-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, RFtgBJEwIjCDhGZ+Z8IferbjmPByHA5lnJZkY81cnWXZW1hx9GGa2EULDciIXgO0 FLQyoE/bY5GXA5M2PbRsMw== 0000950123-98-002694.txt : 19980323 0000950123-98-002694.hdr.sgml : 19980323 ACCESSION NUMBER: 0000950123-98-002694 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980319 SROS: NYSE FILER: COMPANY DATA: COMPANY CONFORMED NAME: ALLEGHANY CORP /DE CENTRAL INDEX KEY: 0000775368 STANDARD INDUSTRIAL CLASSIFICATION: TITLE INSURANCE [6361] IRS NUMBER: 510283071 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-09371 FILM NUMBER: 98568732 BUSINESS ADDRESS: STREET 1: PARK AVE PLZ CITY: NEW YORK STATE: NY ZIP: 10055 BUSINESS PHONE: 2127521356 MAIL ADDRESS: STREET 1: PARK AVENUE PLAZA CITY: NEW YORK STATE: NY ZIP: 10055 FORMER COMPANY: FORMER CONFORMED NAME: ALLEGHANY FINANCIAL CORP DATE OF NAME CHANGE: 19870115 10-K 1 ALLEGHANY CORPORATION 1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission For the fiscal year ended December 31, 1997 File Number 1-9371 ALLEGHANY CORPORATION (Exact name of registrant as specified in its charter) Delaware 51-0283071 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 375 Park Avenue, New York, New York 10152 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: 212/752-1356 Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange Title of each class on which registered ------------------- ------------------- Common Stock, $1 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act: Not applicable Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes X No -- -- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] As of March 2, 1998, 7,373,739 shares of Common Stock were outstanding, and the aggregate market value (based upon the closing price of these shares on the New York Stock Exchange) of the shares of Common Stock of Alleghany Corporation held by non-affiliates was $2,008,827,590. 2 DOCUMENTS INCORPORATED BY REFERENCE Portions of the following documents are incorporated by reference into the indicated part(s) of this Report:
Part Annual Report to Stockholders of Alleghany I and II Corporation for the year 1997 Proxy Statement relating to Annual Meeting III of Stockholders of Alleghany Corporation to be held on April 24, 1998
3 ALLEGHANY CORPORATION Annual Report on Form 10-K for the year ended December 31, 1997 Table of Contents
Description Page ----------- ---- PART I Item 1. Business 5 Item 2. Properties 53 Item 3. Legal Proceedings 61 Item 4. Submission of Matters to a Vote of Security 62 Holders Supplemental Item Executive Officers of Registrant 62 PART II Item 5. Market for Registrant's Common Equity and 63 Related Stockholder Matters Item 6. Selected Financial Data 63 Item 7. Management's Discussion and Analysis of 63 Financial Condition and Results of Operations Item 8. Financial Statements and Supplementary Data 63 Item 9. Changes in and Disagreements With 63 Accountants on Accounting and Financial Disclosure
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Description Page ----------- ---- PART III Item 10. Directors and Executive Officers of Registrant 64 Item 11. Executive Compensation 64 Item 12. Security Ownership of Certain Beneficial 64 Owners and Management Item 13. Certain Relationships and Related 64 Transactions PART IV Item 14. Exhibits, Financial Statement Schedules and 65 Reports on Form 8-K Signatures 78
Index to Financial Statement Schedules FINANCIAL STATEMENT SCHEDULES INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES Index to Exhibits EXHIBITS -4- 5 PART I Item 1. Business. Alleghany Corporation ("Alleghany") was incorporated in 1984 under the laws of the State of Delaware. In December 1986, Alleghany succeeded to the business of its parent company, Alleghany Corporation, a Maryland corporation incorporated in 1929, upon the parent company's liquidation. Alleghany's principal executive offices are located at 375 Park Avenue, New York, New York 10152 and its telephone number is (212) 752-1356. Alleghany is engaged, through its subsidiaries Chicago Title and Trust Company ("CT&T"), Chicago Title Insurance Company ("CTI"), Security Union Title Insurance Company ("Security Union") and Ticor Title Insurance Company ("Ticor Title") and their subsidiaries, in the sale and underwriting of title insurance and in other real estate-related services business, and through CT&T's subsidiary, Alleghany Asset Management, Inc. ("Alleghany Asset Management") and its subsidiaries, in the financial services business. Alleghany is also engaged, through its subsidiary Underwriters Re Group, Inc. ("Underwriters Re Group") and its subsidiaries, in the property and casualty reinsurance and insurance businesses. In addition, Alleghany is engaged, through its subsidiaries World Minerals Inc. ("World Minerals"), Celite Corporation ("Celite"), Harborlite Corporation ("Harborlite") and Europerlite Acquisition Corporation ("Europerlite") and their subsidiaries, in the industrial minerals business. Alleghany conducts a steel fastener importing and distribution business through its Heads and Threads division. On December 17, 1997, Alleghany announced its intention to establish the title insurance and real estate-related services businesses conducted by CT&T as an independent, publicly traded company. This is to be accomplished by a spin-off to Alleghany stockholders of shares of a newly formed holding company for CT&T to be called Chicago Title Corporation. The spin-off, which is expected to occur in the second quarter of 1998, is subject to, among other conditions, the receipt of an IRS ruling to the effect that the spin-off will not be taxable. The common stock of the Chicago Title Corporation is expected to be listed on the New York Stock Exchange. The asset management business conducted through Alleghany Asset Management, currently a subsidiary of CT&T, will not be part of the distribution and will remain with Alleghany. Until October 31, 1994, Alleghany was also engaged, through its subsidiary Sacramento Savings Bank ("Sacramento Savings") in retail banking. On that date, Alleghany completed the sale of Sacramento Savings and an ancillary company to First Interstate Bank of California for a cash purchase price of $331 million. As part of the transaction, Alleghany, through its wholly owned subsidiary Alleghany Properties, Inc. -5- 6 ("API"), purchased real estate and real estate-related assets of Sacramento Savings for a purchase price of about $116 million. During 1994 and early 1995, with temporary borrowings under Alleghany's revolving credit agreement, the proceeds from the sale of Sacramento Savings and cash on hand, Alleghany and its subsidiaries acquired a substantial number of shares of common stock of Santa Fe Pacific Corporation ("Santa Fe"). On September 22, 1995, Santa Fe and Burlington Northern, Inc. merged under a new holding company named Burlington Northern Santa Fe Corporation ("BNSF"). As a result of the merger, the shares of Santa Fe beneficially owned by Alleghany were converted into about 7.43 million shares of BNSF, or about 4.8 percent of BNSF's currently outstanding common stock. BNSF is engaged primarily in rail transportation. BNSF owns one of the largest railroad networks in North America, providing transportation services to shippers throughout the western two-thirds of the United States as well as to Canada and Mexico. In 1997, Alleghany studied a number of potential acquisitions. Alleghany intends to continue to expand its operations through internal growth at its subsidiaries as well as through possible operating-company acquisitions and investments. Reference is made to Items 7 and 8 of this Report for further information about the business of Alleghany in 1997. The consolidated financial statements of Alleghany, incorporated by reference in Item 8 of this Report, include the accounts of Alleghany and its subsidiaries for all periods presented. In light of the proposed spin-off of CT&T, Alleghany is required to classify the operation to be spun-off as a "discontinued operation." Accordingly, the financial statements incorporated by reference in Item 8 of this Report report the results of CT&T (excluding Alleghany Asset Management) as a single net number. More detailed information on CT&T's results is included in Note 2 to the Consolidated Financial Statements of Alleghany, incorporated by reference in Item 8 of this Report. TITLE INSURANCE AND REAL ESTATE-RELATED SERVICES BUSINESS CT&T provides, through its subsidiaries, title insurance and real estate-related services which facilitate residential and commercial real estate transactions. CT&T, headquartered in Chicago, was organized as an Illinois corporation in 1912 and was acquired, along with CTI, by Alleghany in June 1985. CTI, a Missouri corporation incorporated in 1961, succeeded to businesses conducted by predecessor corporations since 1847, and is headquartered in Chicago. Security Union (acquired in 1987) and Ticor Title (acquired in 1991) were incorporated in California in 1962 and 1965, respectively. However, both were a part of business organizations that had succeeded to -6- 7 businesses conducted since around the turn of the century. Security Union and Ticor Title are headquartered in Pasadena, California. CT&T and its title subsidiaries, CTI, Security Union and Ticor Title, constitute one of the largest title insurance organizations in the nation, based upon revenues as disclosed in statutory filings. Confirming the organization's financial strength, each of the principal title insurance subsidiaries -- CTI, Security Union and Ticor Title -- carries a claims-paying ability rating of "A" from Standard & Poor's Corporation and from Duff & Phelps Credit Rating Co. In addition, Moody's Investors Service has assigned an insurance financial strength rating of "A2" to CTI, "A3" to Ticor Title and "Baa1" to Security Union. CT&T has approximately 300 full-service offices and more than 3,800 policy-issuing agents in 49 states, Puerto Rico, the Virgin Islands, Guam, Canada and Mexico. In 1995, CT&T acquired Chicago Title Flood Services Inc. (formerly National Flood Information Services, Inc.), a Delaware corporation based in Arlington, Texas and Chicago Title Credit Services Inc. (formerly Credit Data Reporting Services, Inc.), a New York corporation headquartered in Kingston, New York. Chicago Title Flood Services Inc. has provided flood certification services since 1987. Chicago Title Credit Services Inc. has been in the credit reporting business since 1941. In July 1996, CT&T acquired Chicago Title--Market Intelligence, Inc. (formerly Market Intelligence, Inc.), a Massachusetts corporation based in Hopkinton, Massachusetts. Chicago Title--Market Intelligence, Inc. has been in the property evaluation business since 1989. In 1998, CT&T acquired Chicago Title Field Services Inc. (formerly Universal Mortgage Services, Inc.) and Consolidated Reconveyance Company. Based in Cleveland, Ohio, Chicago Title Field Services Inc. has provided field inspection services since 1968. Based in Calabasas, California, Consolidated Reconveyance Company has been furnishing foreclosure and reconveyance services since 1979. Title Insurance CT&T's title insurance subsidiaries insure a variety of interests in real property. For a one-time premium, purchasers of residential and commercial properties, mortgagees, lessees and others with an interest in real property purchase insurance policies to insure against loss suffered, including the cost of legal defense, as a result of encumbrances or other defects in title, as that title is defined in the policy. Prior to the issuance of a policy, a title insurer conducts a title search and examination of the records relevant to the property and its owners, a process by which it identifies and defines the risks to be assumed by the insurer under the policy. To conduct a title search and examination, an agent or employee of a CT&T title insurance subsidiary reviews various records providing a history of transfers of interests -7- 8 in the parcel of real estate with respect to which a policy of title insurance is to be issued. These records are maintained by local governmental entities, such as counties and municipalities. Title records, known as title plants, owned by the CT&T title insurance subsidiaries are also used as a reference, allowing complete title searches without resorting to governmental records. The title plants consist of compilations of land title and deed information copied from public records dating back many years on properties in various geographic locations. These title plants are updated daily. Closing, escrow and disbursement services are key elements in many real estate transactions. CT&T's closing and escrow officers are responsible for coordinating the activities of buyers, sellers, attorneys, lenders and real estate agents. Responsibilities include managing escrow accounts; prorating and adjusting insurance, taxes and rents; preparation, review and recording of documents; ensuring that liens are properly cleared; disbursement of funds; and transmittal of final documents. In 1997, approximately 62 percent of CT&T's title revenues were generated by residential real estate activity, consisting of resales (40 percent), refinancings (14 percent) and new housing (8 percent). Commercial and industrial real estate activity accounted for the remaining 38 percent of 1997 revenues, consisting of initial sales and resales (31 percent) and refinancings (7 percent). Underwriting Operations While most other forms of insurance provide for the assumption of risk of loss arising out of unforeseen future events, title insurance serves to protect the policyholder principally from the risk of loss from events that predate the issuance of the policy. This distinction underlies the low claims loss experience of title insurers as compared with other types of insurers. Realized losses generally result from either judgment errors or mistakes made in the title search and examination process or the escrow process, or from other problems such as fraud or incapacity of persons transferring property rights. Operating expenses, on the other hand, are higher for title insurance companies than for other companies in the insurance industry. Most title insurers incur considerable costs relating to the personnel required to process forms, search titles, collect information on specific properties and prepare title insurance commitments and policies. Many title insurers also face ongoing costs associated with the establishment, operation and maintenance of title plants, or, in the case of smaller regional title insurers, access to title plants owned by others or employment of abstractors to search public records on behalf of such regional title insurers. CT&T's title operations facilitate rapid communication between field underwriters and the principal office underwriting staff for dealing with difficult, large or unusual underwriting risks. Authority levels for field underwriters are set based on their skills and -8- 9 experience level. The most experienced field underwriters are required to be involved in the decision to insure difficult, large or unusual risks. Risks with very high potential liability require approval from higher levels of the title insurer's management, which may include, depending upon the particular risk, the Chief Underwriting Counsel, the General Counsel or senior executive officers of the title insurer. Geographic concentration of risk is less significant in underwriting title insurance coverage than in casualty insurance lines. The title insurance underwriting process reduces the number of perils which are covered to a minimum through reliance on state public records acts. However, maintaining geographic diversity spreads the risk of fraud which may result from regional economic recession, and of claims which are not readily determinable from public records, such