income (Loss).
REVENUES
Three Months Ended Nine Months Ended
September 30 September 30
- ----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------
PROPERTY & CASUALTY
Safeco Personal Insurance (SPI)
Personal Auto $ 581.3 $ 497.4 $ 1,662.7 $1,424.1
Homeowners 191.5 192.7 573.1 565.3
Specialty 50.9 51.1 151.2 152.3
-------------------------------------------------
Total SPI 823.7 741.2 2,387.0 2,141.7
-------------------------------------------------
Safeco Business Insurance (SBI)
Regular 275.4 255.4 813.5 751.8
Special Accounts Facility 100.6 75.2 281.7 186.8
Runoff 2.2 24.2 0.3 162.8
-------------------------------------------------
Total SBI 378.2 354.8 1,095.5 1,101.4
-------------------------------------------------
Surety 40.0 32.7 110.6 93.6
P&C Other 8.5 6.5 22.2 20.0
-------------------------------------------------
Total Property & Casualty Earned Premiums 1,250.4 1,135.2 3,615.3 3,356.7
Net Investment Income 113.7 114.5 343.0 345.0
-------------------------------------------------
Total Property & Casualty Revenues
(excluding Net Realized Investment Gains (Losses)) 1,364.1 1,249.7 3,958.3 3,701.7
-------------------------------------------------
LIFE & INVESTMENTS
Group 133.9 149.3 420.7 327.6
Income Annuities 121.7 134.0 383.9 392.6
Retirement Services 96.6 96.3 289.1 284.1
Individual 96.3 96.2 288.0 282.8
Asset Management 7.0 7.0 19.9 23.2
L&I Other 52.8 47.6 159.0 141.9
-------------------------------------------------
Total Life & Investments Revenues (excluding Net
Realized Investment Gains (Losses)) 508.3 530.4 1,560.6 1,452.2
-------------------------------------------------
CORPORATE 3.1 2.0 17.5 13.1
Consolidated Net Realized Investment Gains (Losses) (95.5) 12.5 (123.1) 138.5
-------------------------------------------------
TOTAL REVENUES $ 1,780.0 $ 1,794.6 $ 5,413.3 $5,305.5
- ----------------------------------------------------------------------------------------------------------
UNDERWRITING PROFITS (LOSSES), PRETAX OPERATING EARNINGS
AND NET INCOME (LOSS)
Three Months Ended Nine Months Ended
September 30 September 30
- ----------------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
PROPERTY & CASUALTY
Underwriting Profits (Losses)
Safeco Personal Insurance (SPI)
Personal Auto $ 35.4 $ (6.2) $ 37.2 $ (33.8)
Homeowners 32.1 5.5 38.2 (49.6)
Specialty 12.5 9.6 38.8 20.6
-------------------------------------------------------
Total SPI 80.0 8.9 114.2 (62.8)
-------------------------------------------------------
Safeco Business Insurance (SBI)
Regular (51.3) (11.9) (68.1) (59.5)
Special Accounts Facility 5.8 3.9 11.6 10.3
Runoff (149.8) (15.4) (165.5) (74.5)
-------------------------------------------------------
Total SBI (195.3) (23.4) (222.0) (123.7)
-------------------------------------------------------
Surety 8.5 2.7 19.0 11.6
P&C Other (0.6) (33.6) (9.9) (46.0)
-------------------------------------------------------
Total Underwriting Losses (107.4) (45.4) (98.7) (220.9)
Net Investment Income 113.7 114.5 343.0 345.0
Restructuring Charges -- (3.0) -- (15.1)
-------------------------------------------------------
Total Property & Casualty Pretax Operating Earnings 6.3 66.1 244.3 109.0
-------------------------------------------------------
LIFE & INVESTMENTS
Pretax Operating Earnings
Group 12.5 22.4 66.0 46.7
Income Annuities (0.9) 11.5 17.6 27.6
Retirement Services 3.3 1.4 13.2 13.4
Individual 3.9 3.5 5.3 17.7
Asset Management 1.1 0.9 1.3 4.9
L&I Other 21.2 19.9 67.4 60.4
-------------------------------------------------------
Total Life & Investments Pretax Operating Earnings 41.1 59.6 170.8 170.7
-------------------------------------------------------
CORPORATE
Pretax Operating Earnings * (29.9) (16.1) (56.2) (42.3)
-------------------------------------------------------
Consolidated Pretax Operating Earnings 17.5 109.6 358.9 237.4
Consolidated Net Realized Investment Gains (Losses)
before Income Taxes (95.5) 12.5 (123.1) 138.5
-------------------------------------------------------
Consolidated Income (Loss) before Income Taxes (78.0) 122.1 235.8 375.9
Consolidated Provision (Benefit) for Income Taxes (49.1) 35.6 40.4 98.2
-------------------------------------------------------
Distributions on Capital Securities, Net of Taxes * -- (11.3) (22.4) (33.7)
-------------------------------------------------------
NET INCOME (LOSS) $ (28.9) $ 75.2 $ 173.0 $ 244.0
- ----------------------------------------------------------------------------------------------------------------
* Effective July 1, 2003, Safeco adopted SFAS 150, "Accounting for Financial
Instruments with Characteristics of Liabilities, Equity or Both" and,
accordingly, Distributions on Capital Securities are now reported with
interest expense in our Corporate segment.
ASSETS
SEPTEMBER 30 2003 2002
- -------------------------------------------------------------------------------------------------------------
PROPERTY & CASUALTY
Safeco Personal Insurance (SPI)
Personal Auto $ 3,686.5 $ 3,289.9
Homeowners 1,793.4 1,800.9
Specialty 646.4 667.4
----------------------------
Total SPI 6,126.3 5,758.2
----------------------------
Safeco Business Insurance (SBI)
Regular 3,295.7 3,090.4
Special Accounts Facility 703.9 439.3
Runoff 1,525.4 1,824.9
----------------------------
Total SBI 5,525.0 5,354.6
----------------------------
Surety 396.6 393.8
P&C Other 1,032.4 1,075.6
----------------------------
Total Property & Casualty 13,080.3 12,582.2
----------------------------
LIFE & INVESTMENTS
Group 346.9 340.7
Income Annuities 7,582.9 7,471.4
Retirement Services 8,012.2 7,228.6
Individual 4,555.3 4,283.2
Asset Management 69.9 63.7
L&I Other 2,101.9 1,795.5
----------------------------
Total Life & Investments 22,669.1 21,183.1
----------------------------
CORPORATE 89.7 (22.4)
----------------------------
TOTAL ASSETS $ 35,839.1 $ 33,742.9
- -------------------------------------------------------------------------------------------------------------
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
(Dollar amounts in millions unless noted otherwise)
Management's discussion and analysis (MD&A) reviews our consolidated and segment
financial condition as of September 30, 2003 and December 31, 2002, our
consolidated results of operations for the periods ended September 30, 2003 and
2002 and, where appropriate, factors that may affect our future financial
performance. This discussion should be read in conjunction with Safeco's MD&A
and annual audited financial statements as of December 31, 2002 contained in its
2002 annual report on Form 10-K and the unaudited consolidated financial
statements and related condensed notes included elsewhere in this report.
Forward-looking information contained in this report is subject to risk and
uncertainty
Statements, analysis and other information contained in this report that relate
to anticipated financial performance, business prospects and plans, regulatory
developments and similar matters are "forward-looking statements" as defined in
the Private Securities Litigation Reform Act of 1995. Statements in this report
that are not historical information are forward-looking. The operations,
performance and development of our business are subject to certain risks and
uncertainties that may cause actual results to differ materially from those
contained in or suggested by the forward-looking statements in this report. The
risks and uncertainties include, but are not limited to:
o Safeco's ability to successfully divest the Life & Investments operations;
o achievement of Safeco's overall expense reduction goals;
o the ability to obtain rate increases and decline or non-renew underpriced
insurance accounts;
o achievement of premium targets and profitability;
o realization of growth and business retention estimates;
o success in implementing a new business entry model for personal and
commercial lines;
o success in obtaining regulatory approval of price-tiered products and the
use of insurance scores, including credit scores as a component;
o the ability to freely enter and exit lines of business;
o changes in the mix of Safeco's book of business;
o driving patterns;
o the competitive pricing environment, initiatives by competitors and other
changes in competition;
o weather conditions, including the severity and frequency of storms,
hurricanes, snowfalls, hail and winter conditions;
o the occurrence of significant natural disasters, including earthquakes;
o the occurrence of significant man-made disasters, such as the attack on
September 11, 2001 or war;
o the occurrence of bankruptcies that result in losses under surety bonds,
investment losses or lower investment income;
o the adequacy of loss and benefit reserves for the Property & Casualty and
Life & Investments businesses;
o the ability to run off the Lloyds' of London business without incurring
material unexpected charges;
o the availability of, pricing of, and ability to collect reinsurance;
o the ability to price for, exclude and reinsure the risk of loss from
terrorism;
o interpretation of insurance policy provisions by courts, court decisions
regarding coverage and theories of liability, trends in litigation and
changes in claims settlement practices;
o the outcome of any litigation against us;
o legislative and regulatory developments affecting the actions of insurers,
including requirements regarding rates, application and availability of
coverage;
o changes in tax laws and regulations that affect the favorable taxation of
certain life insurance products or that decrease the usefulness of life
insurance products for estate-planning purposes;
o the effect of current insurance and credit ratings levels on business
production and the effect of negative changes to our ratings;
o inflationary pressures on medical care costs, auto parts and repair,
construction costs and other economic sectors that increase the severity of
claims;
o availability of bank credit facilities;
o the use of derivative securities by Safeco Financial Products, Inc. (SFP);
o fluctuations in interest rates;
o performance of financial markets; and
o general economic and market conditions.
Because insurance rates in some jurisdictions are subject to regulatory review
and approval, our achievement of rate increases may occur in amounts and on a
time schedule different than planned, which may affect efforts to continue to
grow profitability in our Property & Casualty lines.
Overview
Safeco Corporation is a Washington corporation that has been in the insurance
business since 1923. We operate subsidiaries on a nationwide basis in segments
of the insurance industry and other financial services-related businesses. Our
two principal businesses are (1) property and casualty insurance, including
surety, and (2) life and stop-loss medical insurance and asset management. These
activities generated nearly all of our revenues for the interim periods
presented in this report.
Strategic Initiatives
Safeco's strategy continues to focus on reshaping our company into a profitable,
growing enterprise. Central to this strategy is our decision to put our Life &
Investments business up for sale and focus on property and casualty insurance.
We expect the completion of the sale to take at least six months. We believe
this will put Safeco in position to continue delivering improved results across
our largest product lines - auto, homeowners and small business insurance - and
to become a more focused and successful competitor. We intend to use a portion
of the proceeds to reduce our debt to a level appropriate for our new size and
then assess our capital for ongoing new business needs. We anticipate that we
will return the remainder to shareholders in the form of a special dividend, a
stock repurchase plan, or a combination of the two.
We have identified expense reductions across the company that will enable us to
better compete in property and casualty markets. We expect to eliminate
approximately 500 positions, primarily in our corporate departments, by the end
of 2004,excluding any reduction due to the sale of our Life & Investments
business. When fully implemented, this initiative is expected to reduce our 2004
operating expenses by approximately $75.0. Related to this effort, we expect to
record a restructuring charge of approximately $10.0 after tax in the fourth
quarter of this year.
Our primary measures of progress in executing our strategy are growth in
earnings per share (EPS) and return on equity (ROE). Specifically, our objective
is, over the long term, to achieve average annual EPS growth of 15% and top
decile ROE performance when compared with our peer group. In addition, but
secondary to these financial goals, our objective is to achieve double digit
growth in our Property & Casualty revenues when we can do so successfully within
the context of our profit and return goals.
The three key elements of our strategy are 1) to sell standardized products, 2)
through independent distributors and 3) to offer multiple products for our
distributors to sell.
o Standardization of products - our standardized products in personal auto,
homeowners and small business serve the basic insurance needs of the
majority of the U.S. marketplace. These products leverage Safeco's
strengths in producing and servicing homogeneous products that require
large volumes of repeatable transactions executed efficiently and
effectively. Our changes in product line mix since 2001 reflect this
recognition of our core strengths.
o Independent distributors - Safeco is committed to partnering with
independent distributors to sell our products. We believe that independent
distributors serve as trusted advisors to insurance customers, and that
customers will continue to prefer this purchasing method. We believe that
independent distributors are, and will continue to be, best equipped to
appropriately match insurance products to their customers' specific needs.
Our strategy focuses on providing more products for our distributors to
sell, for example, through expanded multi-tier product offerings using
multi-variate models to more accurately match price to customer risk
characteristics, enabling us to serve a broader spectrum of risks. In
addition, we have focused on making it easier for independent distributors
to use our new point of sale technology, providing operating efficiencies
in their offices. Our distributors are able to be more profitable selling
Safeco products through use of this technology, and our commission programs
are structured to incent profitable growth such that both Safeco and our
distribution partners benefit from increased sales of profitable
business.Put succinctly, we offer our distribution partners more to sell,
make it easier to sell and service, and thereby make us and them more
money selling Safeco products.
o Multiple products - Safeco's multiple product lines enable us to meet the
key product needs of most of our distributors, primarily personal auto,
homeowners and small business insurance. We believe that our ability to
provide multiple property and casualty products facilitates an efficient
relationship for our distributors with Safeco, and provides us with a
"shelf space" advantage in our distributors' businesses. Our P&C products
of auto, homeowners, small commercial and surety are the crucial products
for our partners.
Application of Critical Accounting Policies
We have identified Property & Casualty Loss and Loss Adjustment Expense (LAE)
Reserves, Property & Casualty Reinsurance, and Valuation of Investments as
accounting policies critical to understanding our results of operations and
financial condition. As such, they require management to use judgments involving
assumptions and estimates concerning future results, trends, or other
developments that could significantly influence our results should actual
experience differ from those assumptions and estimates.
Property & Casualty Loss and Loss Adjustment Expense (LAE) Reserves
The process of estimating Property & Casualty Loss and LAE Reserves involves
significant judgment and is complex and imprecise due to the number of variables
and assumptions inherent in the estimation process. Due to the assumptions and
judgments inherent in the estimation of loss and LAE reserves, actual experience
may differ from these estimates. We refine reserve estimates in an ongoing
quarterly process as experience develops. We record adjustments to reserves in
our results of operations in the periods in which we change the estimate.
Asbestos, workers compensation and construction defect reserves are subject to
the greatest degree of uncertainty and subjectivity in their estimation.
Specifically with regard to workers compensation reserves, such reserves are
subject to a greater degree of uncertainty than most reserves due to the
late-reporting nature of certain of the claims, the long-term payout of many
claims and the resulting impact of inflationary trends over time, particularly
for medical costs, and the impact of legislative actions and judicial
interpretations in establishing the prescribed benefits.
In determining management's best estimate for workers compensation reserves,
long-term medical cost inflation trends over the average claim payout period are
a significant assumption. The rate of change in medical inflation and payment
trends may impact our estimates in future periods due to the difficulty of
precisely estimating the pattern of such trends over the claim payout period.
Workers compensation reserves also have been impacted by our claim practices and
changes to our business. Since late 2001, we have placed greater emphasis on
full exposure recognition in case reserving and on settlement of long-term
claims. In addition, the nature of our workers compensation business has changed
as we have focused our efforts on small-to-medium business and de-emphasized
workers compensation writings. This change in business emphasis has also changed
our mix by state. As with medical inflation, variation in historic claim
practices and business mix decrease the predictive value of the available
internal data.
In the second quarter, we began performing additional actuarial analysis of our
workers compensation book, primarily focused on medical inflation trends and the
changes in Safeco claim practices and mix of business. This analysis included
varying industry views on medical inflation that increased the volatility of our
estimates.
During the third quarter, we further refined our analysis and actuarial
techniques to better reflect the claim and business changes at Safeco. These
refinements included greater reliance on external information as a supplement to
historical claims patterns to project future development in medical costs. We
also evaluated medical inflation trends by state using both Safeco and industry
data. In addition, we completed claim file reviews to evaluate reserving trends
by state as they related to case reserving patterns and practices and paid
claims development. Our analysis showed relatively stable indemnity payouts,
higher medical payouts and longer payout periods than previously expected. Based
on these analyses, we increased our loss and allocated LAE reserves for losses
occurring in prior years by $180.0 pretax during the third quarter of 2003. The
largest amount of reserve development relates to California, particularly the
large account business that we began exiting in 2001. Of the $180.0 increase,
$130.0 was recorded in SBI Runoff, $48.0 in SBI Regular and $2.0 in SBI Special
Accounts Facility.
We also increased unallocated LAE reserves by $25.0 pretax, to reflect the
ongoing expense of servicing the increasingly long payout period of workers
compensation claims. Of the $25.0 increase, $14.9 was recorded in SBI Runoff,
$9.6 in SBI Regular, and $0.5 in SBI Special Accounts Facility.
These reserve additions reflect management's best estimate of ultimate losses
and loss adjustment expenses for Safeco's workers compensation business. Like
industry-wide workers compensation reserves, these reserves will continue to be
subject to the uncertainties presented by this late reporting, long payout line
of business.
Valuation of Investments
We classify all of our fixed maturity and equity securities as
available-for-sale and, accordingly, carry them at fair value. Fixed maturity
securities include bonds, mortgage-backed securities and redeemable preferred
stock. Equity securities include common stock and non-redeemable preferred
stock.
We analyze all investments with a fair value below cost as of each quarterly
reporting date to determine if an other than temporary decline in value has
occurred. The determination of whether a decline is other than temporary is made
based on the relevant facts and circumstances related to the security. These
considerations include: (1) the length of time and the extent to which the fair
value has been less than cost; (2) the financial condition and near-term
prospects of the issuer, including any specific events that influence the
operations of the issuer or that affect its future earnings potential; (3) our
intent and ability to retain the investment for a period of time sufficient to
allow for a recovery in value; (4) a review of any downgrades of the security by
a rating agency; and (5) any reduction or elimination of dividends or
non-payment of scheduled interest payments. Determining what constitutes an
other than temporary decline involves judgment. Declines in fair value below
cost not considered other than temporary in the current period could be
considered other than temporary in a future period and reduce earnings to the
extent of the impairment.
On September 29, 2003, we announced our intent to sell our Life & Investments
business. As a result, our intent and ability to retain securities with
unrealized losses held in our Life & Investments portfolio for a period of time
sufficient to allow for a recovery in their value has changed. In accordance
with SFAS 115, "Accounting for Certain Investments in Debt and Equity
Securities", we recorded $119.6 in pretax realized investment losses ($77.7
after tax) in the Consolidated Statements of Income (Loss) during the third
quarter of 2003 to write down securities with unrealized losses that may not
recover in value before the completion of the sale.
Financial Measures Used in MD&A
In addition to financial measures presented in the consolidated financial
statements prepared in accordance with accounting principles generally accepted
in the United States (GAAP), we also use certain non-GAAP financial measures to
analyze and report our financial results. Management believes that these
non-GAAP measures, when used in conjunction with the consolidated financial
statements, can aid in understanding our financial condition and results of
operations and, in accordance with SFAS 131, "Disclosures About Segments of
Enterperise and Related Information" are presented here. These non-GAAP measures
are not a substitute for GAAP measures, and where these measures are used we
provide tables that reconcile the non-GAAP measures to the GAAP measures
reported in our consolidated financial statements. The non-GAAP measures used in
this report include:
Property & Casualty Underwriting Profit (Loss) and Combined Ratio
Underwriting profit (loss) represents the net amount of earned premium less
underwriting losses and expenses on a pretax basis. Management views
underwriting profit (loss) as a critical measure to assess underwriting
effectiveness and to evaluate the results of the Property & Casualty operations.
The related investment portfolio is managed separately from these underwriting
businesses and, accordingly, net investment income and net realized investment
gains and losses are discussed separately. The most directly comparable GAAP
measure is Income (Loss) before Income Taxes on our Consolidated Statements of
Income (Loss). We provide a reconciliation of the GAAP measure to the non-GAAP
measure in the Segment - Results of Operations section following. Combined ratio
is a standard gauge of underwriting performance and is calculated as losses and
expenses expressed as a percentage of earned premiums.
Life & Investments Pretax Operating Earnings
Life & Investments results are evaluated based on pretax operating earnings, a
non-GAAP measure, which excludes net realized investment gains and losses.
Management believes the presentation of pretax operating earnings enhances the
understanding of our Life & Investments results of operations by excluding net
realized investment gains and losses, which can fluctuate significantly and
distort the comparison between periods. The most directly comparable GAAP
measure is Income (Loss) before Income Taxes on our Consolidated Statements of
Income (Loss). We provide a reconciliation of the GAAP measure to the non-GAAP
measure in the Segment - Results of Operations section following.
Consolidated - Results of Operations
The following table presents summary consolidated financial information prepared
in accordance with GAAP.
Three Months Ended Nine Months Ended
September 30 September 30
- ----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
--------------------------------------------------------
REVENUES
Property & Casualty Earned Premiums $ 1,250.4 $ 1,135.2 $ 3,615.3 $ 3,356.7
Life & Investments Premiums and
Other Revenues 212.6 223.3 657.6 554.5
Net Investment Income 409.8 420.4 1,255.4 1,247.9
Net Realized Investment Gains (Losses) (95.5) 12.5 (123.1) 138.5
Other 2.7 3.2 8.1 7.9
--------------------------------------------------------
Total 1,780.0 1,794.6 5,413.3 5,305.5
--------------------------------------------------------
EXPENSES
Losses, Loss Adjustment Expenses and
Policy Benefits 1,347.0 1,171.8 3,667.1 3,512.8
Other Underwriting, Acquisition and Operating
Expenses 481.1 479.8 1,450.2 1,351.4
Interest Expense (including $17.3 Distributions
on Capital Securities in 2003) 29.9 17.9 60.2 50.3
Restructuring Charges -- 3.0 -- 15.1
--------------------------------------------------------
Total Expenses 1,858.0 1,672.5 5,177.5 4,929.6
--------------------------------------------------------
Income (Loss) before Income Taxes (78.0) 122.1 235.8 375.9
Provision (Benefit) for Income Taxes (49.1) 35.6 40.4 98.2
--------------------------------------------------------
Distributions on Capital Securities, Net of Taxes -- (11.3) (22.4) (33.7)
--------------------------------------------------------
Net Income (Loss) $ (28.9) $ 75.2 $ 173.0 $ 244.0
- ----------------------------------------------------------------------------------------------------------
Consolidated revenues decreased slightly to $1,780.0 during the three months
ended September 30, 2003, compared with revenues of $1,794.6 for the same period
in 2002. Consolidated revenues increased 2.0% to $5,413.3 during the nine months
ended September 30, 2003, compared with $5,305.5 for the same period in 2002.