as aboriginal title claims of Native Americans. CTI, Ticor Title, and Security Union each have generally restricted the size of any one risk of loss that they will retain to $70 million, $50 million and $30 million, respectively. The title insurance subsidiaries of CT&T reinsure risks with each other and with other title insurance companies in excess of what they are willing to retain. In addition, the title insurers have purchased excess loss coverage for individual losses in excess of $12.5 million, subject to certain exclusions. This coverage will pay 90 percent of such losses up to $50 million. However, reinsurance arrangements do not relieve a title insurance company that issues a policy from its legal liability to the holder of the policy and, thus, the risk of nonperformance by the assuming reinsurer is borne by the issuer of the policy. Losses and Loss Adjustment Expenses The largest single liability of CT&T is its reserve for title insurance claims and associated legal defense costs. Historical experience with respect to payments for claims and external legal defense costs made under title insurance policies indicates that, for policies issued in a given year, approximately two-thirds of the total projected payments with respect to such policies are made within five years of the issuance of such policies. The reserve also covers losses arising from the escrow, closing and disbursement functions due to fraud or operational error, and includes the costs of external legal defense. Title losses are reported to CT&T directly by its insured parties. When a claim is reported, CT&T establishes a "case" reserve, based upon the best estimate of the total amount necessary to settle the claim and to provide for allocated loss adjustment expenses, including legal defense costs ("LAE"). These reserves are periodically adjusted by CT&T based on its evaluation of subsequent reports regarding the reported claim. -9- 10 In addition to "case" reserves, CT&T also maintains reserves for losses that are incurred but not yet reported ("IBNR reserves"). These reserves are particularly significant in long tail lines of insurance, such as title insurance, for which the claim and the circumstances causing the claim may be separated by a long period of time. Unlike most other types of insurance, the event giving rise to a possible future claim under a title insurance policy, the defect in the title, occurred before issuance of the policy but may not be discovered, if ever, until a future date. CT&T establishes IBNR reserves by using actuarial principles and procedures commonly used in the title insurance industry to estimate the ultimate liability for losses and LAE. The actuarial procedures use historic claims reporting patterns to predict likely future reporting of claims. Projections are analyzed in the context of changing economic conditions, including implicitly recognizing the impact of inflation, business mix and other contingent variables, and the projections and related reserves are modified when appropriate. IBNR reserves are also established for very large or unusual claims which might fall outside the normal distribution of expected claims experience. Reserves for these claims are based on an analysis of the experience of both CT&T and the title insurance industry generally. CT&T's reserves are reviewed regularly by management and are certified by an independent actuary on an annual basis. CT&T does not discount its reserves for anticipated investment income. Initial reserve provisions are derived directly from premium revenues, based upon anticipated loss ratios. There are inherent uncertainties in estimating reserves primarily due to the long-term nature of most title insurance business. Actual losses and LAE may deviate, perhaps substantially, from reserves on CT&T's financial statements, which could have a material adverse effect on CT&T's financial condition and results of operations. Based on current information, CT&T believes reserves for losses and LAE at December 31, 1997 are adequate. Flood Certifications Federal law requires lenders to determine whether a parcel of real property pledged to secure a loan is in a flood hazard zone and, since 1995, to monitor the flood zone status of a mortgaged property for the life of the loan. Property found to be in a flood hazard zone is required to be covered by flood insurance before it can be used to secure a loan. Chicago Title Flood Services Inc. has the ability to check the flood zone status of any property located in the United States and of many properties on an automated basis and is neither an issuer nor an underwriter of flood insurance policies. -10- 11 Credit Reporting Mortgage credit reporting is a specialized task which usually requires the obtaining and merging of credit information from at least two of the three nationally recognized repositories of such information. Chicago Title Credit Services Inc. has developed a state-of-the-art proprietary system which can receive an order; obtain, edit and merge credit information from each of the three national repositories; and report back to the lending institution in a matter of seconds. Chicago Title Credit Services Inc. can also perform the investigative work required to verify items appearing on a borrower's mortgage loan application (e.g., employment, financial assets and disputed credit items). In addition to mortgage credit reporting, Chicago Title Credit Services Inc. also serves as a traditional credit bureau in a limited number of locations and provides customers with retail and commercial collection services. Property Valuation Services Chicago Title--Market Intelligence, Inc. provides real estate property evaluation services and alternatives to appraisals nationwide using database research supplemented by a network of 15,000 real estate agents that verify computer reports through physical property inspections. Chicago Title--Market Intelligence, Inc. also maintains a network of state-licensed contract appraisers offering a full array of property appraisal products for residential mortgage loans throughout the United States. Property appraisals for commercial properties are also available on a limited basis. Field Inspection Services Chicago Title Field Services Inc. performs on-site property inspections and personal interviews through a nationwide network of independent field agents, serving the first mortgage, residential loan and default servicing markets. Foreclosure and Reconveyance Services Consolidated Reconveyance Company furnishes foreclosure and reconveyance services for institutional lenders. It recently developed a national reconveyance software package that improves the efficiency of processing transactions and that will be available through CT&T nationwide. Marketing CT&T's title insurance subsidiaries issue title insurance policies directly through its branch office operations as well as through policy-issuing independent agents. CT&T's title insurance subsidiaries also issue insurance policies where the title search -11- 12 and examination process is performed by approved attorneys working as independent contractors. CT&T's primary customers are the major participants in the real estate markets: attorneys, builders, commercial banks, thrift institutions, mortgage banks, life insurance companies, pension funds and real estate brokers. CT&T's sources of revenue are not concentrated with one or a few customers. Reflecting the relatively fragmented nature of the real estate industry as a whole, decision-making on the part of these customer groups has traditionally been locally centered. Recently, a trend has emerged for customer groups to consolidate into larger entities encompassing broader geographic areas. The larger, consolidated customers are more centralized in their decision-making and may use different criteria for making buying decisions than that employed by the more traditional local businesses. Recognizing this changing customer landscape, CT&T has organized its distribution network to serve three distinct customer sectors: Core Local--The largest of these sectors is the core local operation which requires flexibility and responsiveness to local market needs. Institutional Residential Lenders--This sector represents the emerging large centralized customer that needs high volume, competitive cost products. Key elements are a relentless cost focus, seamless integration of all CT&T products, standardization and consistency, and technology linkages. Commercial and Industrial Businesses--This sector focuses on the facilitation of large commercial transactions, which require service on a nationwide basis. Success is dependent upon integrated relationship management on a national basis, technical excellence, customization to customer needs and seamless national service. In addition, CT&T is developing an "electronic spine" or customer interface to allow customers to order and receive electronically any of CT&T's products from any location. In 1997, CT&T also created the CastleLink (SM) division to market CT&T's title and real estate-related products and services, allowing customers to order title, credit, flood, property valuation, escrow and closing services through one single source. Business Conditions; Seasonality The title insurance industry is highly dependent upon the volume of real estate transactions, which is highly sensitive to interest rate levels and general economic conditions. Because these factors can be very volatile, revenue levels for the title industry also can be very volatile. As business volume for the real estate-related businesses are -12- 13 correlated to mortgage loan origination volumes, revenue levels for these businesses tend to be impacted by economic factors in a fashion similar to the title industry. High short-term interest rates reduced the volume of real estate transactions in the first half of 1995. Lower interest rates in the second half of 1995 prompted an increase in refinancing and commercial transactions. The refinance volume remained strong in the first quarter of 1996 but diminished as interest rates leveled off. Interest rates remained relatively stable for the remainder of 1996 resulting in an increase in the volume of real estate construction and resale activity. 1997, particularly the second half of the year, was marked by low inflation, unemployment rates and interest rates in the United States resulting in exceptional growth in the commercial and industrial segment and a resurgence in the second half of 1997 in residential resale and refinancing transactions. The business of CT&T's title insurance subsidiaries is seasonal, as real estate activity is seasonal. The fourth quarter is typically the strongest due to the desire of commercial entities to complete transactions by year-end. The first quarter is typically the weakest quarter as the volume of home sales are generally at their low point in the winter. CT&T generally recognizes revenues at the time of the closing of the real estate transaction with respect to which a title insurance policy is issued. As a result, there is typically a lag of about two months between the time that a title insurance order is placed, at which time work commences, and the time that CT&T recognizes the revenues associated with the order. Additionally, agency revenues are recognized by CT&T when reported by the agent and typically lag two or three months from the time realized by the agent. Competition The title insurance industry is competitive throughout the United States, with large title insurance firms such as the title insurance subsidiaries of CT&T competing on a national basis, while smaller firms have significant market shares on a regional basis. Based on 1996 revenues, CTI, Security Union, Ticor Title, First American Title Insurance Company, Reliance Group Holdings, Inc., Stewart Title Insurance Co., Fidelity National Title Insurance Co., Lawyers Title Insurance Corporation and Old Republic Title Insurance Group, Inc. together accounted for approximately 89 percent of all title insurance revenues. CT&T's title insurance subsidiaries also compete with abstractors, attorneys issuing opinions and, in some areas, state land registration systems. CT&T's flood certification, credit reporting, property valuation, field inspection and foreclosure and reconveyance services businesses face significant competition from -13- 14 other similar real estate service providers. Mortgage lenders may choose to produce these services internally rather than purchasing them from outside vendors. The basis of competition varies by the service provided by CT&T but includes price, service, technical expertise, technological capabilities, and the ability to integrate a wide range of products. In addition, the financial strength of the insurer has become an increasingly important factor in title insurance purchase decisions, particularly in multi- site transactions and investment decisions regarding real estate-related investment vehicles such as real estate investment trusts and real estate mortgage investment conduits. Regulation Title insurance companies are subject to regulation and supervision by state insurance regulators under the insurance statutes and regulations of states in which they are incorporated. CTI is incorporated in Missouri, Security Union is incorporated in California and has a title insurance subsidiary incorporated in Oregon, and Ticor Title is incorporated in California. Each of these companies is also regulated in each jurisdiction in which it is authorized to write title insurance. Regulation and supervision vary from state to state, but generally cover such matters as the standards of solvency which must be met and maintained, the nature of limitations on investments, the amount of dividends which may be distributed to a parent corporation, requirements regarding reserves for statutory premiums and losses, the licensing of insurers and their agents, the approval of policy forms and premium rates, periodic examinations of title insurers and annual and other reports required to be filed on the financial condition of title insurance companies. In addition, market behavior of all entities involved in real estate transactions is governed by the Real Estate Settlement Practices Act and related regulations. As insurance holding companies, Alleghany and CT&T are also subject to the insurance regulations of Missouri, California and Oregon. The acquisition of CTI, Security Union and Ticor Title and their respective title insurance subsidiaries by Alleghany and/or CT&T was subject to prior approval from the insurance regulatory authorities in the states in which such title insurance companies are incorporated. Alleghany, CT&T and their other subsidiaries, however, are generally not subject to restrictions on their business activities due to their affiliation with CT&T's title insurance subsidiaries. CT&T, in its capacity as a non-depository trust company, is regulated by the State of Illinois Office of Banks and Real Estate. Regulation covers such matters as the fiduciary's management capabilities, the investment of funds held for its own account, the soundness of its policies and procedures, the quality of the services it renders to the public and the effect of its trust activities on its financial soundness. -14- 15 While Chicago Title Flood Services Inc., Chicago Title Credit Services Inc., Chicago Title--Market Intelligence, Inc., Chicago Title Field Services Inc. and Consolidated Reconveyance Company are not subject to direct regulatory supervision, federal and state laws governing real estate settlement practices, credit reporting and flood zone determinations significantly impact their businesses. Investment Operations Investments held by CT&T or any of its title insurance subsidiaries must comply with the insurance laws of the state of incorporation of the company holding the investment; relevant states are Illinois, Missouri, California, and Oregon, as applicable. These laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks and real estate mortgages. CT&T's current investment policy is to minimize the cyclical volatility of the portfolio to maintain stability of principal, consistency of cash flow and liquidity, and earn a favorable total return. The following table reflects investment results for CT&T (excluding Alleghany Asset Management) for the years ended December 31, 1997, 1996 and 1995 (dollars in thousands): Investment Results