Our revenues for the three months ended September 30, 2003 primarily reflected
an overall increase in Property & Casualty earned premiums offset by pretax net
realized investment losses. Our revenues for the nine months ended September 30,
2003 reflected increases in Property & Casualty earned premiums and Life &
Investments premiums and other revenues, offset by pretax net realized
investment losses. The 10.1% and 7.7% increases in Property & Casualty earned
premiums for the three and nine months ended September 30, 2003, respectively,
were largely driven by growth in personal auto policies sold as well as premium
rate increases across all lines of business. Life & Investments premiums and
other revenues increased 18.6% for the nine months ended September 30, 2003,
primarily due to the acquisition of Swiss Re's stop-loss medical business in the
third quarter of 2002.
Revenues included pretax net realized investment losses of $95.5 and $123.1 for
the three and nine months ended September 30, 2003, respectively. Revenues for
the comparable periods in 2002 contained $12.5 and $138.5 of pretax net realized
investment gains. Pretax impairment losses included in net realized investment
gains and losses were $133.9 and $264.8 for the three and nine months ended
September 30, 2003, respectively, compared with $38.0 and $152.1 for the same
periods in 2002. The pretax impairment losses in the third quarter of 2003 were
largely due to charges of $119.6 as a result of our decision to sell the Life &
Investments business and the resultant impact on our intent and ability to hold
securities for a period of time sufficient to allow for a recovery in their
value before the completion of the sale of the Life & Investments business.
Loss before Income Taxes was $78.0 for the three months ended September 30,
2003, compared with Income before Income Taxes of $122.1 in the same period of
2002. Income before Income Taxes was $235.8 for the nine months ended September
30, 2003, compared with $375.9 for the same period in 2002. Improved
underwriting results in our personal lines in 2003 were offset by a third
quarter charge of $205.0 pretax, to strengthen workers compensation reserves, as
well as the higher net realized investment losses discussed above. Also,
impacting comparative results in 2003 is the change in the classification of
Distributions on Capital Securities as a result of our adoption of SFAS 150 on
July 1, 2003. For the three and nine months ended September 30, 2003, $17.3 in
Distributions on Capital Securities is included with pretax Interest Expense
while in previous periods it is reported in Distributions on Capital Securities,
Net of Taxes on our Consolidated Statements on Income (Loss). SFAS 150 does not
allow prior periods to be restated to reflect the current presentation.
Net Loss was $28.9 for the three months ended September 30, 2003, compared with
Net Income of $75.2 in the same period in 2002. Net Income was $173.0 for the
nine months ended September 30, 2003 compared with $244.0 in the same period of
2002. In addition to the reserve strengthening and net realized investment
losses described above, 2003 results include a $13.2 tax benefit from a
favorable federal income tax settlement related to prior tax years for our Life
& Investment business.
Segment - Results of Operations
The following table summarizes the GAAP measure "Income (Loss) before Income
Taxes" for Property & Casualty, Life & Investments and Corporate. In the
following sections we discuss Results of Operations for each and reconcile the
non-GAAP measures used, Property & Casualty underwriting profit (loss) and Life
& Investments pretax operating earnings, to this GAAP measure.
Three Months Ended Nine Months Ended
INCOME (LOSS) BEFORE INCOME TAXES September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Property & Casualty $ 13.5 $ 137.3 $ 254.9 $ 411.7
Life & Investments (67.2) 46.6 11.1 70.8
Corporate (24.3) (61.8) (30.2) (106.6)
---------------------------------------------------------
Income (Loss) before Income Taxes $ (78.0) $ 122.1 $ 235.8 $ 375.9
- -----------------------------------------------------------------------------------------------------------
Property & Casualty - Results of Operations
Safeco's Property & Casualty operations are organized around our four operating
segments, Safeco Personal Insurance (SPI), Safeco Business Insurance (SBI),
Surety and Property & Casualty Other (P&C Other). Within SPI there are three
reportable segments, Personal Auto, Homeowners and Specialty. Within SBI the
three reportable segments are SBI Regular, SBI Special Accounts Facility and SBI
Runoff.
Property & Casualty Operating Statistics
The following three tables for Property & Casualty reflect: (1) net earned
premiums by segment; (2) underwriting profits (losses) by segment and (3)
combined ratios by segment.
Three Months Ended Nine Months Ended
NET EARNED PREMIUMS September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Personal Auto $ 581.3 $ 497.4 $ 1,662.7 $ 1,424.1
Homeowners 191.5 192.7 573.1 565.3
Specialty 50.9 51.1 151.2 152.3
---------------------------------------------------------
Total SPI 823.7 741.2 2,387.0 2,141.7
---------------------------------------------------------
Regular 275.4 255.4 813.5 751.8
Special Accounts Facility 100.6 75.2 281.7 186.8
Runoff 2.2 24.2 0.3 162.8
---------------------------------------------------------
Total SBI 378.2 354.8 1,095.5 1,101.4
---------------------------------------------------------
Surety 40.0 32.7 110.6 93.6
P&C Other 8.5 6.5 22.2 20.0
---------------------------------------------------------
Total Property & Casualty $ 1,250.4 $ 1,135.2 $ 3,615.3 $ 3,356.7
- -----------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
UNDERWRITING PROFITS (LOSSES) September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Personal Auto $ 35.4 $ (6.2) $ 37.2 $ (33.8)
Homeowners 32.1 5.5 38.2 (49.6)
Specialty 12.5 9.6 38.8 20.6
---------------------------------------------------------
Total SPI 80.0 8.9 114.2 (62.8)
---------------------------------------------------------
Regular (51.3) (11.9) (68.1) (59.5)
Special Accounts Facility 5.8 3.9 11.6 10.3
Runoff (149.8) (15.4) (165.5) (74.5)
---------------------------------------------------------
Total SBI (195.3) (23.4) (222.0) (123.7)
---------------------------------------------------------
Surety 8.5 2.7 19.0 11.6
P&C Other (0.6) (33.6) (9.9) (46.0)
---------------------------------------------------------
Total Underwriting Losses (107.4) (45.4) (98.7) (220.9)
Property & Casualty Net Investment Income 113.7 114.5 343.0 345.0
Property & Casualty Restructuring Charges -- (3.0) -- (15.1)
Property & Casualty Net Realized Investment Gains 7.2 71.2 10.6 302.7
---------------------------------------------------------
Property & Casualty Income before Income Taxes $ 13.5 $ 137.3 $ 254.9 $ 411.7
- -----------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
COMBINED RATIOS+ September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Personal Auto 93.9% 101.2% 97.8% 102.4%
Homeowners 83.3 97.1 93.3 108.8
Specialty 75.4 81.2 74.3 86.4
---------------------------------------------------------
Total SPI 90.3 98.8 95.2 102.9
---------------------------------------------------------
Regular 118.6 104.7 108.4 107.9
Special Accounts Facility 94.3 94.8 95.9 94.5
Runoff * * * *
---------------------------------------------------------
Total SBI 151.6 106.6 120.3 111.2
---------------------------------------------------------
Surety 78.8 91.8 82.8 87.6
P&C Other * * * *
---------------------------------------------------------
Total Property & Casualty 108.6% 104.0% 102.7% 106.6%
- -----------------------------------------------------------------------------------------------------------
* Not meaningful.
+ Combined ratios are GAAP basis and are calculated based on losses and expenses
expressed as a percentage of earned premiums.
Safeco Personal Insurance
Personal Auto
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Net Earned Premiums $ 581.3 $ 497.4 $ 1,662.7 $ 1,424.1
Underwriting Profit (Loss) 35.4 (6.2) 37.2 (33.8)
Combined Ratio 93.9% 101.2% 97.8% 102.4%
- -----------------------------------------------------------------------------------------------------------
Net earned premiums increased 16.9% to $581.3 in the third quarter of 2003 from
$497.4 in the same quarter of 2002. Net earned premiums for the first nine
months of 2003 increased 16.8% to $1,662.7 compared with $1,424.1 for the same
period in 2002. The increases in premiums in the third quarter and the first
nine months of 2003 reflect rate increases as well as growth in policies in
force (PIF) each quarter since the third quarter of 2002. We implemented
mid-single digit rate increases throughout 2002 and into the third quarter of
2003, and we expect to continue to implement similar rate increases during the
remainder of the year. PIF increased 8.9% at September 30, 2003 compared with a
year ago, reflecting increased new business production.
Three strategic initiatives launched in 2002 continue to positively impact auto
results: the introduction of our new auto insurance product, our new business
entry model using point-of-sale (POS) technology and increased agent commissions
on new business.
The new auto insurance product contains additional underwriting tiers both to
provide more refined price points based on risk and to make insurance available
to a broader range of drivers. This new auto product has been introduced in 40
of the 44 states where we currently write business. Our new auto product also
expands the use of automated underwriting techniques, using multi-variate
analysis to classify auto insurance risks into tiers.
In early 2002, we also implemented improved POS technology in our agents'
offices, making it easier for agents to write business with Safeco. This
technology allows agents to quote policies more quickly and makes it easier for
our agents to sell Safeco products.
Our new commission structure was introduced in the first quarter of 2002 and
increased commissions on new auto policies for the first six-month policy
period, and revised the bonus commission structure to align our bonus incentives
to agents with both our growth and profitability goals.
Personal Auto's underwriting profit in the third quarter of 2003 was $35.4, an
improvement of $41.6 from a $6.2 underwriting loss in the comparable quarter of
2002. For the first nine months of 2003, the underwriting profit was $37.2, an
improvement of $71.0 from a $33.8 underwriting loss in the comparable period of
2002. Similarly, the combined ratio for the three and nine month periods ended
September 30, 2003 improved to 93.9% and 97.8%, respectively, compared with
101.2% and 102.4% in the prior year respective periods. The improved
underwriting results for both the three and nine month periods reflected higher
premium rates and an improved loss ratio. Our loss ratios were 59.1% and 60.9%
for the three and nine month periods ended September 30, 2003 compared with
64.9% and 66.5% for the same periods in 2002. The lower loss ratios were driven
primarily by the higher premium rates previously discussed, as well as lower
claims frequency, partially offset by mid-single digit increases in severity.