Net Pre-Tax Pre-Tax After-Tax Realized After Average Investment Investment Gains Effective Tax Period Investments (1) Income (2) Income (3) (Losses) Yield (4) Yield (5) - --------------------------------------------------------------------------------------------------------------------------------- Year Ended $947,210 $67,897 $48,316 $1,469 7.2% 5.1% December 31, 1997 Year Ended $820,230 $60,787 $42,997 $1,436 7.4% 5.2% December 31, 1996 Year Ended $829,521 $57,245 $40,601 $3,697 6.9% 4.9% December 31, 1995
(1) Average of amortized cost of fixed maturities plus cost of equity securities at beginning and end of period, excluding operating cash. (2) Excludes realized gains or losses from sale of investments. (3) Pre-tax investment income less appropriate income taxes. (4) Pre-tax investment income for the period divided by average investments for the same period. (5) After-tax investment income for the period divided by average investments for the same period. -15- 16 The following table summarizes the investments of CT&T (excluding Alleghany Asset Management), excluding cash, as of December 31, 1997, with all investments carried at fair value in its financial statements prepared in accordance with generally accepted accounting principles (dollars in thousands): Investments
Amortized Cost or Cost Fair Value --------------------------- --------------------------- Amount Percentage Amount Percentage Short-term investments ............. $180,710 17.22% $180,710 16.94% Corporate bonds..................... 120,045 11.44% 122,037 11.44% United States government and government agency bonds ......... 243,173 23.17% 248,262 23.28% Mortgage-and asset-backed securities....................... 186,276 17.74% 189,508 17.77% Municipal bonds..................... 267,914 25.52% 272,182 25.52% Foreign bonds....................... 2,714 .26% 2,777 .26% Redeemable preferred stock 15,613 1.49% 16,613 1.56% Equity securities................... 33,233 3.16% 34,489 3.23% Total............................ $1,049,678 100.00% $1,066,578 100.00% ========== ====== ========== ======
-16- 17 The following table indicates the composition of the long-term fixed maturity portfolio, including preferred stock, as of December 31, 1997 by the rating system of the National Association of Insurance Commissioners ("NAIC") (dollars in thousands): Long-Term Fixed Maturity Portfolio by NAIC Rating
Fair Value Percentage ---------- ---------- NAIC 1............................... $784,937 92.20% NAIC 2............................... 42,724 5.07% NAIC 3............................... 4,570 .54% NAIC 4............................... 2,534 .30% NAIC L & P3 (Preferred stock-redeemable)............... 16,613 1.95% ------ ----- Total........................... $851,378 100.00% ======== =======
-17- 18 The following table indicates the composition of the long-term fixed maturity portfolio, including preferred stock, by years until contractual maturity as of December 31, 1997 (dollars in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Long-Term Fixed Maturity Portfolio by Years Until Maturity
Fair Value Percentage ---------- ---------- One year or less*...................... $ 98,878 11.61% Over one through five years 399,362 46.91% Over five through ten years 57,022 6.70% Over ten years......................... 106,608 12.52% Mortgage- and asset-backed 189,508 22.26% ------- ------ Total........................... $851,378 100.0% ======== ======
* Included in this category are $16,613 of preferred stock-redeemable. The principal tangible asset of CT&T and its subsidiaries is the investment portfolio. The entire investment portfolio is classified as available for sale. CT&T has a conservative investment philosophy with respect to both asset quality and maturity distribution. CT&T maintains a short-term investment portfolio ranging from approximately $60 million to $250 million, consisting of top rated commercial paper (A-1/P-1), highest rated bank certificates of deposit, and institutional money market funds. The average maturity period of securities in the short-term portfolio is typically less than 30 days. CT&T's long-term portfolio consists of top rated tax-exempt bonds, United States Treasury securities, corporate bonds of United States issuers, mortgage backed securities, and a limited amount of publicly traded common stocks. Average quality of the long-term portfolio is maintained at a Moody's rating of "Aa3" or higher, with over 98 percent of all securities rated investment grade by Moody's and less than 1 percent in derivative instruments as of 1997 year-end. The duration of the short term and fixed income securities in CT&T's portfolio is approximately 2.2 years, and is managed within a duration range of 1.9 to 3.1 years. Duration measures a portfolio's sensitivity to change in interest rates; a change within a range of plus or minus 1 percent in interest rates would be expected to result in an inverse change of approximately 2.2 percent in the value of CT&T's portfolio. This relatively short portfolio maturity structure is maintained so that investment income responds to changes in the level of interest rates, offsetting to some degree the cyclicality of title insurance operations. -18- 19 CT&T does not specifically match particular assets to related liabilities, but instead holds the investment portfolio to a shorter maturity than liabilities. However, CT&T regularly re-examines its portfolio strategies and periodically modifies asset allocation and bond portfolio maturity, based on the market outlook, interest rates and/or title insurance operating conditions. Employees At December 31, 1997, CT&T and its subsidiaries, exclusive of Alleghany Asset Management, had approximately 8,100 employees, including full-time and part-time employees. FINANCIAL SERVICES BUSINESS Alleghany Asset Management, conducts a financial services business through its subsidiaries, The Chicago Trust Company ("Chicago Trust"), a Chicago-based independent investment firm with trust powers, Montag & Caldwell, Inc. ("Montag & Caldwell"), an Atlanta-based investment counseling firm, and Chicago Deferred Exchange Corporation ("CDEC"), which facilitates certain tax-deferred property exchanges. CT&T's financial services group was restructured in 1995 under Alleghany Asset Management, a Delaware corporation and a newly-formed subsidiary of CT&T. The financial services businesses conducted directly by CT&T were transferred to Chicago Trust. Also transferred to Alleghany Asset Management were Montag & Caldwell, which was acquired in July 1994, and CDEC. In 1996, Chicago Trust acquired Security Trust Company ("Security Trust"), a California trust company, from a subsidiary of CT&T. As described above, Alleghany Asset Management and its subsidiaries will not be part of the spin-off of CT&T and will remain with Alleghany. Alleghany Asset Management provides distribution and marketing services to its investment managers through the 401(k) services offered by Chicago Trust and the Alleghany Funds (formerly CT&T Funds), a mutual funds family offering eight no-load mutual funds. Chicago Trust's full service 401(k) administration group provides trustee, plan design, investment management and other administrative services to companies primarily in the Midwest and South. Such services are marketed through internal sales forces in Chicago and Atlanta as well as consultants and brokerage sources. The Alleghany Funds had approximately $1.9 billion in assets under management at December 31, 1997. The mutual funds are marketed primarily through registered investment advisers, broker-dealers and direct sales to institutional clients. -19- 20 Montag & Caldwell Founded in 1945, Montag & Caldwell, one of the Southeast's oldest investment management firms, concentrates on managing large capitalization growth equity and balanced portfolios for institutional, mutual fund and high net worth clients. Montag & Caldwell believes that success in the institutional investment business is dependent upon a disciplined and consistently applied investment process translating into outstanding investment results. Montag & Caldwell's equity results have consistently placed the firm among the top money managers in its category. Montag & Caldwell targets separate accounts of $40 million and higher, accessed through independent consultants or direct calls to prospective clients. Its investment expertise is also available through the Alleghany Funds. Montag & Caldwell advises two of the Alleghany Funds' mutual funds. Chicago Trust Chicago Trust, and its predecessors, has managed assets for investors since 1887. Chicago Trust is an independent investment firm with full trust powers and is engaged in the following lines of business: institutional investment management, full service 401(k) administration, personal trust and investment services and administration of the Alleghany Funds. Chicago Trust specializes in fixed income and equity money management for institutional clients. Chicago Trust's fixed income results have consistently placed Chicago Trust among the top money managers in its category. Chicago Trust markets its fixed income and equity products through pension consultants and directly to plan sponsors. Chicago Trust also advises six of the Alleghany Funds' mutual funds. Chicago Trust's personal trust and investment services business serves the investment and estate planning needs of individuals and families, mainly in the greater Chicago area. Chicago Trust believes that the business is well-positioned to benefit from growth in family wealth and the demographics of an aging baby boom generation. Chicago Trust also provides, through Security Trust, trust and tax-deferred property exchange services in California. -20- 21 CDEC CDEC was established in 1989 and facilitates, with the assistance of Chicago Trust, tax-deferred exchanges of like-kind property. In 1997, CDEC facilitated more than 2,000 exchanges. CDEC acts as a qualified intermediary, holding and investing the cash proceeds from the sale of property relinquished by a taxpayer in a qualified trust account, of which Chicago Trust acts as trustee, until replacement property is acquired. Marketing Growth in profitability of Alleghany Asset Management is largely dependent on growth in assets under management, which results from market appreciation of existing assets and new business. Approximately 80 percent of Alleghany Asset Management's assets under management are for institutional clients where competition is intense and success is driven by investment performance. Both Montag & Caldwell and Chicago Trust have strong investment records and have received high ratings in various consultant and mutual fund informational service data bases. As of December 31, 1997, Alleghany Asset Management, through its subsidiaries, managed assets totaling about $23.1 billion. None of the clients of Alleghany Asset Management accounted for 10 percent or more of the revenues of Alleghany Asset Management. The business of Alleghany Asset Management is not seasonal. Investment Operations Investments held by Chicago Trust and Security Trust must comply with the banking laws of the states of Illinois and California. These laws prescribe the kind, quality and concentration of investments which may be made by trust companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, common stocks. Chicago Trust's and Security Trust's current investment strategy is to maximize after-tax investment income through a high-quality diversified investment portfolio, consisting primarily of taxable and tax-exempt fixed maturity securities, while maintaining an adequate level of liquidity. Competition Alleghany Asset Management and its subsidiaries compete with national, regional and local providers of financial services. Such competition is chiefly on the basis of service and investment performance. -21- 22 Regulation Acting as fiduciaries, Chicago Trust is regulated by the State of Illinois Office of Banks and Real Estate, and Security Trust is regulated by the California Department of Banking. Regulation covers such matters as the fiduciary's management capabilities, the investment of funds held for its own account, the soundness of its policies and procedures, the quality of the services it renders to the public and the effect of its trust activities on its financial soundness. Montag & Caldwell is a registered investment advisor and is therefore subject to regulation by the Securities and Exchange Commission, the state of Georgia, its domiciliary jurisdiction, and all other states in which it is licensed to act in the capacity of investment advisor. Employees At December 31, 1997, Alleghany Asset Management and its subsidiaries had approximately 275 employees, including full-time and part-time employees. PROPERTY AND CASUALTY REINSURANCE AND INSURANCE BUSINESSES Underwriters Re Group, Inc., formerly known as URC Holdings Corp. ("URG"), headquartered in Woodland Hills, California, is engaged in the property and casualty reinsurance and insurance businesses, through Underwriters Reinsurance Company ("Underwriters") and its primary insurance subsidiaries (collectively, "Underwriters Re Group"). Underwriters initially was organized in 1867 as a primary insurer in New York under the name "Buffalo German Insurance Company." By 1970, Underwriters had become principally a reinsurer, and in 1977 it changed its corporate domicile to New Hampshire. Underwriters operates throughout the United States, including Puerto Rico and the District of Columbia, and Canada, either as a licensed carrier or accredited reinsurer, and has branch offices in Chicago, Houston, New York and Woodland Hills. In October 1993, Alleghany acquired approximately 93 percent of URG, and thereafter contributed about $51 million in 1993 and $100 million in 1994 to the capital of Underwriters Re Group. The capital contribution in 1994 was in the form of about 6 million shares of Santa Fe common stock, which was subsequently converted into approximately 2.5 million shares of BNSF common stock. As of December 31, 1997, Underwriters' statutory surplus was $659 million. On October 3, 1997, Alleghany exchanged pursuant to its offer shares of common stock of URG, representing 2.7 percent of the outstanding common stock of URG, held by ten employees of URG for shares of -22- 23 Alleghany common stock. Alleghany now owns all of the issued and outstanding shares of common stock of URG. Since 1995, Underwriters has been rated "A+ (Superior)" by A.M. Best Company, Inc., an independent insurance industry rating organization ("Best's"). Best's publications indicate that such rating is assigned to companies which Best's believes have achieved superior overall performance and have a very strong ability to meet their obligations over a long period of time. According to Best's, the rating reflects Underwriters' strong operating earnings, solid internal capital generation and forward market momentum. Additionally, since 1995 Underwriters received a claims-paying ability rating of "AA-(Excellent)" from Standard & Poor's. Standard & Poor's publications indicate that this rating is assigned to companies with strong capacity to meet policyholders' obligations under a variety of economic and underwriting conditions. Underwriters Re Group established Commercial Underwriters Insurance Company ("CUIC") at the end of 1992, acquired Underwriters Insurance Company ("UIC"), an inactive Nebraska insurance company in 1994, and established Newmarket Underwriters Insurance Company ("NUIC") in 1996 to capitalize on advantageous market conditions for certain primary insurance business lines. CUIC, UIC and NUIC are rated "A+ (Superior)" by Best's because Underwriters reinsures a significant share of their business. CUIC is a California property and casualty insurance company that focuses on specialized primary commercial insurance, individual commercial excess liability insurance, commercial surplus lines, and specialized personal lines liability insurance, including excess private passenger liability and comprehensive personal liability insurance. CUIC conducts its business in California and New York on an admitted basis and in 44 other states, Guam and the District of Columbia on an approved nonadmitted basis. In 1997, CUIC generated $113.3 million in direct written premiums and retained net written premiums of $33.5 million representing 8.1 percent of Underwriters Re Group's consolidated net written premiums in 1997. UIC has licenses to write primary property and casualty insurance in 48 states and the District of Columbia and focuses on marine insurance, primary liability policies for medium- to large-sized businesses and certain professional liability coverages. In connection with the acquisition of UIC, Underwriters was indemnified for all losses that occurred prior to the acquisition date. In 1997, UIC generated $28.2 million in direct written premiums and retained net written premiums of $11.7 million, constituting 2.8 percent of Underwriters Re Group's consolidated net written premiums in 1997. -23- 24 NUIC is licensed to write property and casualty insurance in New Hampshire, and is qualified on a non-admitted basis in California and New York. It will focus on general liability policies for medium to large-sized businesses. The Center Insurance Services, Inc. ("The Center"), was established in 1995 as a wholly owned subsidiary of URG to capitalize on the considerable expertise of certain individuals in handling specialized classes of primary business. The Center's four subsidiaries act as agents and underwrite business on behalf of CUIC, UIC, NUIC and at present, to a lesser extent, non-affiliated insurers. Business underwritten by The Center includes marine insurance, products liability insurance and general liability insurance for certain insureds with self-insured retentions. During 1997 approximately $66.1 million of gross written premiums was underwritten by The Center. The Center's subsidiaries has offices in Kennesaw and Roswell, Georgia and New York, New York. Representative offices were established in Barbados at the end of 1995 and in London, England in 1996 to capitalize on international underwriting opportunities. In addition, Underwriters Re Group made strategic investments in reinsurance and insurance companies in Barbados and Bermuda. General Description of Reinsurance Reinsurance is an agreement between two insurance companies in which one company, the "reinsurer," agrees to indemnify the other company, the "cedent" or "ceding company," for all or part of the insurance risks underwritten by the ceding company. Reinsurance provides ceding companies with three major benefits: (i) it reduces net liability on individual risks, (ii) it protects against catastrophic losses, and (iii) it helps to maintain acceptable surplus and reserve ratios. In addition, reinsurance provides the ceding company with additional underwriting capacity. Ordinarily, a ceding company will enter into a reinsurance agreement only if it will receive credit for the reinsurance ceded on its statutory financial statements. In general, such credit is allowed if the reinsurer meets the licensing and accreditation requirements of the ceding company's domicile, or the reinsurance obligations are collateralized by letters of credit, funds withheld or pledged trust agreements. In general, property insurance protects the insured against financial loss arising out of loss of property or its use caused by an insured peril. Casualty insurance protects the insured against financial loss arising out of the insured's obligation to others for loss or damage to persons or property. While both property and casualty reinsurance may involve a high degree of loss volatility, property losses are generally reported within a relatively short time period after the event; in contrast, there tends to be a significant time lag in the reporting and payment of casualty claims. Consequently, an insurer generally -24- 25 knows of the losses associated with property risks in a shorter time than losses associated with casualty risks. Underwriters provides reinsurance on both a treaty and a facultative basis. Treaty reinsurance is based on a standing arrangement (a "treaty"), usually for a year, between a cedent and a reinsurer for the cession and assumption of a certain class of risk specified in such treaty. Under most treaties, the cedent is obligated to offer, and the reinsurer is obligated to accept, a specified portion of a class of risk underwritten by the cedent. Reinsurers assume classes of risk under treaties without having reviewed each individual risk. Alternatively, facultative certificate reinsurance is the reinsurance of individual risks. Unlike treaty reinsurance, in the case of facultative reinsurance contracts, a reinsurer separately rates and underwrites each individual risk and is free to accept or reject each risk offered by the cedent. Facultative reinsurance is normally purchased by insurance companies for risks not otherwise covered or covered only in part by their reinsurance treaties, and for unusual risks. Underwriters writes treaty and facultative reinsurance on both a pro rata and excess of loss basis. Under pro rata reinsurance contracts, the ceding company and reinsurer share the premiums as well as the losses and expenses of any single risk, or an entire group of risks, based upon contractually defined rates. Under excess of loss reinsurance contracts, the reinsurer agrees to reimburse the ceding company for all losses in excess of a predetermined amount (commonly referred to as the cedent's "retention"), generally up to a predetermined limit. Excess of loss reinsurance is often written in "layers" or levels, with one reinsurer assuming the risk of loss on the primary insurance policy in excess of the cedent's retention level up to a predetermined level, above which the risk of loss is assumed by another reinsurer or reverts to the cedent. Excess of loss reinsurance allows the reinsurer to better control the relationship of the premium charged to the related exposure assumed by it. The reinsurer assuming the risk immediately above the cedent's retention level is said to write "working layer" or "low layer" excess of loss reinsurance. A loss that reaches just beyond a cedent's retention level would create a loss for such cedent's low layer reinsurers but would not adversely affect the reinsurers on higher layers. Marketing Reinsurance An important element of Underwriters' strategy is to respond quickly to market opportunities (such as increased demand or more favorable pricing) by adjusting the mix of property and casualty business it writes. In recent years, Underwriters has taken advantage of such market opportunities by increasing its writings of marine and aviation, -25- 26 property catastrophe, clash, homeowners and workers compensation coverages and certain excess and surplus lines. Underwriters concentrates on coverages which require a relatively high degree of underwriting or actuarial expertise, including certain excess and surplus lines programs, umbrella liability and directors and officers' liability. Such expertise is also required for certain business that Underwriters has developed in nontraditional areas, such as providing capital in combination with reinsurance and providing reinsurance to alternative risk markets, including risk retention groups, captives, underwriting syndicates and self-insured funds and associations. Nontraditional reinsurance may also refer to reinsurance contracts which limit exposure to loss through the use of aggregate loss limits, loss ratio caps or other loss containment features. Underwriters believes that coverages which require high levels of underwriting or actuarial expertise offer greater potential for favorable results than more general coverages, based on current market conditions. In 1997, Underwriters wrote 67% of its treaty business and all of its facultative certificate business through reinsurance brokers. The remaining treaty business was principally reinsurance of portions of the primary insurance underwritten by subsidiaries of Underwriters. By working primarily through brokers, Underwriters does not need to maintain a large sales organization which, during periods of reduced premium volume, could result in significant non-productive overhead. In addition, management believes that submissions from the broker market, including those for certain targeted specialty coverages, are more numerous and diverse than would be available through a salaried sales organization. Consequently, Underwriters is able to exercise greater selectivity than would usually be possible in dealing directly with ceding companies. As a result of certain of Underwriters' subsidiaries placing reinsurance on their primary business through reinsurance brokers, management believes that such brokers may also bring more reinsurance opportunities to Underwriters. Reinsurance brokers regularly approach Underwriters for quotations on reinsurance being placed on behalf of ceding companies. In 1997, Underwriters paid brokers $10.3 million in commissions, which represents approximately 2% of its gross written premiums of $461.3 million. Underwriters' five leading brokers, AON, Inc. and its subsidiaries, Sedgwick Re, Inc., E.W. Blanch Company, Jardine Thompson Graham Limited and Preferred Reinsurance Intermediaries, accounted for 41% of Underwriters' gross written premiums in 1997. Over this period, AON, Inc. and its subsidiaries accounted for 18% of such premiums and no other broker accounted for more than 10% of such premiums. The brokers that account for relatively large percentages of gross written premiums tend to vary from year to year. Management does not believe that the termination of its business with any one broker would have a material effect on Underwriters Re Group's financial condition or results of operations. -26- 27 A significant percentage of Underwriters' gross written premiums are generally obtained from a relatively small number of ceding companies. In 1997, approximately 39% of gross written premiums were obtained from Underwriters' ten largest unaffiliated ceding companies. One of the ceding companies accounted for 12% of such premiums and no other unaffiliated ceding company accounted for more than 10% of such premiums. The ceding companies that account for relatively large percentages of gross written premiums tend to vary from year to year. Management does not believe that the loss of any one ceding company account would have a material effect on Underwriters Re Group's financial condition or results of operations. Primary Insurance Insurance is purchased from the primary insurance companies of Underwriters Re Group through retail and wholesale agents and brokers. These professional intermediaries are acquainted with the product lines and custom coverage capabilities of Underwriters Re Group's primary insurance companies, which generally concentrate on hard to place risks and markets neglected by the industry. The custom capabilities offered include access to nonadmitted companies that operate under Underwriters Re Group and carry Underwriters' Best's rating. Underwriting Operations Reinsurance Underwriters maintains a disciplined underwriting program with a focus on generating profitable business rather than on increasing market share. Underwriters has maintained a defensive underwriting posture by reducing writings in lines of business that it considers offer inadequate contract terms. Another factor supporting Underwriters' underwriting discipline is its focus on low level attachment points (i.e., dollar-levels at which risk is assumed). While such layers are generally characterized by greater loss frequency, they are also characterized by lower loss severity and quicker loss settlement than layers with higher attachment points. Management believes that these factors result in greater predictability of losses, which improves Underwriters' ability to analyze its exposure on each contract and to price such exposure appropriately. In addition, Underwriters seeks to serve as lead or co-lead underwriter on its treaties. Management believes that, as lead or co-lead underwriter, Underwriters, is able to influence more effectively the pricing and terms of the treaties into which it enters and thereby achieve better underwriting results. During 1997, Underwriters acted as lead or co-lead underwriter on a majority of its treaty business. Treaty reinsurance generated approximately $350.4 million, or 95%, of Underwriters' net written premiums in 1997 and facultative certificate reinsurance -27- 28 generated the remainder. Casualty lines represented approximately 64% of Underwriters Re Group's net written premiums, with the remainder represented by property lines. Reinsurance written on an excess of loss basis represented approximately 50% of Underwriters' net reinsurance written premiums, with reinsurance written on a pro rata basis representing the balance. In 1997, Underwriters' net written premiums increased $34.0 million, or 10%, from 1996. A significant part of this growth was in treaty business considered by Underwriters to be nontraditional. Management believes that the increase in such premiums is attributable, in part, to its increased statutory surplus level and upgraded Best's rating, which enabled it to attract more desirable reinsurance opportunities, and also to growth in its primary insurance operations. Underwriters generally wrote up to $2.0 million per reinsurance risk in 1997 on a net basis. In the case of reinsurance of certain clash coverage, Underwriters has written up to $2.5 million on a net basis and in limited circumstances has accepted more. The largest net risk assumed in 1997 was $12.0 million. Primary Insurance Underwriters Re Group's underwriting strategy is to identify insurance opportunities that can be profitably underwritten. Such business is generally in less competitive segments of the overall insurance marketplace because they frequently require a higher level of underwriting expertise or are not viewed as acceptable in conventional markets for some other reason. Many of the classes and risks underwritten are in otherwise normally accepted categories but are viewed as nonstandard due to past loss history. Business written that is viewed as requiring special expertise would include marine insurance, professional liability and errors and omissions insurance. Risks are underwritten by employees of the primary companies and by both affiliated and unaffiliated underwriting agents. Underwriters Re Group wrote up to $1.5 million per primary insurance risk in 1997 on a net basis. Retrocessional and Reinsurance Arrangements A reinsurer often reinsures some of its risk with other reinsurers ("retrocessionaires") pursuant to retrocessional agreements, and pays such retrocessionaires a portion of the premiums it receives. Reinsurance companies enter into retrocessional agreements for the same reasons that primary insurers purchase reinsurance. Underwriters has retrocessional agreements with a number of domestic and international reinsurance companies. In the event that a retrocessionaire is unable to