Homeowners
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Net Earned Premiums $ 191.5 $ 192.7 $ 573.1 $ 565.3
Underwriting Profit (Loss) 32.1 5.5 38.2 (49.6)
Combined Ratio 83.3% 97.1% 93.3% 108.8%
- -----------------------------------------------------------------------------------------------------------
Net earned premiums decreased slightly to $191.5 in the third quarter of 2003
from $192.7 in the same quarter of 2002. Net earned premiums for the first nine
months of 2003 increased 1.4% to $573.1 compared with $565.3 for the same period
in 2002. The increase reflects continued efforts to increase rates in order to
restore profitability in this product line. Our rate increases averaged in the
high teens throughout 2002 and into the third quarter of 2003, and we expect to
implement rate increases averaging in the low teens during the remainder of the
year. The impact of increased rates on earned premiums was largely offset by
continued decreases in PIF, which were down 9.3% at September 30, 2003 compared
with a year ago due to a decrease in new business.
Homeowners insurance written in states where we cannot achieve profitability
continues to decrease. Currently, we have moratoriums on writing new business in
three states. Moratoriums will be lifted in these states as we secure approval
to implement the changes necessary to move this product toward profitability. In
August 2003, we lifted a moratorium placed in July 2003 on new business in
California,our largest market for Homeowners based on 2002 net written premiums.
In October 2003, we lifted our moratorium on new business in Virginia.
In addition, we introduced new language into homeowners policies sold in
storm-prone Midwest states. Currently in place in 12 states, the new language
requires individuals to pay a higher deductible, generally 1% of home's insured
value, for wind and hail damage. We also have filed limits on mold damages for
homeowners policies sold in 38 of the states in which we do business. Generally,
these filing limits cap mold damages at $10 thousand, including remediation. We
will continue to file limits in other states, as allowed.
In the first quarter of 2002, we launched a new tiered pricing structure for
homeowners that more accurately prices business based on risk characteristics.
This approach, which matches rates more closely to risks, is currently in place
in 36 of the 44 states where we write homeowners business, and we expect to have
it in place in all but four by the end of the year.
The underwriting profit for Homeowners in the third quarter of 2003 was $32.1,
an improvement of $26.6 from a $5.5 underwriting profit in the comparable
quarter of 2002. For the first nine months of 2003, the underwriting profit was
$38.2, an improvement of $87.8 compared with a $49.6 underwriting loss in the
same period of 2002. Similarly, the combined ratio improved for both the three
and nine month periods ended September 30, 2003, to 83.3% and 93.3%,
respectively, compared with 97.1% and 108.8% in the prior year's respective
periods. These results reflect the actions taken to increase rates as well as
the continued trend of lower claims frequency, partially offset by higher
severity and catastrophe losses in the first nine months of 2003 compared with
the prior year. Catastrophe losses in the third quarter and first nine months of
2003 were $11.1 and $79.8, respectively, compared with $(6.6) and $50.6 in the
same respective periods of 2002. The catastrophe losses in the third quarter of
2003 were largely due to damage caused by windstorms in Tennessee and Hurricane
Isabel in Virginia. Nine month results in 2003 include hailstorm losses in Texas
and losses from severe storms and tornadoes in the states of Kansas, Missouri,
Tennessee and Wyoming. The $(6.6) in catastrophe losses in the third quarter of
2002 was due to lower weather and catastrophe losses, as well as a reduction of
reserves associated with the Southwest wildfires. These fires were burning out
of control at the end of the second quarter of 2002, preventing adjusters from
compiling precise estimates of customer losses at that time.
During the fourth quarter of 2003 -- in the weeks leading up to the date of our
filing of this quarterly report on Form 10-Q -- we incurred losses related to
the Southern California wildfires. The magnitude of these losses could not be
reasonably estimated at the time of this filing.
Specialty
Three Months Ended Nine Months Ended
September 30 September 30
- ----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
--------------------------------------------------------
Net Earned Premiums $ 50.9 $ 51.1 $ 151.2 $ 152.3
Underwriting Profit 12.5 9.6 38.8 20.6
Combined Ratio 75.4% 81.2% 74.3% 86.4%
- ----------------------------------------------------------------------------------------------------------
Specialty lines include earthquake, dwelling fire, umbrella, inland marine and
boat insurance for individuals.
Net earned premiums decreased slightly to $50.9 in the third quarter of 2003
from $51.1 in the same quarter of 2002. Net earned premiums for the first nine
months of 2003 decreased slightly to $151.2 compared with $152.3 for the same
period in 2002. These decreases reflected a slight reduction in PIF at September
30, 2003.
Specialty's underwriting profit was $12.5, up $2.9 from $9.6 in the comparable
quarter of 2002. For the first nine months of 2003, the underwriting profit was
$38.8, an increase of $18.2 from an underwriting profit of $20.6 in the same
period of 2002. This was primarily due to the rate increases described above and
lower umbrella losses in the current year. The combined ratio was 75.4% and
74.3% for the three and nine month periods of 2003, respectively, compared with
81.2% and 86.4% in the same periods a year ago.
Safeco Business Insurance
SBI Regular
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Net Earned Premiums $ 275.4 $ 255.4 $ 813.5 $ 751.8
Underwriting Loss (51.3) (11.9) (68.1) (59.5)
Combined Ratio 118.6% 104.7% 108.4% 107.9%
- -----------------------------------------------------------------------------------------------------------
SBI Regular is our core commercial segment writing insurance for small- to
medium-sized businesses. Net earned premiums increased 7.8% to $275.4 in the
third quarter of 2003 from $255.4 in the same quarter of 2002. Net earned
premiums for the first nine months of 2003 increased 8.2% to $813.5 compared
with $751.8 for the same period in 2002. The increase in net earned premiums
reflected the impact of rate increases partially offset by a decrease in PIF. We
implemented average insurance price increases in the mid-teens for SBI Regular
throughout 2002 and into 2003 and we expect average price increases near
double-digits for the year.
PIF decreased 5.1% at September 30, 2003 compared with a year ago but decreased
only 0.2% compared to June 30, 2003, as we continue to introduce our redesigned
business model. The business model encompasses a suite of services that includes
an automated underwriting platform, a business service center and a new business
agency interface system. The new underwriting approach provides an increased
number of pricing tiers and better matching of rate to risk. The new business
entry model makes it easier for agents to quote and sell our products to small
businesses, as evidenced by the increase in new business owner policies (BOP) in
2003. SBI Regular experienced an increase in new BOP of 46% for the first nine
months of 2003 compared with the same period in 2002.
SBI Regular's underwriting loss increased to $51.3 in the third quarter of 2003
from $11.9 in the comparable quarter of 2002. For the first nine months of 2003,
the underwriting loss was $68.1, compared with a $59.5 underwriting loss in the
same period of 2002. The combined ratios for the quarter and first nine months
of 2003 were 118.6% and 108.4%, respectively, compared with 104.7% and 107.9% in
the same periods of 2002. Results for the three and nine months ended September
30, 2003 include $57.6 in prior years' workers compensation reserve
strengthening. See further discussion of this charge in the Application of
Critical Accounting Policies section above.
Excluding the reserve strengthening charge, the combined ratio for the quarter
and first nine months of 2003 was 97.7% and 101.3%, respectively, compared with
104.7% and 107.9% in the same periods of 2002. The improvements in 2003 reflect
the rate increases described above and lower claim frequency and better matching
of rate with risk as a result of implementing our automated underwriting
platform. Catastrophe losses in the third quarter and first nine months of 2003
were $5.2 and $18.8, respectively, compared with $(0.3) and $16.3, respectively,
in the same periods in 2002. The increase in catastrophe losses in the third
quarter of 2003 was primarily due to damage caused by Hurricane Isabel in
Virginia. The $(0.3) in catastrophe losses in the third quarter of 2002 was due
to lower weather and catastrophe losses as well as a reduction of reserves
associated with the Southwest wildfires. These fires were burning out of control
at the end of the second quarter of 2002, preventing adjusters from compiling
precise estimates of customer losses at that time.
SBI Special Accounts Facility
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Net Earned Premiums $ 100.6 $ 75.2 $ 281.7 $ 186.8
Underwriting Profit 5.8 3.9 11.6 10.3
Combined Ratio 94.3% 94.8% 95.9% 94.5%
- -----------------------------------------------------------------------------------------------------------
SBI Special Accounts Facility (SAF) writes larger commercial accounts for our
key Safeco agents and our four continuing specialty commercial programs
(lender-placed property insurance, agents' errors and omissions insurance
written predominantly for Safeco agents, mini storage and warehouse property
coverages, and coverages for non-profit social service organizations).
Net earned premiums increased 33.8% to $100.6 in the third quarter of 2003 from
$75.2 in the same quarter of 2002. Net earned premiums for the first nine months
of 2003 increased 50.8% to $281.7 compared with $186.8 for the same period in
2002. The increases in net earned premiums in 2003 were primarily due to the
consolidation of our business insurance products in 2002: as each existing
Safeco large account commercial policy came up for renewal (reported in SBI
Runoff) a decision was made by SAF to renew or not. If it was renewed it became
part of SAF, otherwise underwriting results associated with the discontinued
account remained in SBI Runoff.
Underwriting profit in the third quarter of 2003 increased by $1.9 to $5.8
compared with an underwriting profit of $3.9 a year ago. For the first nine
months of 2003, SAF achieved an underwriting profit of $11.6, an increase from
$10.3 in the comparable period of 2002. Results for three and nine months ended
September 30, 2003 include $2.5 in prior years' workers compensation reserve
strengthening. See further discussion of this charge in the Application of
Critical Accounting Policies section above. The combined ratio was 94.3% and
95.9% for the third quarter and first nine months of 2003, relatively unchanged
from 94.8% and 94.5% in the same periods of 2002. Catastrophe losses in the
third quarter and first nine months of 2003 were $3.6 and $7.2, respectively,
compared with $0.0 and $0.7 in the same periods of 2002.
SBI Runoff
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Net Earned Premiums $ 2.2 $ 24.2 $ 0.3 $ 162.8
Underwriting Loss (149.8) (15.4) (165.5) (74.5)
- -----------------------------------------------------------------------------------------------------------
SBI Runoff includes the large commercial business accounts and 15 specialty
programs that Safeco is exiting. We continue to run off poor-performing large
accounts and are focusing on growth in the small- to medium-sized commercial
business market, as reflected in SBI Regular.
Net earned premiums were $2.2 in the third quarter of 2003 compared with $24.2
in the same quarter of 2002. Net earned premiums for the first nine months of
2003 were $0.3 compared with $162.8 for the same period in 2002. The decreases
reflect the actions taken to exit this unprofitable business and the renewal of
certain policies into SAF, as discussed above.
Underwriting loss in the third quarter of 2003 was $149.8 compared with $15.4 a
year ago. For the first nine months of 2003, the underwriting loss was $165.5
compared with $74.5 in the same period of 2002. Results for the three and nine
months ended September 30, 2003 include $144.9 in prior years' workers
compensation reserve strengthening for large accounts in runoff. See further
discussion of this charge in the Application of Critical Accounting Policies
section above.