meet its obligations assumed under the retrocessional agreement, Underwriters remains liable -28- 29 to its ceding companies for the portion reinsured. Consequently, the most important factors in Underwriters' selection of retrocessionaires are financial strength and stability. Underwriters carefully evaluates potential retrocessionaires, which must meet the approval of several members of senior management before being engaged. Once engaged, Underwriters monitors the financial condition of its retrocessionaires and takes appropriate actions to eliminate or minimize bad debt exposure. Generally, Underwriters requires that unpaid losses and loss adjustment expenses for non-admitted reinsurers that are not regulated by domestic insurance regulatory authorities be collateralized by letters of credit, funds withheld or pledged trust agreements. Additionally, commutations may be taken to reduce or eliminate credit exposure when necessary. Although there can be no assurance that such will be the case in future years, Underwriters' write-offs for unrecoverable reinsurance were negligible in 1997 and 1996. As of December 31, 1997, Underwriters had an allowance for estimated unrecoverable reinsurance of $3.4 million. Underwriters currently has reinsurance contracts in force which cede to retrocessionaires risks in excess of Underwriters' net risk retention. Underwriters cedes up to $1.5 million per casualty facultative risk and up to $1.1 million per property facultative risk. Underwriters also has an aggregate reinsurance contract to cover losses up to $100.0 million incurred during the period July 1, 1997 through June 30, 1998 in excess of a 98.3% net loss and loss adjustment expense ratio. Such net loss ratio is calculated by dividing losses by premiums net of commissions and brokerage. The contract covers essentially all lines of business written by Underwriters; however, property catastrophe losses are subject to a sublimit of $75.0 million. Upon its expiration, management expects to renew this contract or to enter into a new contract providing similar coverage. In addition, Underwriters from time to time purchases retrocessional reinsurance in varying amounts for specific assumed treaties. Underwriters has two reinsurance contracts with Continental Casualty Company (the "Continental Contracts") that provide coverage for pre-1987 business up to an aggregate limit of $200.0 million. Underwriters received payments under these contracts totaling $37.6 million in 1996 and $23.7 million in 1997, reducing the reinsurance receivable attributable to such contracts from $111.5 million at year-end 1996 to $87.8 million at year-end 1997. Such receivable is secured by a trust fund dedicated solely to payments under the Continental Contracts. As of December 31, 1997, Underwriters had reported reinsurance receivables of $387.6 million through retrocessional agreements, including $87.8 million of reinsurance receivables under the Continental Contracts, which was fully secured as described above, and $133.0 million due from another reinsurer, which was fully secured with a combination of letters of credit and funds withheld. -29- 30 Outstanding Losses and Loss Adjustment Expenses In many cases, significant periods of time may elapse between the occurrence of an insured loss, the reporting of such loss to the insurer and the reinsurer, the insurer's payment of such loss and the subsequent payment by the reinsurer. To recognize liabilities for unpaid losses, insurers and reinsurers establish "reserves." These reserves are balance sheet liabilities representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred, including events which have not been reported to the insurer. When a reinsurance claim is reported by the ceding company, Underwriters establishes a "case" reserve for the estimated amount of Underwriters' ultimate payment. Such reserves are based upon the amounts recommended by the ceding company and are often supplemented by additional amounts as deemed necessary by Underwriters after Underwriters has evaluated such claim on the basis of numerous factors, including coverage, liability, severity of injury or damage, jurisdiction and ability of the ceding company to evaluate and handle the claim properly. In many cases Underwriters establishes case reserves even if the ceding company believes that Underwriters will have no ultimate liability. Underwriters always establishes a case reserve in an amount at least equal to that recommended by the ceding company. Case reserves are periodically adjusted by Underwriters based on its evaluation of subsequent reports from and audits of the ceding companies. When a primary claim is reported, Underwriters Re Group personnel establish a "case" reserve based on evaluation of the claim and estimation of the ultimate payment amount. All primary claims are supervised by Underwriters Re Group personnel who at times may engage outside counsel or adjusting firms, if necessary. Additional reserves are established on an aggregate basis to provide for losses incurred but not yet reported ("IBNR") to the reinsurer and to supplement the overall adequacy of reported case reserves and estimated expenses of settling such claims, including legal and other fees and general expenses of administering the claims adjustment process. Underwriters Re Group establishes IBNR reserves by using accepted loss reserving standards and principles to estimate the ultimate liability for LAE. The process implicitly recognizes the impact of inflation and other factors that affect claims reporting by taking into account changes in historic loss reporting patterns and perceived probable trends. Underwriters Re Group reviews its aggregate loss reserves at least twice each year. Between the semi-annual reviews, Underwriters Re Group updates its loss reserves by applying the loss ratios determined in the previous review to earned premiums to date, less incurred losses reported. Underwriters Re Group does not discount its reserves for -30- 31 anticipated investment income. There are inherent uncertainties in estimating reserves primarily due to the significant periods of time that may elapse between occurrence of an insured or reinsured loss and reporting and ultimate settlement of such loss, the diversity of development patterns among different lines of business and types of reinsurance, and the necessary reliance on the ceding company for information regarding reinsurance claims. Actual losses and loss expenses may deviate, perhaps substantially, from reserves in Underwriters Re Group financial statements, which could have a material adverse effect on Underwriters Re Group financial condition and results of operations. Based on current information, management believes reserves for losses and loss expenses at December 31, 1997 are adequate. Asbestos and Environmental Impairment Claims Reserves Underwriters' reserve for losses and loss expenses includes amounts for various liability coverages related to asbestos and environmental impairment claims that arose from certain general liability and commercial multiple-peril coverages. Restrictive asbestos and environmental impairment exclusions were introduced in late 1986 on both primary and reinsurance contracts, significantly reducing these exposures for accidents occurring after 1986. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to those uncertainties include a lack of historical data, the significant period of time that has elapsed between the occurrence of the loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to the number and identity of insureds with potential exposure to such risks, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Such uncertainties are not likely to be resolved in the near future. As with all reinsurance claims, Underwriters establishes case reserves for both asbestos and environmental impairment excess of loss reinsurance claims by applying reinsurance contract terms to losses reported by ceding companies, and analyzing from the first dollar of loss incurred by the primary insurer. Additionally, ceding companies often report potential losses on a precautionary basis (a "precautionary notice") to protect their rights under reinsurance contracts, which generally call for prompt notice to the reinsurer. Ceding companies, at the time they report such potential losses, advise Underwriters of the ceding companies' current estimate of the amount of such loss. Underwriters reviews each of these precautionary notices and, based upon current information, assesses the likelihood of loss to Underwriters. Such assessment is one of the factors used in determining the adequacy of IBNR reserves. For asbestos claims, Underwriters closely reviews precautionary notices which concern any named insured previously linked to large asbestos exposure (a "target -31- 32 defendant"). If the named insured is a "target defendant," Underwriters assumes there is a probability of loss even if the named ceding company has not itself reported reserves. IBNR reserves are recorded based on this review, as well as an additional subjective evaluation of the aggregate reported losses (approximately $3.7 million per year) losses for the last three years. The per year figures are net of reinsurance, including the Continental Contracts. For environmental impairment claims, Underwriters establishes case reserves and reviews precautionary notices as described above. Ultimate environmental impairment claims exposure is especially uncertain because of the problematic apportionment of clean-up costs under federal and state laws, the uncertain enforceability of contract exclusions and the lack of specific "target defendants." IBNR reserves are recorded based on Underwriters' assessment of precautionary notices and a review of aggregate reported losses (approximately $2.6 million per year) for the last three years. The per year figures are net of reinsurance, including the Continental Contracts. During the three years ended December 31, 1997, the average net loss payment per claim (open and settled) for asbestos and environmental impairment exposures (excluding cessions to the Continental Contracts) was $21,000 and $35,700, respectively, and the highest paid loss was $2.0 million for an asbestos claim and $0.4 million for an environmental impairment claim, in each case net of ceded reinsurance (excluding cessions to the Continental Contracts). All loss payments for asbestos and environmental impairment exposures for the last three years have been recovered through cessions to the Continental Contracts. Most claims paid to date have been paid under contracts with varying levels of retention by the ceding company or insurer. Although the range of losses paid by Underwriters has been wide, most losses paid have involved dollar amounts at the lower end of such range. As of December 31, 1997, Underwriters' case and IBNR reserves (net of reinsurance, including cessions to the Continental Contracts) totaled approximately $21.2 million for asbestos liabilities, which includes reserves for approximately 618 open claims where cedents have advised Underwriters that they currently expect to recover from Underwriters. As of December 31, 1997, Underwriters' case and IBNR reserves (net of reinsurance, including cessions to the Continental Contracts) totaled about $23.9 million for environmental impairment claims, which includes reserves for approximately 473 open claims where cedents have advised Underwriters that they currently expect to recover from Underwriters. Additionally, ceding companies have submitted 1,804 precautionary notices for asbestos claims and 5,663 precautionary notices for environmental impairment claims to Underwriters; however, based on information provided by the ceding companies and Underwriters' assessment of such claims, Underwriters does not currently expect the losses with respect to such claims to grow large enough to reach Underwriters' layer of reinsurance coverage. -32- 33 The reconciliation of the beginning and ending reserves for unpaid losses and LAE related to asbestos and environmental impairment claims for the last three years (net of cessions to the Continental Contracts, but excluding an additional $18.9 million provision for such claims, discussed in the text following the tables), is shown below (dollars in thousands): Reconciliation of Asbestos-Related Claims Reserve for Losses and LAE
1997 1996 1995 ---- ---- ---- Reserve, net of reinsurance recoverables, as of January 1........................................... $17,494 $14,494 $10,136 Incurred loss, net of reinsurance....................... 3,678 3,000 4,358 Paid loss, net of reinsurance........................... 0 0 0 ------- ------- ------- Reserve, net of reinsurance recoverables, as of December 31......................................... 21,172 17,494 14,494 Reinsurance recoverables, as of December 31............. 14,726 15,176 17,506 ------- ------- ------- Reserve, gross of reinsurance recoverables, as of December 31......................................... $35,898 $32,670 $32,000 ======= ======= ======= Type of Reserve, net of reinsurance recoverables: Case................................................ $ 3,172 $ 4,494 $ 4,494 IBNR................................................ 18,000 13,000 10,000 ------- ------- ------- Total................................................... $21,172 $17,494 $14,494 ======= ======= =======
-33- 34 Reconciliation of Environmental Impairment Claims Reserve for Losses and LAE
1997 1996 1995 ---- ---- ---- Reserve, net of reinsurance recoverables, as of January 1........................................... $22,600 $19,600 $16,198 Incurred loss, net of reinsurance....................... 1,322 3,000 3,402 Paid loss, net of reinsurance........................... 0 0 0 ------- ------- ------- Reserve, net of reinsurance recoverables, as of December 31......................................... 23,922 22,600 19,600 Reinsurance recoverables, as of December 31............. 4,640 4,939 12,896 ------- ------- ------- Reserve, gross of reinsurance recoverables, as of December 31......................................... $28,562 $27,539 $32,496 ======= ======= ======= Type of Reserve, net of reinsurance recoverables: Case................................................ $10,922 $ 9,600 $ 9,600 IBNR................................................ 13,000 13,000 10,000 ------- ------- ------- Total................................................... $23,922 $22,600 $19,600 ======= ======= =======