Excluding the reserve strengthening, the underwriting loss in the third quarter
of 2003 was $4.9 compared with $15.4 a year ago, reflecting the decrease in
premium volume expected for this runoff segment.
Surety
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Net Earned Premiums $ 40.0 $ 32.7 $ 110.6 $ 93.6
Underwriting Profit 8.5 2.7 19.0 11.6
Combined Ratio 78.8% 91.8% 82.8% 87.6%
- -----------------------------------------------------------------------------------------------------------
Surety's net earned premiums increased 22.3% to $40.0 in the third quarter of
2003 from $32.7 in the same quarter of 2002. Net earned premiums for the first
nine months of 2003 increased 18.2% to $110.6 compared with $93.6 for the same
period of 2002. The increase in net earned premiums reflected the impact of new
business production, the opening of a new office in Glendale, California and
rate increases.
Underwriting profit in the third quarter of 2003 increased by $5.8 to $8.5 from
$2.7 a year ago. For the first nine months of 2003, underwriting profit improved
to $19.0 compared with $11.6 in 2002. The combined ratio in the third quarter
and first nine months of 2003 was 78.8% and 82.8%, respectively, compared with
91.8% and 87.6%, respectively, in the prior year. The underwriting improvement
compared with prior year reflects the increases in net earned premium described
above, combined with decreases in commission expense for the current year.
P&C Other
Three Months Ended Nine Months Ended
September 30 September 30
- ---------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
Net Earned Premiums $ 8.5 $ 6.5 $ 22.2 $ 20.0
Underwriting Loss (0.6) (33.6) (9.9) (46.0)
- ---------------------------------------------------------------------------------------------------------
P&C Other includes our discontinued assumed reinsurance business, our
involuntary assigned risk and other state-mandated personal lines business, our
Lloyd's of London operations which are in runoff, and certain discontinued
product lines.
Net earned premiums were $8.5 in the third quarter of 2003 compared with $6.5 in
the same quarter of 2002. Net earned premiums for the first nine months of 2003
were $22.2, compared with $20.0 for the same period of 2002.
The underwriting loss in the third quarter of 2003 was $0.6 compared with a
$33.6 underwriting loss in the same quarter of 2002. For the first nine months
of 2003, the underwriting loss was $9.9 compared with $46.0 in the same period
of 2002. In the third quarter of 2002, we made the decision to put our London
operations into runoff, resulting in a pretax charge of $26.3.
Life & Investments - Results of Operations
On September 29, 2003, we announced our intent to sell our Life & Investments
business. As of September 30, 2003, we have not met all of the "held-for-sale"
criteria under SFAS 144, "Accounting for the Impairment & Disposal of Long-lived
Assets" and therefore we have not presented Life & Investments as a discontinued
operation in the unaudited consolidated financial statements.
Life & Investments operations are managed separately as six reportable segments:
Group, Income Annuities, Retirement Services, Individual, Asset Management and
Life & Investments Other (L&I Other). The following table summarizes comparative
operating results for Life & Investments:
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Total Revenues $ 508.3 $ 530.4 $ 1,560.6 $ 1,452.2
---------------------------------------------------------
Policy Benefits 343.4 353.6 1,027.8 971.7
Other Expenses 123.8 117.2 362.0 309.8
---------------------------------------------------------
Total Benefits and Expenses 467.2 470.8 1,389.8 1,281.5
---------------------------------------------------------
Pretax Operating Earnings 41.1 59.6 170.8 170.7
Net Realized Investment Losses (108.3) (13.0) (159.7) (99.9)
---------------------------------------------------------
Income (Loss) before Income Taxes $ (67.2) $ 46.6 $ 11.1 $ 70.8
- -----------------------------------------------------------------------------------------------------------
Life & Investments revenues are comprised of premiums, net investment income and
other fees. The following tables summarize revenues (excluding net realized
investment gains and losses) and pretax operating earnings by reportable
segment.
Three Months Ended Nine Months Ended
REVENUES September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Group $ 133.9 $ 149.3 $ 420.7 $ 327.6
Income Annuities 121.7 134.0 383.9 392.6
Retirement Services 96.6 96.3 289.1 284.1
Individual 96.3 96.2 288.0 282.8
Asset Management 7.0 7.0 19.9 23.2
L&I Other 52.8 47.6 159.0 141.9
---------------------------------------------------------
Total Life & Investments Revenues $ 508.3 $ 530.4 $ 1,560.6 $ 1,452.2
- -----------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
PRETAX OPERATING EARNINGS September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Group $ 12.5 $ 22.4 $ 66.0 $ 46.7
Income Annuities (0.9) 11.5 17.6 27.6
Retirement Services 3.3 1.4 13.2 13.4
Individual 3.9 3.5 5.3 17.7
Asset Management 1.1 0.9 1.3 4.9
L&I Other 21.2 19.9 67.4 60.4
---------------------------------------------------------
Pretax Operating Earnings 41.1 59.6 170.8 170.7
Net Realized Investment Losses (108.3) (13.0) (159.7) (99.9)
---------------------------------------------------------
Income (Loss) before Income Taxes $ (67.2) $ 46.6 $ 11.1 $ 70.8
- -----------------------------------------------------------------------------------------------------------
Group
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Revenues $ 133.9 $ 149.3 $ 420.7 $ 327.6
Pretax Operating Earnings 12.5 22.4 66.0 46.7
Loss Ratio 63.3% 58.4% 58.5% 59.2%
- -----------------------------------------------------------------------------------------------------------
Group's principal product offering is stop-loss medical insurance sold to
employers with self-insured medical plans. Also offered in this line are group
life, accidental death and dismemberment, and disability products.
Revenues decreased 10.3% to $133.9 in the third quarter of 2003 from $149.3 in
the same quarter of 2002. The decrease in revenues in the third quarter of 2003
reflects the current competitive rate environment, resulting in some
policyholders renewing their coverage with other carriers. We continue to adhere
to our disciplined underwriting standards in this environment and not lower
premiums to compete for business where it does not meet our profit targets.
Revenues for the first nine months of 2003 increased to $420.7 compared with
$327.6 for the same period in 2002. The increase in revenues for the first nine
months of 2003 is primarily due to the acquisition of Swiss Re's stop-loss
medical business in July 2002.
Pretax operating earnings decreased to $12.5 in the third quarter of 2003 from
$22.4 in the same quarter of 2002. The decrease in pretax operating earnings in
the third quarter of 2003 is due to a higher loss ratio, which was 63.3%
compared with 58.4% in 2002. This loss ratio reflected a more normal and
expected level of profitability. Pretax operating earnings for the first nine
months of 2003 increased to $66.0 compared with $46.7 for the same period in
2002. The increase in pretax operating earnings primarily reflected the addition
of the Swiss Re business, as well as an improved loss ratio of 58.5% for the
nine months ended September 30, 2003, compared with 59.2% in the same period of
2002. Also impacting pretax operating earnings for the nine months ended
September 30, 2003 was favorable reserve development of $10.5 in the first
quarter primarily related to policies obtained in the acquisition of Swiss Re's
stop-loss medical business.
Income Annuities
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Revenues $ 121.7 $ 134.0 $ 383.9 $ 392.6
Pretax Operating Earnings (0.9) 11.5 17.6 27.6
Policyholder Liabilities at September 30 6,341.7 6,286.3 6,341.7 6,286.3
- -----------------------------------------------------------------------------------------------------------
Income Annuities' primary product is the structured settlement annuity that is
sold to fund third-party personal injury settlements, providing a reliable
income stream to the injured party. This product is extremely sensitive to
financial strength ratings, and our ratings downgrades in 2001 decreased our
ability to sell this product. Income Annuities also sells non-structured fixed
annuities, that provide an immediate payment stream. Overall sales of immediate
annuities (including structured settlements) were $29.3 and $93.6 in the three
and nine months ended September 30, 2003, respectively, compared with $34.1 and
$69.8 in the same periods of 2002. The increase during the first nine months of
2003 was due to continued efforts to grow the sales of non-structured settlement
annuity products. Structured settlement sales included $10.4 and $27.2 in
annuities purchased by Property & Casualty affiliates in the three and nine
months ended September 30, 2003, respectively, compared with $17.9 and $33.8 in
the same periods of 2002. Income Annuities' contracts are non-surrenderable and
supported by long-term invested assets consisting primarily of long duration
bonds and mortgage-backed securities.
Revenues decreased to $121.7 in the third quarter of 2003 from $134.0 in the
same quarter of 2002. Revenues for the first nine months of 2003 decreased to
$383.9 compared with $392.6 for the same period in 2002. Revenues for the three
months ended September 30, 2003 were impacted by unfavorable prepayment
adjustments on mortgage-backed securities of $5.8 in the quarter compared with
favorable prepayment adjustments of $6.3 in the same period of 2002. Revenues
for the nine months ended September 30, 2003 reflected lower favorable
prepayment adjustments on mortgage-backed securities ($1.3 for the nine months
ended September 30, 2003 compared with $5.2 in the same period of 2002) and
lower interest rates on reinvestment.
Pretax operating loss was $0.9 in the third quarter of 2003 compared with pretax
operating earnings of $11.5 in the same quarter of 2002 due to the unfavorable
prepayment adjustment on mortgage-backed securities described above. Pretax
operating earnings for the first nine months of 2003 decreased to $17.6 compared
with $27.6 for the same period in 2002. This was due to lower interest income
and the lower favorable prepayment adjustments on mortgage-backed securities
described above.
Retirement Services
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Revenues $ 96.6 $ 96.3 $ 289.1 $ 284.1
Pretax Operating Earnings 3.3 1.4 13.2 13.4
General Account Liabilities at September 30 6,572.5 5,864.4 6,572.5 5,864.4
Separate Account Liabilities at September 30 938.3 770.3 938.3 770.3
- -----------------------------------------------------------------------------------------------------------
The primary products in this business line are fixed deferred and variable
annuities (both qualified and non-qualified), and guaranteed investment
contracts (GIC). The profitability of these products is highly dependent on our
ability to earn an acceptable interest spread on new business. In response to
the low interest rate environment, we sell in those states that have lowered
their minimum guaranteed interest rate requirements and have curtailed sales in
states where interest spreads on our products are not acceptable.
Products in Retirement Services have protection against early withdrawals in the
form of surrender charges during the initial years of each policy or the option
for Safeco to spread payouts over five years.
Revenues of $96.6 in the third quarter of 2003 were flat compared with the same
quarter of 2002. Revenues for the first nine months of 2003 increased to $289.1
compared with $284.1 for the same period in 2002. The increase in 2003 was due
to higher investment income as a result of growth in general account
liabilities, partially offset by decreased interest income due to lower
reinvestment rates.
Pretax operating earnings increased to $3.3 in the third quarter of 2003 from
$1.4 in the same quarter of 2002. The increase in 2003 was due to improved
margins on our fixed deferred annuities and increased income on our variable
annuity products as a result of improving equity markets. These positive impacts
were reduced by increased operating expenses. Pretax operating earnings of $13.2
for the first nine months of 2003 were flat compared with the same period in
2002. This reflected higher operating expenses in the nine months ended
September 30, 2003, offset by improved margins on our fixed deferred annuities.
General account liabilities increased to $6,572.5 at September 30, 2003 from
$5,864.4 at September 30, 2002. The increase was due to sales of our fixed
deferred annuity products over that time period, partially offset by scheduled
GIC withdrawals. The increase in separate account liabilities to $938.3 from
$770.3 was a result of the improving equity markets.
Individual
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Revenues $ 96.3 $ 96.2 $ 288.0 $ 282.8
Pretax Operating Earnings 3.9 3.5 5.3 17.7
- -----------------------------------------------------------------------------------------------------------
Individual products include term, universal and variable universal life and
BOLI. BOLI is universal life insurance sold to banks and is extremely sensitive
to financial strength ratings; consequently, our ratings downgrades in 2001
significantly curtailed the volume of new BOLI deposits.
Revenues of $96.3 in the third quarter of 2003 were flat compared with the same
quarter of 2002. Revenues for the first nine months of 2003 increased to $288.0
compared with $282.8 for the same period in 2002. Updated term and universal
life insurance products launched in 2002 and a new internet sales tool (Safeco
Now) contributed to the increased sales in 2003.
Pretax operating earnings increased to $3.9 in the third quarter of 2003 from
$3.5 in the same quarter of 2002. The slight increase in the third quarter of
2003 was due to decreased claim experience, partially offset by increased
operating expenses and a lower BOLI interest spread. Pretax operating earnings
for the first nine months of 2003 decreased to $5.3 compared with $17.7 for the
same period in 2002. The decrease was due primarily to higher claims, higher
operating expenses, and a lower BOLI interest spread in the nine months ended
September 30, 2003.
Asset Management
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Revenues $ 7.0 $ 7.0 $ 19.9 $ 23.2
Pretax Operating Earnings 1.1 0.9 1.3 4.9
Assets Under Management at September 30 3,993.0 3,747.8 3,993.0 3,747.8
- -----------------------------------------------------------------------------------------------------------
Asset Management serves as the investment advisor for the Safeco Mutual Funds
and variable insurance portfolios, and for institutional and trust accounts.
Revenues of $7.0 in the third quarter of 2003 were flat compared with the same
quarter of 2002. Revenues for the first nine months of 2003 were $19.9 down from
$23.2 for the same period in 2002, due to decreased investment advisory fee
revenue on lower average assets under management.
Assets under management of $3,993.0 at September 30, 2003 were up from $3,747.8
a year ago and reflected improved equity markets in the third quarter of 2003.
Pretax operating earnings of $1.1 in the third quarter of 2003 were up slightly
compared with the same period a year ago. The decline in pretax operating
earnings to $1.3 in the first nine months of 2003 from $4.9 a year ago reflected
the overall decline in equity markets and the consequent reduction in fees
earned.
L&I Other
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Revenues $ 52.8 $ 47.6 $ 159.0 $ 141.9
Pretax Operating Earnings 21.2 19.9 67.4 60.4
- -----------------------------------------------------------------------------------------------------------
Our L&I Other segment is comprised mainly of investment income on capital and
accumulated earnings of the other reportable segments, as well as commissions
received by Talbot Financial Corporation (Talbot), our insurance agency that
distributes property and casualty and life insurance and investment products.
Revenues were $52.8 for the third quarter of 2003 compared with $47.6 in the
same quarter of 2002. Revenues for the first nine months of 2003 were $159.0
compared with $141.9 for the same period in 2002. The increase in revenues in
2003 was primarily due to an increase in contingent commission bonuses and
brokerage income received by Talbot, and increased investment income. Pretax
operating earnings were $21.2 for the third quarter of 2003 compared with $19.9
in the same quarter of 2002. Pretax operating earnings for the first nine months
of 2003 were $67.4 compared with $60.4 for the same period in 2002.
Corporate - Results of Operations
Three Months Ended Nine Months Ended
September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Pretax Loss before Net Realized Investment Gains
(Losses) $ (29.9) $ (16.1) $ (56.2) $ (42.3)
Net Realized Investment Gains (Losses) before
Income Taxes 5.6 (45.7) 26.0 (64.3)
---------------------------------------------------------
Loss before Income Taxes $ (24.3) $ (61.8) $ (30.2) $ (106.6)
- -----------------------------------------------------------------------------------------------------------
The Corporate segment includes operating results for Safeco Corporation, SFP,
Safeco Properties, Inc. and intercompany transaction eliminations. Interest
expense on borrowings and capital securities totaled $29.9 and $17.9 in the
third quarter of 2003 and 2002, respectively, and $60.2 and $50.3 for the nine
months ended September 30, 2003 and 2002, respectively. Interest expense for the
three and nine months ended September 30, 2003 includes $17.3 for the
distributions on our Capital Securities due to our July 1, 2003 adoption of SFAS
150. Prior to adoption of SFAS 150, these amounts were reported after tax as
Distributions on Capital Securities on our Consolidated Statements of Income
(Loss). SFAS 150 does not allow prior periods to be restated to reflect the
current presentation.
SFP was organized in 2000 to write S&P 500 index options to mitigate the risk
associated with Life & Investments' Equity Indexed Annuity (EIA) product. SFP
also engages in limited activity for its own account by selling single-name
credit default swaps (credit swaps), writing and hedging S&P 500 Index options
and investing in and hedging convertible bonds. In conjuction with our strategy
to focus on Property & Casualty products, we will wind down SFP's operations.
Changes in the fair values of derivative instruments and any net realized gain
or loss are recognized in current income. Net investment income includes the
premium income on the credit swaps and the earnings and fair value adjustments
for the S&P 500 index options and the convertible bonds. Net realized investment
gain and loss includes the fair value adjustments and net realized investment
gains and losses from the credit swaps. SFP's pretax loss before net realized
investment gains and losses was $0.9 for the third quarter of 2003 compared with
a loss of $5.4 in 2002. SFP's pretax income (loss) before net realized
investment gains and losses was $0.3 and ($0.6) in the first nine months of 2003
and 2002, respectively.
SFP had credit swaps with notional amounts outstanding totaling $894.0 and
$835.0 at September 30, 2003 and December 31, 2002, respectively. These credit
swaps involved selling credit protection for a fee that covered certain credit
events on assets owned by the buyer (financial institutions and investment
banks) such that if a credit event occurs SFP would make a payment to the buyer.
The credit swaps are marked-to-market and this adjustment is recorded in net
realized investment gains and losses on the Consolidated Statements of Income
(Loss). Total net realized investment gain before taxes in the third quarter of
2003 was $2.8 compared with a total net realized investment loss before taxes of
$27.3 in the same period of 2002. Total net realized investment gain before
taxes for the nine months ended September 30, 2003 was $22.1 compared with a
total net realized investment loss before taxes of $43.6 for the same period in
2002.
The table below summarizes the quality of the credit swap portfolio:
Percent at
September 30
RATING 2003
- -------------------------------------------------------------------------
AAA 14%
AA 1
A 40
BBB 42
BB and lower 3
--------------------
Total 100%
- -------------------------------------------------------------------------
The fair value of SFP's written S&P 500 index options liability was $45.8 and
$21.4 at September 30, 2003 and 2002, respectively. SFP's investment portfolio
included investment grade convertible bonds with market values totaling $66.9
and $50.1 at September 30, 2003 and 2002, respectively.
Capital Resources and Liquidity
Sources and Uses of Funds
Safeco's operations have liquidity requirements that vary among the segments and
their principal product lines. Life insurance, retirement services and annuity
product reserves are primarily longer-duration liabilities that are typically
predictable in nature and are supported by investments that are generally
longer-duration. Property & Casualty liabilities are both short-term and
long-term. These liabilities are less predictable in nature and generally
require greater liquidity in the investment portfolio.
Safeco's liquidity needs are met by dividends from its subsidiary operations,
the sale and maturity of invested assets and the issuance of debt and equity.
Our subsidiaries' primary sources of cash from operations are insurance
premiums, funds received under deposit contracts, dividends, interest and asset
management fees. Safeco has not engaged in the sale by securitization of any
investments or other assets.
Safeco uses funds to support operations, service and pay down debt, pay
dividends to our shareholders and grow the investment portfolio. Cash from
insurance operations is used primarily to pay claims and claim adjustment
expenses. Most insurance premiums are received before or at the time premium
revenues are recognized, while related claims are incurred and paid in
subsequent months or years. Catastrophe claims, the timing and amount of which
are inherently unpredictable, may create increased liquidity requirements.
Total cash provided by operating activities was $1,031.3 for the first nine
months of 2003 compared with $588.9 in the same period a year ago. The increase
in 2003 was primarily due to improved underwriting results in Auto, Homeowners
and SBI-Regular.
On January 27, 2003, Safeco issued $200.0 of senior notes with a coupon of
4.200% that mature in 2008 and $300.0 of senior notes with a coupon of 4.875%
that mature in 2010. The notes are unsecured and rank equally with all our other
unsecured senior indebtedness. The proceeds from the notes were used to repay
$300.0 principal amount of 7.875% medium term notes due March 15, 2003 and to
call $200.0 principal amount of 7.875% notes maturing in 2005 at par on April 1,
2003.
On November 20, 2002, Safeco completed the sale of 10,465,000 shares of common
stock at $33.00 per share. Safeco received proceeds net of related expenses of
$328.7 from the sale of these shares. The net proceeds were used to contribute
capital of $150.0 to our Property & Casualty operations and $100.0 to our Life &
Investments operations in December 2002 to support future growth in our core
product lines and strengthen the capital base of these operations. Remaining
proceeds were used for general corporate purposes and the repayment of
outstanding indebtedness.
Safeco maintains a bank credit facility of $500.0 available through September
2005. Safeco pays a fee to have the facility available and does not maintain
deposits as compensating balances. The facility carries certain covenants that
require Safeco to maintain a specified minimum level of shareholders' equity and
a maximum debt-to-capitalization ratio. There were no borrowings under the
facility as of September 30, 2003 or December 31, 2002 and Safeco was in
compliance with all covenants.
Management believes that cash flow from operations, investment portfolio and
credit facilities are sufficient to meet our future liquidity needs.
The following tables summarize Safeco's contractual obligations as of September
30, 2003:
Payments due
- -----------------------------------------------------------------------------------------------------------
Less than More than
CONTRACTUAL OBLIGATIONS Total 1 Year 1-3 Years 3-5 Years 5 Years
- -----------------------------------------------------------------------------------------------------------
Long-Term Debt (including Capital $ 1,952.7 $ 4.3 $ 5.7 $ 404.6 $ 1,538.1
Securities of $850.0)
Operating Leases 329.8 52.4 92.5 78.9 106.0
------------------------------------------------------------------
Total Contractual Obligations $ 2,282.5 $ 56.7 $ 98.2 $ 483.5 $ 1,644.1
- -----------------------------------------------------------------------------------------------------------
Material terms of contractual obligations are described in the notes to our
consolidated financial statements included in our 2002 Annual Report on Form
10-K.