Increases to asbestos and environmental impairment claims reserves, if any, may be covered to varying degrees by Underwriters' existing reinsurance contracts with its retrocessionaires. In addition to the case and IBNR reserves for asbestos and environmental impairment claims reported in the tables above, Underwriters carries an additional reserve for such exposures in its financial statements prepared in accordance with generally accepted accounting principles ("GAAP"). The amount of such reserve was $18.9 million as of December 31, 1997, compared with $27.4 million as of December 31, 1996. While there can be no assurance that such total reserves will be adequate, management believes that Underwriters' total asbestos and environmental impairment -34- 35 reserves, taking into consideration the additional GAAP reserves, are a reasonable provision for such claims. Changes in Historical Net Loss and LAE Reserves The following table shows changes in historical net loss and LAE reserves for Underwriters Re Group for each year since 1987. Reported reserve development is derived primarily from information included in statutory financial statements of Underwriters, CUIC and UIC. The first line of the upper portion of the table shows the net reserves at December 31 of each of the indicated years, representing the estimated amounts of net outstanding losses and LAE for claims arising during that year and in all prior years that are unpaid, including losses that have been incurred but not yet reported to Underwriters Re Group. The upper (paid) portion of the table shows the cumulative net amounts paid as of December 31 of successive years with respect to the net reserve liability for each year. The lower portion of the table shows the re-estimated amount of the previously recorded net reserves for each year based on experience as of the end of each succeeding year. The estimate changes as more information becomes known about claims for individual years. In evaluating the information in the table, it should be noted that a reserve amount reported in any period includes the effect of any subsequent change in such reserve amount. For example, if a loss was first reserved in 1987 at $100,000 and was determined in 1990 to be $150,000, the $50,000 deficiency would be included in the Cumulative Redundancy (Deficiency) row shown below for each of the years 1987 through 1989. Conditions and trends that have affected the development of the net reserve liability in the past may not necessarily occur in the future. Accordingly, it is not appropriate to extrapolate future redundancies or deficiencies based on this table. During the mid-1980s, the reinsurance industry, including Underwriters Re Group, experienced substantial underwriting losses. Such losses are reflected in the table, beginning with the comparatively high cumulative deficiencies in the year 1987. The cumulative reserve deficiencies in the years 1987 through 1992 primarily resulted from prior increases to asbestos and environmental impairment claims reserves and includes the $35.8 million reserve strengthening in 1993. -35- 36 Changes in Historical Net Reserves for Losses and LAE (in millions)
Year Ended December 31, 1987 1988 1989 1990 1991 1992 1993 1994 ---- ---- ---- ---- ---- ---- ---- ---- Net liability as of the end of year* ................................. $470 $461 $453 $411 $411 $437 $509 $536 Cumulative amount of net liability paid as of: One year later ..................... $116 $119 $137 $101 $84 $98 $112 $102 Two years later .................... 208 242 227 173 161 178 189 167 Three years later .................. 330 306 285 239 214 236 236 220 Four years later ................... 380 348 342 274 254 266 265 -- Five years later ................... 416 394 370 294 276 287 -- -- Six years later .................... 458 414 384 311 287 -- -- -- Seven years later .................. 475 425 396 319 -- -- -- -- Eight years later .................. 483 434 403 -- -- -- -- -- Nine years later ................... 489 440 -- -- -- -- -- -- Ten years later .................... 490 -- -- -- -- -- -- -- Net liability re-estimated as of: One year later ..................... 481 454 457 414 412 483 516 539 Two years later .................... 473 457 460 421 455 487 518 538 Three years later .................. 476 462 474 465 460 491 523 531 Four years later ................... 478 492 520 472 469 496 519 -- Five years later ................... 516 538 528 485 469 493 -- -- Six years later .................... 562 548 545 483 468 -- -- -- Seven years later .................. 572 568 544 479 -- -- -- -- Eight years later .................. 591 567 541 -- -- -- -- -- Nine years later ................... 591 567 -- -- -- -- -- -- Ten years later .................... 590 -- -- -- -- -- -- -- Cumulative Redundancy (Deficiency) ....................... $(120) $(106) $(88) $(68) $(57) $(56) $(10) $5 Gross Liability-End of Year $861 $940 Reinsurance Recoverable 352 404 ---- ---- Net Liability - End of Year $509 $536 ==== ==== Gross Re-estimated Liability-Latest $959 $939 Re-estimated Recoverable-Latest 440 408 ---- ---- Net Re-estimated Liability-Latest $519 $531 ==== ====
1995 1996 1997 ---- ---- ---- Net liability as of the end of year* ................................. $628 $732 $ 784 Cumulative amount of net liability paid as of: One year later ..................... $117 $175 -- Two years later .................... 214 -- -- Three years later .................. -- -- -- Four years later ................... -- -- -- Five years later ................... -- -- -- Six years later .................... -- -- -- Seven years later .................. -- -- -- Eight years later .................. -- -- -- Nine years later ................... -- -- -- Ten years later .................... -- -- -- Net liability re-estimated as of: One year later ..................... 629 727 -- Two years later .................... 622 -- -- Three years later .................. -- -- -- Four years later ................... -- -- -- Five years later ................... -- -- -- Six years later .................... -- -- -- Seven years later .................. -- -- -- Eight years later .................. -- -- -- Nine years later ................... -- -- -- Ten years later .................... -- -- -- Cumulative Redundancy (Deficiency) ....................... $6 $5 -- Gross Liability-End of Year $1,014 $1,110 $1,159 Reinsurance Recoverable 386 378 375 ------ ------ ------ Net Liability - End of Year $ 628 $ 732 $ 784 ====== ====== ====== Gross Re-estimated Liability-Latest $1,058 $1,139 Re-estimated Recoverable-Latest 436 412 ------ ------ Net Re-estimated Liability-Latest $ 622 $ 727 ====== ======
-36- 37 The reconciliation between the reserves reported in the annual statements filed with state insurance departments in accordance with statutory accounting practices ("SAP") and those reported in Underwriters Re Group's consolidated financial statements prepared in accordance with GAAP for the last three years is shown below (in thousands): Reconciliation of Reserves for Losses and LAE from SAP Basis to GAAP Basis
December 31 1997 1996 1995 ---- ---- ---- Statutory Reserves................................... $765,418 $705,105 $596,070 Additional Mass Action Reserves (1) 18,850 27,350 32,350 Reinsurance Recoverables............................. 374,802 377,565 385,580 ---------- ---------- ---------- GAAP Reserves........................................ $1,159,070 $1,110,020 $1,014,000 ========== ========== ==========
(1) Amount represents additional reserves recorded by Underwriters in 1993 for probable asbestos-related and environmental impairment claims exposure. -37- 38 The reconciliation of reserves for the last three years on a GAAP basis is shown below (in thousands): Reconciliation of Reserves for Losses and LAE
1997 1996 1995 ---- ---- ---- Reserve, net of reinsurance recoverables, as of January 1......................................... $ 732,455 $ 628,420 $ 536,317 Incurred Loss, net of reinsurance, related to: Current year.............................................. 267,530 242,332 200,543 Prior years............................................... (5,702) 1,393 2,565 ---------- ---------- ---------- Total Incurred Loss, net of reinsurance .................. 261,828 243,725 203,108 ---------- ---------- ---------- Paid Loss, net of reinsurance, related to: Current year......................................... (35,033) (23,342) (9,239) Prior years.......................................... (174,982) (116,348) (101,766) ---------- ---------- ---------- Total Paid Loss, net of reinsurance ...................... (210,015) (139,690) (111,005) ---------- ---------- ---------- Reserve, net of reinsurance recoverables, as of December 31....................................... 784,268 732,455 628,420 Reinsurance recoverables, as of December 31............... 374,802 377,565 385,580 ---------- ---------- ---------- Reserve, gross of reinsurance recoverables, as of December 31.................................... $1,159,070 $1,110,020 $1,014,000 ========== ========== ==========
Investment Operations Investments of Underwriters Re Group must comply with the insurance laws of New Hampshire, California and Nebraska, the domiciliary states of Underwriters and NUIC, CUIC, and UIC, respectively, and the other states in which they are licensed. These laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks and real estate mortgages. -38- 39 Underwriters Re Group's investment strategy is to match the average duration of its high-quality diversified fixed maturity portfolio to the average adjusted duration of its liabilities and to provide sufficient cash flow to meet its obligations while maximizing its after-tax rate of return. The average adjusted duration of liabilities is estimated by adjusting the average duration of liabilities to reflect anticipated cash flows from writings of future business. Underwriters Re Group's average adjusted duration of liabilities is currently estimated to be four years and is re-estimated from time to time. Securities may be sold from time to time to take advantage of investment opportunities created by changing interest rates, prepayments, tax and credit considerations or other factors. Underwriters Re Group's entire fixed maturity portfolio has been designed to enable management to react to such opportunities or to circumstances that could result in a mismatch between the duration of such portfolio assets and the duration of liabilities and, as such, is classified as available for sale. The following table reflects investment results for the fixed maturity portfolio of Underwriters Re Group for the years ended December 31, 1997, 1996 and 1995 (dollars in thousands): Investment Results
Net Net Pre-Tax After-Tax Pre-Tax Average Investment Investment Realized Effective After-Tax Period Investments (1) Income (2) Income (3) Losses Yield (4) Yield (5) - -------------------------------------------------------------------------------------------------------------------------------- Year Ended December 31, 1997 $1,147,064 $69,229 $50,239 $ (855) 6.0% 4.4% Year Ended December 31, 1996 $984,345 $59,542 $42,971 $ (94) 6.0% 4.4% Year Ended December 31, 1995 $797,132 $50,173 $36,113 $ (5,476) 5.9% 4.5%
(1) Average of amortized cost of fixed maturities at beginning and end of period, excluding operating cash. (2) After investment expenses, excluding realized gains or losses from sale of investments. (3) Net pre-tax investment income less appropriate income taxes. (4) Net pre-tax investment income for the period divided by average investments for the same period. (5) Net after-tax investment income for the period divided by average investments for the same period. -39- 40 As of December 31, 1997, the equity portfolio of Underwriters Re Group was carried at a market value of approximately $302.0 million with an original cost of approximately $166.0 million, and consisted primarily of approximately 2.5 million shares of BNSF common stock. The cost of equities listed in the table below, $140.2 million, includes the cost paid by Alleghany for the BNSF common stock prior to being contributed to Underwriters Re Group. In 1997, Underwriters Re Group realized a gain of $1.8 million related to the sale of equity securities and had dividend income of $5.6 million therefrom. The following table summarizes the investments of Underwriters Re Group, excluding cash, as of December 31, 1997, with all investments carried at fair value (dollars in thousands): Investments
Amortized Cost or Cost Fair Value Amount Percentage Amount Percentage ------ ---------- ------ ---------- Short-term investments ........................ $ 92,989 7% $ 92,989 6% Corporate bonds ............................... 256,066 19 259,217 17 United States government and government agency bonds ................... 102,422 8 103,149 7 Mortgage- and asset-backed securities ................................ 328,657 25 337,241 22 Foreign bonds ................................. 19,264 1 19,337 1 Redeemable and auction preferred stocks .......................... 33,917 3 34,956 3 Municipal bonds ............................... 355,287 27 363,252 24 Equity securities (1) ......................... 140,186 10 302,037 20 ---------- ---- ---------- ---- Total ..................................... $1,328,788 100% $1,512,178 100% ========== ==== ========== ====
(1) Includes 2,474,823 shares of BNSF common stock at the original cost to Alleghany. -40- 41 The following table indicates the composition of the long-term fixed maturity portfolio by Moody's rating as of December 31, 1997 (dollars in thousands): Long-Term Fixed Maturity Portfolio by Moody's Rating
Fair Value Percentage ---------- ---------- Aaa............................................. $ 618,857 55% Aa.............................................. 165,606 15 A............................................... 229,560 21 Baa............................................. 80,534 7 Ba.............................................. 22,595 2 ---------- ---- Total .................................. $1,117,152 100% ========== ====
The following table indicates the composition of the long-term fixed maturity portfolio by years until contractual maturity as of December 31, 1997 (dollars in thousands): Long-Term Fixed Maturity Portfolio by Years Until Maturity
Fair Value Percentage ---------- ---------- One year or less................................ $ 46,901 4% Over one through five years..................... 268,696 24 Over five through ten years..................... 312,897 28 Over ten years.................................. 151,417 14 Mortgage- and asset-backed securities .......... 337,241 30 ---------- ---- Total ................................. $1,117,152 100% ========== ====
Competition Underwriters competes primarily in the United States reinsurance market with numerous domestic and foreign reinsurers, many of which have greater financial resources than Underwriters. Underwriters' competitors include independent reinsurance companies, subsidiaries or affiliates of worldwide insurance companies, reinsurance departments of certain primary insurance companies and domestic, European and Asian underwriting syndicates. Competition in the types of reinsurance in which Underwriters is engaged is based on many factors, including the perceived overall financial strength of the reinsurer, premiums charged, contract terms and conditions, services offered, speed of claims payment, reputation and experience. -41- 42 Competition in the property and casualty reinsurance industry has historically been cyclical in nature. Typically, a cycle begins with attractive premium rates for reinsurance, which cause increased writing by existing reinsurers and the entrance into the market of new reinsurers. Competition within the market continues to grow, resulting in a decrease in premium rates. As the cycle continues, assuming loss experience is consistent, these declining premium rates eventually result in a period of underwriting losses. Such losses in turn cause reinsurers to slow or stop writing reinsurance or to withdraw from the market altogether, which results in decreased competition and a subsequent increase in premium rates. Management believes this competitive cycle, which may affect particular market segments at different times, is a critical factor affecting reinsurance profitability over time. There can be no assurance that historical trends in the property and casualty reinsurance industry will continue or that Underwriters will be able to accurately anticipate any such trends. To enhance Underwriters' financial strength, Alleghany, through URG, contributed approximately $51 million in cash and equity securities in 1993 and $100 million in equity securities in 1994 to the capital of Underwriters. Underwriters' enhanced financial strength has allowed it to benefit from the continuing trend toward consolidation in the domestic reinsurance market, resulting from the tendency of reinsurance buyers to purchase coverage from larger and more financially secure reinsurers. In 1996, URG issued $200 million principal amount of 7-7/8% Senior Notes due 2006. Of the net proceeds of the offering, $120 million was contributed to the capital of Underwriters, $50 