Ratings
The financial strength of insurers is rated to provide both insurance consumers
and industry participants with comparative information on specific insurance
companies. Financial strength ratings are important for the marketing of our
products and some lines are especially sensitive to ratings such as structured
settlement annuities, BOLI products and GICs. Higher ratings generally indicate
greater financial strength and a stronger ability to pay claims. Lower ratings
for Safeco could, among other things, significantly affect our ability to sell
certain life insurance and investment products, materially increase the number
of policy surrenders and withdrawals by policyholders of cash value from their
policies, adversely affect relationships with broker-dealers, banks, agents and
other distributors of our products and services, adversely affect new sales,
significantly affect borrowing costs or limit our access to capital, and
adversely affect our ability to compete. Any of these factors could have a
material adverse effect on our business, consolidated results of operations and
financial condition.
Ratings focus on factors such as results of operations, capital resources,
debt-to-capital ratio, demonstrated management expertise in the insurance
business, marketing, investment operations, minimum policyholders' surplus
requirements and capital sufficiency to meet projected growth, as well as access
to such capital as may be necessary to continue to meet standards for capital
adequacy.
On September 29, 2003, we announced our intent to sell our Life & Investments
business. As a result, A.M. Best and Fitch placed the financial strength ratings
of our life insurance subsidiaries under review with developing implications and
commented that our debt ratings, as well as the financial strength ratings of
our Property & Casualty subsidiaries, are unaffected. Also, Standard & Poor's
(S&P) lowered its ratings on our life insurance subsidiaries with developing
implications and affirmed its ratings on Safeco Corporation and our Property &
Casualty subsidiaries with a stable outlook. At the same time, Moody's
downgraded the financial strength rating of Safeco Life Insurance Company with
direction uncertain and affirmed the ratings of Safeco Corporation and our
Property & Casualty subsidiaries with a stable outlook.
We believe our financial position is sound and continue to execute our action
plans to improve Property & Casualty operating results. The effect of our
operating action plans has been reflected in improved operating results and this
has improved Safeco's debt service coverage during 2002 and the first nine
months of 2003.
It is, however, possible that further negative ratings actions may occur. If
ratings are further lowered, Safeco may incur higher borrowing costs, may have
more limited means to access capital, and may have additional difficulties
marketing certain of its insurance products that are dependent upon ratings
being at or above a particular level.
The following table summarizes Safeco's current ratings:
Standard
A.M.Best Fitch Moody's & Poor's
- ------------------------------------------------------------------------------------------------------------
Safeco Corporation
Senior Debt bbb+ A- Baa1 BBB+
Capital Securities bbb BBB+ Baa2 BBB-
Financial Strength/Claims-Paying Ability
Property & Casualty Subsidiaries A AA- A1 A+
Life Subsidiaries A AA- A2 A-
- ------------------------------------------------------------------------------------------------------------
Investment Summary
Net Investment Income
Safeco's consolidated pretax net investment income was $409.8 in the third
quarter of 2003 compared with $420.4 in the same quarter of 2002. Pretax net
investment income for the first nine months of 2003 was $1,255.4 compared with
$1,247.9 for the same period in 2002. The investment portfolios of Property &
Casualty and Life & Investments produced substantially all of this net
investment income.
Three Months Ended Nine Months Ended
PRETAX NET INVESTMENT INCOME September 30 September 30
- ---------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
Property & Casualty $ 113.7 $ 114.5 $ 343.0 $ 345.0
Life & Investments 295.7 307.1 903.0 897.7
Corporate and Other 0.4 (1.2) 9.4 5.2
-------------------------------------------------------
Total $ 409.8 $ 420.4 $ 1,255.4 $ 1,247.9
- ---------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30 September 30
-------------------------------------------------------
PRETAX INVESTMENT INCOME YIELDS 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------
Property & Casualty 5.6% 5.9% 5.7% 5.9%
Life & Investments 6.7% 7.5% 6.8% 7.4%
- ---------------------------------------------------------------------------------------------------------
Property & Casualty pretax net investment income decreased to $113.7 in the
third quarter of 2003 from $114.5 in the same quarter of 2002. Pretax net
investment income declined in the first nine months of 2003 to $343.0 compared
with $345.0 for same period in 2002. On an after tax basis, net investment
income was $83.3 and $84.1 for the third quarters ending September 30, 2003 and
2002, respectively, and $253.3 and $260.4 for the nine months ended September
30, 2003 and 2002, respectively. Income for the first nine months of 2003
reflected lower interest rates and the repositioning of the Property & Casualty
investment portfolio in 2002 to reduce the average duration and to reduce equity
holdings.
Life & Investments pretax net investment income decreased to $295.7 in the third
quarter of 2003 from $307.1 in the same quarter of 2002, and increased in the
first nine months of 2003 to $903.0 compared with $897.7 for the same period in
2002. On an after tax basis, net investment income was $205.1 and $199.7 for the
quarter ended September 30, 2003 and 2002, respectively, and $601.5 and $585.3
for the nine months ended September 30, 2003 and 2002, respectively. The
decrease in pretax net investment income during the third quarter of 2003 was
due to unfavorable adjustments on mortgage-backed securities of $5.8 in Income
Annuities compared with favorable prepayment adjustments of $6.3 in the same
period of 2002. The increase in after-tax net investment income in the third
quarter of 2003 reflects a lower effective tax rate as a result of a favorable
federal income tax settlement regarding prior tax years. The growth in net
investment income during the first nine months of 2003 was due to higher
invested assets related to the growth of total funds held under deposit
contracts, partially offset by lower yields on new investments and reinvested
assets.
Net Realized Investment Gains and Losses
Pretax net realized investment gains and losses for the periods indicated by
business and component were as follows:
Three Months Ended Nine Months Ended
NET REALIZED INVESTMENT GAINS (LOSSES) September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
Property & Casualty $ 7.2 $ 71.2 $ 10.6 $ 302.7
Life & Investments 11.3 (13.0) (40.1) (99.9)
Impairments related to intent to sell L&I (119.6) -- (119.6) --
Corporate 5.6 (45.7) 26.0 (64.3)
-------------------------------------------------------
Total $ (95.5) $ 12.5 $ (123.1) $ 138.5
- -----------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
NET REALIZED INVESTMENT GAINS (LOSSES) September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
-------------------------------------------------------
Gains on Securities Transactions $ 24.8 $ 42.1 $ 98.8 $ 301.8
Impairments on Fixed Maturities (7.1) (37.4) (124.7) (137.4)
Impairments on Equity Securities (7.2) (0.6) (20.5) (14.7)
Impairments related to intent to sell L&I (119.6) -- (119.6) --
Credit Swap Mark-to-Market 2.8 (27.3) 22.1 (43.6)
Other 10.8 35.7 20.8 32.4
-------------------------------------------------------
Total $ (95.5) $ 12.5 $ (123.1) $ 138.5
- -----------------------------------------------------------------------------------------------------------
Pretax investment impairments by portfolio were as follows:
Three Months Ended Nine Months Ended
PRETAX INVESTMENT IMPAIRMENTS September 30 September 30
- -----------------------------------------------------------------------------------------------------------
2003 2002 2003 2002
---------------------------------------------------------
Property & Casualty $ 10.0 $ 1.7 $ 46.4 $ 20.6
Life & Investments 123.9 36.1 217.6 117.2
Corporate -- 0.2 0.8 14.3
---------------------------------------------------------
Total $ 133.9 $ 38.0 $ 264.8 $ 152.1
- -----------------------------------------------------------------------------------------------------------
Gains on securities transactions for the nine months ended September 30, 2003
relate primarily to calls and fixed maturity sales initiated to manage our call
risk and improve the credit quality of the underlying portfolio. Gains on
securities transactions for the nine months ended September 30, 2002 relate
primarily to the repositioning of our Property & Casualty portfolio to reduce
average duration.
The increase in fixed maturity impairments in the first nine months of 2003
compared with a year ago, partially reflected impairments primarily in the
airline and franchise sectors and was due to continued credit deterioration,
which began to slow in the second quarter. Due to our intent to sell the Life &
Investments business and its related investment portfolio (see MD&A "Strategic
Initiatives"), we recorded $119.6 in impairment charges during the third quarter
of 2003 for securities with unrealized losses that may not be held for the time
period necessary to recover in value before the completion of the sale.
We analyze all investments with a fair value below cost each quarter to
determine if an other than temporary decline in value has occurred. The
determination of whether a decline is other than temporary is made based on the
relevant facts and circumstances related to the security. These considerations
include: (1) the length of time and the extent to which the fair value has been
less than cost; (2) the financial condition and near-term prospects of the
issuer, including any specific events that influence the operations of the
issuer or that affect its future earnings potential; (3) our intent and ability
to retain the investment for a period of time sufficient to allow for a recovery
in value; (4) a review of any downgrades of the security by a rating agency; and
(5) any reduction or elimination of dividends or non-payment of scheduled
interest payments. Determining what constitutes an other than temporary decline
involves judgment. Declines in fair value below cost not considered other than
temporary in the current period could be considered other than temporary in a
future period and reduce earnings to the extent of the impairment.
The total proceeds at fair value from fixed maturities and equities sold at a
loss were $88.5 for the third quarter ended September 30, 2003. The related
total pretax net realized investment loss on these sales was $14.0. The total
proceeds at fair value from fixed maturities and equities sold at a loss were
$287.3 for the nine months ended September 30, 2003. The related total pretax
net realized investment loss on these sales was $42.8. In accordance with our
investment impairment process described above, we consider our intent and
ability to retain investments for a period of time sufficient to allow for a
market value recovery. However, our intent to hold is reassessed frequently in
light of financial market fluctuations and the financial condition and near term
prospects of the issuer. Safeco's sales activity reflects ongoing management
decisions and modifications in our intent due to actual or expected
deterioration in the issuer's credit, our decisions to lessen exposure to a
particular industry and our actions to reposition our asset allocation.
Credit swap mark-to-market gains of $2.8 and $22.1 for the three and nine months
ended September 30, 2003, respectively, were due to tightening in credit spreads
on SFP's credit default swap portfolio. This compared with a widening of credit
spreads and the resulting mark-to-market loss of $27.3 and $43.6 over the same
respective periods in 2002.
Included in Other for the nine months ended September 30, 2003 was $15.2 related
to interest rate hedges on forecasted transactions not probable of occurring.
SFAS 133 requires amounts recorded in AOCI that relate to forecasted
transactions that are no longer probable of occurring within a specified time
period to be recognized in earnings immediately. No such amounts were
reclassified from AOCI into earnings during the three months ended September 30,
2003 or the three and nine months ended September 30, 2002.
Investment Portfolio
The table below summarizes Safeco's consolidated securities investment portfolio
at September 30, 2003:
Cost or
SEPTEMBER 30, 2003 Amortized Cost Carrying Value
- -----------------------------------------------------------------------------------------------------------
PROPERTY & CASUALTY
Fixed Maturities - Taxable $ 5,103.9 $ 5,454.1
Fixed Maturities - Nontaxable 2,047.0 2,203.2
Equity Securities 655.5 1,029.2
LIFE & INVESTMENTS
Fixed Maturities - Taxable 16,360.4 17,977.2
Fixed Maturities - Nontaxable 7.6 7.7
Equity Securities 96.2 112.6
CORPORATE
Fixed Maturities - Taxable 25.3 91.3
Equity Securities 8.5 25.3
------------------------------
Total Fixed Maturities and Equity Securities 24,304.4 26,900.6
Mortgage Loans 937.9 937.9
Other Invested Assets 159.0 159.0
Short-Term Investments 449.2 449.2
------------------------------
Total Consolidated Investment Portfolio $ 25,850.5 $ 28,446.7
- -----------------------------------------------------------------------------------------------------------
Safeco's consolidated portfolio of investment securities at September 30, 2003
consisted of $25,733.5 fixed maturities and $1,167.1 of equity securities at
market value. Included in the fixed maturities carrying amount were gross
unrealized losses of $15.9 and gross unrealized gains of $2,205.2. Included in
the equity securities carrying value were gross unrealized losses of $1.4 and
gross unrealized gains of $408.3. The only industry that contributed more than
10% of the total gross unrealized loss were air and freight couriers (20%).
Safeco reviewed all securities in an unrealized loss position and determined
that these declines in fair value were temporary as of September 30, 2003.
As of September 30, 2003, unrealized losses on fixed maturities that were in an
unrealized loss position for longer than a year amounted to $8.6. This compared
with $88.2 as of June 30, 2003. The decrease from June 30, 2003 is due to the
impairment recorded during the third quarter related to our announced intent to
sell our Life & Investments business.
We continue to monitor fixed maturities and equities in an unrealized loss
position as part of our overall portfolio evaluation and if an unrealized loss
were determined to be other than temporary, the impairment loss would be
recognized in the Consolidated Statements of Income (Loss) in the current period
when that determination is made.
Safeco's consolidated investment portfolio included $340.6 of non-publicly
traded fixed maturities and equity securities, representing 1.3% of the
portfolio at September 30, 2003.
On a consolidated basis, below investment-grade securities with a fair value of
$1.4 billion were held at September 30, 2003 compared with $1.1 billion at
December 31, 2002. The related amortized cost for the below investment-grade
securities at September 30, 2003 and December 31, 2002 was $1.3 billion and $1.2
billion, respectively.
The quality of Property & Casualty's fixed maturities portfolio (at fair value)
is detailed in the following table:
Percent at
RATING September 30, 2003
- -----------------------------------------------------------------------------------------------------------
AAA 40%
AA 11
A 24
BBB 20
BB and Lower 4
Not Rated 1
----------------------
Total 100%
- -----------------------------------------------------------------------------------------------------------
The quality of Life & Investments' fixed maturities (at fair value) portfolio is
detailed in the following table:
Percent at
RATING September 30, 2003
- -----------------------------------------------------------------------------------------------------------
AAA 32%
AA 4
A 24
BBB 32
BB and Lower 6
Not Rated 2
----------------------
Total 100%
- -----------------------------------------------------------------------------------------------------------
Our consolidated fixed maturity and equity securities portfolio is
well-diversified by issuer and by industry type. As of September 30, 2003, there
were no single-issuer holdings exceeding 1% of our consolidated investment
portfolio. Industry concentrations exceeding 3% of our consolidated investment
portfolio were as follows at September 30, 2003:
Percent at
INDUSTRY Carrying Value September 30, 2003
- -----------------------------------------------------------------------------------------------------------
State and Political Subdivisions $ 2,960.1 10%
Electric Utilities 2,150.5 8
U.S. Government & Agencies 1,842.0 6
Banks 1,753.0 6
Diversified Financial Services 1,145.6 4
Mortgage-Backed Securities 5,370.5 19
Other 11,678.9 41
-------------------------------------------
Total Fixed Maturities and Equity Securities 26,900.6 94
Mortgage Loans 937.9 3
Other Invested Assets 159.0 1
Short-Term Investments 449.2 2
-------------------------------------------
Total Consolidated Investment Portfolio $ 28,446.7 100%
- -----------------------------------------------------------------------------------------------------------
The table below summarizes Safeco's consolidated holdings of mortgage-backed
securities at September 30, 2003:
Carrying Value
Cost or -------------------------
SEPTEMBER 30, 2003 Amortized Cost Amount Percent
- -----------------------------------------------------------------------------------------------------------
RESIDENTIAL
Planned and Targeted Amortization Class and Sequential Pay CMOs $ 2,309.1 $ 2,403.3 45%
Accrual Coupon (Z-Tranche) CMOs 433.9 481.3 9
Floating Rate CMOs 85.6 89.9 2
Companion/Support, Principal Only, Interest Only CMOs 9.7 10.5 --
Subordinates 23.0 23.7 --
Residential Mortgage-Backed Pass-Throughs (Non-CMOs) 379.9 391.4 7
-------------------------------------------
Total 3,241.2 3,400.1 63
-------------------------------------------
SECURITIZED COMMERCIAL REAL ESTATE
Government/Agency-Backed 460.1 490.0 9
CMOs and Pass-Throughs (Non-agency) 1,074.5 1,165.7 22
-------------------------------------------
Total 1,534.6 1,655.7 31
Other CMOs 301.1 314.7 6
-------------------------------------------
Total $ 5,076.9 5,370.5 100%
- -----------------------------------------------------------------------------------------------------------
Safeco's consolidated investment holdings in mortgage-backed securities with a
fair value of $5.4 billion at September 30, 2003, consists mainly of residential
collateralized mortgage obligations (CMOs), pass-throughs and commercial
loan-backed mortgage obligations (CMBSs). Life & Investments portfolio holds
80.0% and Property & Casualty portfolio holds 20.0% of these securities.
Ninety-two percent of the mortgage-backed securities were
government/agency-backed or AAA rated at September 30, 2003. Safeco has
intentionally limited its investment in riskier, more volatile CMOs and CMBSs
(e.g., principal only, interest only, etc.) to $34.2 or 0.6% of total
mortgage-backed securities at September 30, 2003.
ITEM 4 - CONTROLS AND PROCEDURES
(a) Disclosure Controls and Procedures. We have evaluated the effectiveness of
the design and operation of our "disclosure controls and procedures" as of the
end of the period covered by this report. Safeco conducted this evaluation under
the supervision and with the participation of management, including our Chief
Executive Officer, Chief Financial Officer and our disclosure committee.
(i) Definition of Disclosure Controls and Procedures. Disclosure
controls and procedures are controls and other procedures that are
designed with the objective of ensuring that information required to be
disclosed in our periodic reports filed under the Exchange Act, such as
this report, is recorded, processed, summarized and reported within the
time periods specified in the SEC's rules and forms. As defined by the
SEC, such disclosure controls and procedures are also designed with the
objective of ensuring that such information is accumulated and
communicated to our management, including our Chief Executive Officer
and Chief Financial Officer, in such a manner as to allow timely
disclosure decisions.
(ii) Limitations on the Effectiveness of Disclosure Controls and
Procedures and Internal Controls. Safeco recognizes that a system of
disclosure controls and procedures (as well as a system of internal
controls), no matter how well conceived and operated, can provide only
reasonable assurance that it will meet its objectives. Even an
effective control system has inherent limitations, including resource
constraints, the possibility of intentional circumvention or overriding
of controls, lapses in judgment and simple error or mistake.
(iii) Conclusions with Respect to Our Evaluation of Disclosure Controls
and Procedures. Our Chief Executive Officer and Chief Financial Officer
have concluded that our disclosure controls and procedures are
effective, meaning that the controls and procedures provide reasonable
assurance that the objectives described in paragraph (i) above are met.
(b) Changes in Internal Control Over Financial Reporting. There were no changes
in internal control over financial reporting during the third quarter that
materially affected or are reasonably likely to materially affect our internal
control over financial reporting.
Safeco Corporation and Subsidiaries
- -------------------------------------------------------------------------------
PART II - OTHER INFORMATION
- -------------------------------------------------------------------------------
ITEM 1 - LEGAL PROCEEDINGS
Because of the nature of our businesses, Safeco's insurance and other
subsidiaries are subject to legal actions filed or threatened in the ordinary
course of our business operations, generally as liability insurers defending
third-party claims brought against our insureds or as insurers defending policy
coverage claims brought against them. Safeco does not believe that such
litigation will have a material adverse effect on our financial condition,
future operating results or liquidity.
Our property and casualty insurance subsidiaries are parties to a number of
lawsuits for liability coverages related to environmental claims. Although
estimation of reserves for environmental claims is difficult, we do not expect
the loss and LAE with respect to any such lawsuit, or all lawsuits related to a
single incident combined, to be material to our financial condition.
Our property and casualty insurance companies recently defeated allegations in a
suit filed on July 18, 2001, by a plaintiff who purported to represent a class
of present and former claim adjusters. The plaintiff claimed that claims
adjusters should have been considered non-exempt employees under the labor laws,
and sought damages representing back overtime pay for certain hours worked. The
U.S. District Court for the Northern District of Ohio disagreed and dismissed
the action on January 31, 2003. Our property and casualty insurance companies
are defending two other lawsuits alleging similar claims, one filed on August
10, 2001 in California and the other on January 14, 2003 in U.S. District Court
for the District of Connecticut. We intend to defend vigorously against these
allegations.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(A) EXHIBITS
31.1 Certification of Chief Executive Officer of Safeco
Corporation, dated November 5, 2003, in accordance with
Securities Exchange Act Rule 13a-14(a)/15d-14(a) as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification of Chief Financial Officer of Safeco
Corporation, dated November 5, 2003, in accordance with
Securities Exchange Act Rule 13a-14(a)/15d-14(a) as
adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification of Chief Executive Officer of Safeco
Corporation, dated November 5, 2003, in accordance with 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer of Safeco
Corporation, dated November 5, 2003, in accordance with 18
U.S.C. Section 1350 as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
(B) REPORTS ON FORM 8-K
The registrant filed the following 8-K's during the quarter ended
September 30, 2003 and for the period up to the filing date of this
Form 10-Q.
Filing dated Under Filing related to:
-------------------------------------------------------------------------------------------------
July 28, 2003 Item 9 (Regulation Earnings Release for quarter ended June 30, 2003.
FD Disclosure)
September 29, 2003 Item 5 (Other Event) Announcements regarding intent to: (1) sell Life &
Investments business; (2) eliminate 500 positions;
and (3) strengthen workers compensation loss
reserves by $205 million pretax.
October 6, 2003 Item 9 (Regulation Appointment of corporate controller.
FD Disclosure)
October 27, 2003 Item 12 (Results of Earnings Release for
Operations and quarter ended September 30,2003.
Financial Condition)
-------------------------------------------------------------------------------------------------
Safeco Corporation and Subsidiaries
- -------------------------------------------------------------------------------
Signatures
- -------------------------------------------------------------------------------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized on November 5, 2003.
Safeco Corporation
-----------------------------------------------
Registrant
/s/ CHRISTINE B. MEAD
-----------------------------------------------
Christine B. Mead
Senior Vice President, Chief Financial Officer
and Secretary