million was used to repay indebtedness under URG's credit agreement and the remainder is being used for general corporate purposes. According to the Reinsurance Association of America, at December 31, 1997 there were 43 domestic professional reinsurers, and Underwriters was the nation's ninth-largest in terms of statutory surplus and fifteenth-largest in terms of net written premiums. The commercial property and casualty insurance industry is highly competitive on the basis of price and service. CUIC's, UIC's and NUIC's competitors include other primary insurers and new forms of insurance organizations such as alternative self-insurance mechanisms. Many such competitors have considerably greater financial resources, greater experience in the insurance industry and offer a broader line of insurance products than CUIC, UIC and NUIC. Regulation Underwriters, CUIC, UIC and NUIC are subject to regulation and supervision by state insurance regulatory authorities under the insurance statutes and regulations of states in which they are incorporated (New Hampshire for Underwriters and NUIC, California for CUIC, and Nebraska for UIC). In addition, each of these companies is regulated in each jurisdiction in which it conducts business. Among other things, insurance statutes -42- 43 and regulations typically limit the amount of dividends that can be paid without prior regulatory notification and approval, impose restrictions on the amounts and types of investments that may be held, prescribe solvency standards that must be met and maintained, require filing of annual or other reports with respect to financial condition and other matters and provide for periodic company examinations. The terms and conditions of reinsurance agreements generally are not subject to regulation by any governmental authority with respect to rates or policy terms. These agreements contrast with primary insurance policies and agreements, the rates and policy terms of which are generally closely regulated by state insurance departments. As a practical matter, however, the rates charged by primary insurers have an effect on the rates that can be charged by reinsurers. Each of the operating subsidiaries of The Center is subject to regulation and supervision by state insurance regulators in the states in which its subsidiary is licensed as an insurance agency. Such regulations address the solicitation and effectuation of insurance in such states and impose certain requirements relating to, among other things, countersignatures, continuing education and maintenance of trust accounts. State insurance holding company statutes provide a regulatory mechanism designed to protect the financial condition of domestic insurance companies operating as subsidiaries of holding companies. All holding company statutes require disclosure and, in some instances, prior approval of significant transactions between a domestic insurance company and its affiliates. Holding company statutes also may require, among other things, prior approval of any acquisition of control of a domestic insurance company. As an insurance holding company, Alleghany is subject to such regulations in New Hampshire, California and Nebraska. The acquisition of Underwriters, CUIC and UIC by Alleghany was subject to prior approval from the insurance regulatory authorities in the states in which such companies are incorporated. Alleghany and its other subsidiaries, however, generally are not otherwise subject to restrictions on their business activities due to their affiliation with Underwriters, CUIC, UIC and NUIC. Beginning with the 1994 year-end statutory financial statements, the insurance laws of New Hampshire, California and Nebraska imposed risk-based capital ("RBC") requirements on property and casualty insurers and reinsurers, based on a model adopted by the National Association of Insurance Commissioners. The RBC requirements attempt to assess a property and casualty company's statutory capital and surplus needs, taking into account the risk characteristics of the companies' investments and products, by measuring the following risks: (i) underwriting, which encompasses the risk of adverse loss developments and inadequate pricing, (ii) declines in asset values arising from credit risks and (iii) declines in asset values arising from investment risks. The ratio of a company's total adjusted capital to its risk-based capital provides regulators with an early -43- 44 warning tool to identify weakly capitalized companies for purposes of initiating corrective action. At December 31, 1997, each of Underwriters, CUIC, UIC and NUIC had surplus well in excess of the risk-based capital thresholds that would require any corrective action. Employees Underwriters Re Group employed 248 persons as of December 31, 1997. INDUSTRIAL MINERALS BUSINESS On July 31, 1991, a holding company subsidiary of Alleghany acquired all of Manville Corporation's worldwide industrial minerals business, now conducted principally through World Minerals. The present chief executive officer of World Minerals currently owns an equity interest, including outstanding options, of about 6.6 percent of World Minerals' immediate parent company. World Minerals, headquartered in Santa Barbara, California, is principally engaged in the mining, production and sale of two industrial minerals, diatomite and perlite: Diatomite World Minerals conducts its diatomite business through Celite. In 1995, World Minerals, through various subsidiaries of Celite, acquired controlling interests in three joint ventures which are engaged in the mining and processing of diatomite in Jilin Province, Peoples Republic of China ("PRC"). Celite is believed to be the world's largest producer of filter-aid grade diatomite, which it markets worldwide under the Celite(R) and Kenite(R) brand names; Celite also markets filter-aid grade diatomite in Europe under the Primisil(R) brand name and in Latin America and other areas under the Diactiv(R) brand name. Diatomite is a silica-based mineral consisting of the fossilized remains of microscopic freshwater or marine plants. Diatomite's primary applications are in filtration and as a functional filler. Filtration accounts for the majority of the worldwide diatomite market and for over 50 percent of Celite's diatomite sales. Diatomite is used as a filter aid in the production of beer, food, juice, wine, water, sweeteners, fats and oils, pharmaceuticals, chemicals, lubricants and petroleum. Diatomite is used as a filler, mainly in paints, and as an anti-block agent in plastic film. In addition to diatomite, Celite also produces calcium silicate products and magnesium silicate products, which are sold worldwide under the MicroCel(R) and -44- 45 Celkate(R) brand names (except in portions of Europe where calcium silicate products are sold under the Calflo(R) brand name). These products, which have high surface area and adsorption and absorption capabilities, are used to convert liquid, semi-solid and sticky ingredients into dry, free-flowing powders in the production of rubber, sweeteners, flavorings and pesticides. Celite has its world headquarters in Lompoc, California and owns, directly or through wholly owned subsidiaries, diatomite mines and/or processing plants in Lompoc, California; Quincy, Washington; Murat, France; Alicante, Spain; Arica, Chile; Arequipa, Peru; and Guadalajara, Mexico. Celite also owns 48.6 percent of Kisilidjan, h.f., a joint venture with the Government of Iceland which mines and processes diatomite from Lake Myvatn in Iceland and owns controlling interests in three joint ventures which mine and process diatomite in Jilin Province, PRC. Perlite World Minerals conducts its perlite business through Harborlite and Europerlite. World Minerals believes that its Harborlite and Europerlite subsidiaries are, in the aggregate, the world's largest producers of perlite filter aids and that Harborlite, which is also engaged in the business of selling perlite ore, is one of the world's largest merchant producers of perlite ore. These products are marketed worldwide under the Harborlite(R) and Europerl(R) brand names. Perlite is a volcanic rock which contains between 2 percent and 5 percent natural combined water. When heated rapidly, the natural combined water turns explosively to steam and the perlite ore "pops" in a manner similar to popcorn, expanding up to twenty times its original volume and creating a soft material with large surface area and correspondingly low density. Perlite ore is mined at Harborlite's No Agua, New Mexico mine and is sold primarily to companies that expand it in their own expansion plants and use it in the manufacture of roofing board, formed pipe insulation and acoustical ceiling tile. Perlite ore for filter aid and certain filler applications is mined at Harborlite's Superior, Arizona mine and is expanded at Harborlite's six expansion plants located within the United States. Expanded perlite is also produced at Harborlite's European expansion plants at Hessle, United Kingdom and Wissembourg, France and Europerlite's expansion plants at Barcelona, Spain and Milan, Italy, from perlite ore obtained from Harborlite's Turkish perlite mine at Dikili, Turkey and from merchant ore producers in Europe. Most of the expanded perlite is used as a filter aid in the brewing, food, wine, sweetener, pharmaceutical, chemical and lubricant industries, or as a filler and insulating medium in various construction applications. -45- 46 On October 31, 1995, World Minerals, through Europerlite, acquired control of all of the outstanding capital stock of two privately owned perlite filter aid companies with operations in Italy and Spain, respectively, and a privately owned perlite sales company in Spain. The perlite sales company has since been merged into the Spanish filter aid company. Harborlite has its world headquarters in Lompoc, California and owns a perlite mine and mill in No Agua, New Mexico, a perlite loading facility in Antonito, Colorado, a perlite mine and a mill in Superior, Arizona, a perlite mine and mill in Dikili, Turkey, a perlite deposit in Central Mexico, and perlite expansion facilities in Escondido, California; Green River, Wyoming; Laporte, Texas; Youngsville, North Carolina; Vicksburg, Michigan; Quincy, Florida; Wissembourg, France; and Hessle, England. Europerlite also has its world headquarters in Lompoc, California and owns perlite expansion plants in Barcelona, Spain and Milan, Italy. World Minerals conducts its business on a worldwide basis, with mining and processing operations in eleven countries. In 1997, approximately 43 percent of World Minerals' revenues (equal to 11.0 percent of Alleghany's consolidated revenues) were generated by foreign operations, and an additional 12.2 percent of World Minerals' revenues were generated by export sales from the United States. While World Minerals believes that the international scope of its operations gives it unique competitive advantages, international operations can be subject to additional risks, such as currency fluctuations, changes in foreign legal requirements and political instability. World Minerals closely monitors its methods of operating in each country and adopts strategies responsive to changing economic and political environments. World Minerals minimizes its exposure to the risk of foreign currency fluctuation by, among other things, causing its subsidiaries to declare and pay dividends whenever feasible, and having its foreign subsidiaries invoice their export customers in United States dollars or other "hard currencies." World Minerals' foreign operations do not subject Alleghany to a material risk from foreign currency fluctuation. It is not currently expected that the currency turmoil in Asia will have a material adverse impact on World Minerals' earnings in 1998. Celite's largest diatomite mine and plant is located near Lompoc, California. All additional diatomite supplies are currently obtained by Celite from its mines in the state of Washington, in France, Spain, Mexico, Chile, Peru, and PRC, and from the Lake Myvatn mine in Iceland (although environmental regulations and seismic activity may adversely affect future production at Lake Myvatn). Celite believes that diatomite reserves at each site are generally sufficient to last for at least 20 more years at the current rate of utilization, except at its Quincy, Washington mine where reserves are estimated to -46- 47 last for another 15 years at current utilization rates. Celite is conducting drilling activities to identify additional quality reserves in the area and expects to be able to increase reserve estimates for Quincy by the end of 1998. Harborlite obtains perlite ore in the United States from its No Agua and Superior mines, and believes that its perlite ore reserves at each site are sufficient to last at least 20 more years at the current rate of utilization. The perlite used by Harborlite and Europerlite for expansion in Europe is obtained from Harborlite's Dikili mine and from third parties in Europe. Ore reserves at Harborlite's Dikili mine are believed to be sufficient to last at least 20 more years at the current rate of utilization. Celite's silicate products are produced from purchased magnesium and calcium compounds and internally supplied diatomite. World Minerals' operating subsidiaries experienced no interruption in raw material availability in 1997, and barring unforeseen circumstances anticipate no such interruption in 1998. While there can be no assurance that adequate supplies of all raw materials will be available in the future, Celite, Harborlite and Europerlite believe that they have taken reasonable precautions for the continuous supply of their critical raw materials. Many of Celite's, Europerlite's and Harborlite's operations use substantial amounts of energy, including electricity, fuel oil, natural gas, and propane. Celite, Europerlite and Harborlite have supply contracts for most of their energy requirements. Most of such contracts are for one year or less. Celite, Europerlite and Harborlite have not experienced any energy shortages and they believe that they have taken reasonable precautions to ensure that their energy needs will be met, barring any unusual or unpredictable developments. From the time World Minerals began operations in 1991, none of its customers accounted for 10 percent or more of World Minerals' annual sales. World Minerals presently owns, controls or holds licenses either directly or through its subsidiaries to approximately 21 United States and 43 foreign patents and patent applications. While World Minerals considers all of its patents and licenses to be valuable, World Minerals believes that none of its patents or licenses is by itself material to its business. World Minerals normally maintains approximately a one- to four-week supply of inventory on certain products due to production lead times. Although diatomite mining activities at Celite's principal mine in Lompoc, California may be suspended during periods of heavy rainfall, World Minerals believes that, because of the stockpiling of ore during dry periods, such suspensions do not materially affect the supply of inventory. In anticipation of forecasted severe "El Nino" wet weather conditions along the California -47- 48 coast this winter, Celite has increased its product inventories as well. Barring unusual circumstances, World Minerals does not experience backlogs of orders. World Minerals' business is not seasonal to any material degree. World Minerals' domestic and international operations have been consolidated into a single, centrally managed worldwide business under the direction of a highly capable management team. Since 1993, financial systems and controls have been upgraded, and the Celite, Europerlite and Harborlite sales, operations and financial groups have been consolidated to improve efficiency and take advantage of synergies. World Minerals acts as the sales agent for both Celite and Harborlite in the United States and procures orders from customers and distributors on their behalf. World Minerals also distributes Celite's, Harborlite's and Europerlite's products in Europe to dealers, distributors and end users on Celite's, Harborlite's and Europerlite's behalf. World Minerals has research and development, environmental control and quality control laboratories at its Lompoc production facilities and quality control laboratories at each of its other production facilities. In 1997, World Minerals spent approximately $2.2 million on company-sponsored research and technical services (in addition to amounts spent on engineering and exploration) related to the development and improvement of its products and services. Competition World Minerals believes that Celite is the world's largest producer of filter-aid grade diatomite. The remainder of the market is shared by Celite's four major competitors: Eagle-Picher Minerals (United States), Grefco (United States), CECA (France) and Showa (Japan), and a number of smaller competitors. World Minerals believes that Harborlite and Europerlite are, in the aggregate, the world's largest producer of perlite filter aids and that Harborlite, which is also engaged in the business of selling perlite ore, is one of the world's largest merchant producers of perlite ore. Harborlite and Europerlite each have two large competitors in the expanded perlite market, Grefco and CECA, and many smaller competitors. Harborlite has two large competitors in the merchant perlite ore market, Grefco and Silver & Baryte, and numerous smaller companies. The filter aid products of Celite, Europerlite and Harborlite compete with other filter aids, such as cellulose, and other filtration technologies, such as crossflow and centrifugal separation. Celite's silicates compete with a wide variety of other synthetic mineral products. -48- 49 In all of World Minerals' businesses, competition is principally on the basis of service, product quality and performance, warranty terms, speed and reliability of delivery, availability of the product and price. Regulation All of Celite's and Harborlite's domestic operations are subject to a variety of federal, state and local environmental laws and regulations. These laws and regulations establish potential liability for costs incurred in cleaning up waste sites and impose limitations on atmospheric emissions, discharges to domestic waters, and disposal of hazardous materials. Certain state and local jurisdictions have adopted regulations that may be more stringent than corresponding federal regulations. Celite and Harborlite believe that the impact of environmental regulation on their respective operating results has been minimal due to their environmental compliance programs; however, Celite and Harborlite cannot predict the potential future impact of such regulations, given the increasing number and complexity, and changing character, of such regulations. Moreover, federal and state laws governing disposal of wastes impact customers who must dispose of used filter-aid materials. World Minerals works with its customers to implement disposal strategies to minimize the impact of these disposal regulations. The domestic mining operations of Celite and Harborlite are subject to regulation by the Mine Safety and Health Administration ("MSHA"). This agency establishes health and safety standards relating to noise, respiratory protection and dust for employee work environments in the mining industry. Celite's and Harborlite's domestic production facilities which are not under the jurisdiction of MSHA are subject to regulation by the Occupational Safety and Health Administration ("OSHA"), which establishes regulations regarding, among other things, workplace conditions, and exposure to dust and noise. In addition, certain state agencies exercise concurrent jurisdiction in these areas. During 1997, both MSHA and OSHA announced special emphasis programs to reduce the incidence of silicosis in the workplace. Due to Celite's industrial hygiene and monitoring programs, Celite does not expect these special emphasis programs to impact its business in any material way. World Minerals maintains a staff of experienced environmental, safety and industrial hygiene professionals who assist plant personnel in complying with environmental, health and safety regulations. Its environmental, safety and industrial hygiene audit group also performs routine internal audits and reviews of World Minerals' plant facilities worldwide. Due to these programs and responsible management at the local plant level, compliance with such regulations has been facilitated and the financial impact of such regulations on operating results has been minimal. -49- 50 Certain products of Celite and Harborlite are subject to the Hazard Communication Standard promulgated by OSHA, which requires Celite and Harborlite to disclose the hazards of those products to employees and customers. Celite's diatomite products and certain of Harborlite's products contain varying amounts of crystalline silica, a mineral which is among the most common found on earth. In 1997, the International Agency for Research on Cancer ("IARC") reclassified the inhalation of crystalline silica from occupational sources from "probably carcinogenic to humans" to a category reflecting "sufficient evidence of human carcinogenicity." Celite and Harborlite provide required warning labels on their products containing in excess of 0.1 percent respirable crystalline silica, advising customers of the IARC designation and providing recommended safety precautions. Such requirements also mandate that industrial customers who purchase diatomite or perlite for use as a filler in their products label such products to disclose hazards which may result from the inclusion of crystalline silica-based fillers, if such products contain in excess of 0.1 percent of crystalline silica by volume. Due to labeling concerns, some manufacturers of paint may be considering the use of other fillers in place of Celite's products. However, Celite believes that the loss of these customers would not have a material adverse effect on its operating results. Several states have also enacted or adopted "right to know" laws or regulations, which seek to expand the federal Hazard Communication Standard to include providing notice of hazards to the general public, as well as to employees and customers. Celite, through the industry-sponsored International Diatomite Producers Association ("IDPA"), has participated in funding several studies to examine in more detail the cancer risk to humans from occupational exposure to crystalline silica. One such study, conducted by the University of Washington on diatomite workers in Lompoc, California (the "Washington Study") found a modest increase in lung cancer deaths in the cohort compared with national rates (indicated by a standardized mortality ratio ("SMR") equal to 1.43). The standardized mortality ratio compares the number of expected cancer deaths in the cohort with 1, representing the number of cancer deaths in the population at large. The study also found an increase in non-malignant respiratory disease ("NMRD") (SMR equal to 2.59); this finding was expected because the NMRD category included silicosis resulting from exposures in past decades. After the publication of the Washington Study, Celite conducted its own review of the portion of the cohort representing the Lompoc plant and found that more workers in this portion of the cohort may have been exposed to asbestos, prior to World Minerals' purchase of the Lompoc plant, than originally thought. Since exposure to asbestos has been found to cause lung cancer and respiratory disease, this finding has raised concern that the Washington Study may have overstated the adverse health effects of exposure to crystalline silica. IDPA engaged an epidemiologist and an industrial hygienist to examine the cohort to determine whether asbestos exposure was properly accounted for in the -50- 51 Washington Study's results. The final IDPA report (the "Asbestos Study") was issued in December 1994 and found: "Although asbestos operations were small relative to the diatomaceous earth operations, analyses in this report showed that exposure to asbestos by workers was relatively common. For example, the number of cohort members who were ever definitely, probably or possibly exposed to asbestos was shown to involve approximately 60 percent of the cohort. Even when only men employed in jobs definitely exposed to asbestos for more than [one] year in the period 1950-1977 were considered, more than 8 percent of the cohort had held such jobs." The Asbestos Study's authors called for further analyses which fully take into account the results of their study stating "[t]he interpretation of the silica-lung cancer risk relationships based on the [Lompoc] cohort should await the outcome of such analyses." The results of the Asbestos Study were analyzed by the authors of the Washington Study. They did not agree that asbestos was a likely confounder of the results of the initial study. In 1996, the Washington Study's authors, in association with researchers from Tulane University, conducted a seven year follow-up study of the Lompoc cohort. The follow-up study, funded by a grant from the National Institute for Occupational Safety and Health, reported a lower SMR for the cohort (1.29 vs. 1.43), a weakened dose response relationship, which may suggest a less conclusive indication of a causative relationship between occupational exposure and cancer deaths, and a continued absence of excess lung cancers in workers hired after 1960. Data errors later discovered in the follow-up study reduced the final SMR to 1.22 and further weakened the dose response relationship. An additional aspect of the study, which seeks to compare results of the cohort study to radiographic readings of the workers, is ongoing. The various agreements covering the purchase of the business of Celite in 1991 provide for the indemnification of the holding company subsidiary of Alleghany which acquired Celite by the various selling Manville entities in respect of any environmental and health claims arising from the operations of the business of Celite prior to its acquisition by the holding company subsidiary. Employees During 1997, World Minerals reorganized and centralized much of the sales functions of its foreign subsidiaries, placing many of them directly under World Minerals ownership. As of December 31, 1997, World Minerals had 202 employees worldwide, Celite had about 1,145 employees worldwide, and Harborlite had about 190 employees -51- 52 worldwide. Europerlite had 54 employees, all located in Europe. Approximately 348 of Celite's employees and 45 of Harborlite's employees in the United States are covered by collective bargaining agreements. All of the collective bargaining agreements covering workers at Celite and Harborlite are in full force and effect. STEEL FASTENER BUSINESS The Heads and Threads division of Alleghany, headquartered in Northbrook, Illinois, is believed to be one of the nation's leading importers and distributors of steel fasteners. Heads and Threads imports and sells commercial fasteners -- nuts, bolts, screws, washers and other fasteners --for resale to fastener manufacturers and distributors through a network of sales offices and warehouses located in sixteen states. The strength of Heads and Threads lies in its five major warehouses and fourteen regional satellite warehouses and long years of association with suppliers and customers. Since Heads and Threads imports virtually all of its fasteners, it is necessary to forecast inventory requirements from six months to a year in advance to allow time for shipments to reach their destinations in the United States. In addition, Heads and Threads' costs are subject to fluctuations in foreign currency and import duties. Increases in import duties may result from determinations by United States federal agencies that foreign countries are violating United States laws or intellectual property rights, or are following restrictive import policies. Heads and Threads' operations do not subject Alleghany to a material risk from fluctuations in foreign currency or import duties. Regulations implementing the Fastener Quality Act, the effective date of which has been postponed to 1998, will increase costs. At December 31, 1997, Heads and Threads had about 182 employees. REAL ESTATE BUSINESS Headquartered in Sacramento, California, Alleghany Properties and its subsidiary own and manage, among other real estate and real estate-related assets, 30 properties in fee in California. Such properties are comprised primarily of improved and unimproved commercial land (office, retail and industrial), and improved and unimproved commercial and residential lots. A major portion of API's real estate assets are located in North Natomas, the only large undeveloped area in the City of Sacramento. Development in the area has been delayed by flood plan zoning and wildlife habitat issues, both of which appear to be close to resolution. At December 31, 1997, API had 5 employees. -52- 53 Item 2. Properties. Alleghany's headquarters is located in leased office space of about 11,000 square feet at 375 Park Avenue in New York City. CT&T and CTI lease about 282,000 square feet for their headquarters operations in the Chicago Title and Trust Center, a 49-story office complex at 171 North Clark Street in Chicago, Illinois. Ticor Title's and Security Union's headquarters are in leased premises of about 45,000 square feet in Pasadena, California. CT&T and its subsidiaries own or lease buildings or office space in approximately 550 locations throughout the United States, primarily for CTI, Security Union and Ticor Title full-service and satellite branch office operations. In 1996, URG agreed to lease approximately 45,000 square feet of office space for its new headquarters in Calabasas, California. The lease term is expected to begin in the second quarter of 1998 upon completion of construction and relocation. Currently, URG leases about 30,000 square feet of office space for its headquarters operations in Woodland Hills, California. All of its five branch office locations are also in leased space, ranging in size from about 2,900 square feet to 6,700 square feet. CUIC leases about 19,700 square feet of office space. All three branch offices of The Center are also in leased space, ranging in size from about 4,300 square feet to 5,800 square feet. World Minerals' headquarters is located in leased premises of approximately 13,000 square feet in Santa Barbara, California. Celite, Harborlite, Europerlite and certain departments of World Minerals share 16,800 square feet of leased premises in Lompoc, California. A description of the major plants and properties owned and operated by Celite, Europerlite and Harborlite is set forth below. All of the following properties are owned, with the exception of Plant # 1 at Quincy, Washington, the headquarters offices at Santa Barbara and Lompoc, California, the Nanterre, France, Santiago, Chile and Izmir, Turkey, offices and the plant at Wissembourg, France, which are leased. -53- 54
Location and Approximate Product Nature of Property Square Footage or Use ------------------ -------------- ------ CELITE: Lompoc, CA 961,410 Diatomite filter aids, Production facility; fillers, silicates and 17 multi-story specialty products production buildings; 5 one-story warehouse buildings; 6 one-story laboratory buildings; 4 multi-story bulk handling buildings; 6 one-story office buildings; 2 one-story lunch and locker-room buildings; and 10 one-story shops. Lompoc, CA 16,800 Administrative office 1 one-story building; and 3 units within 1 one-story building. Quincy, WA 60,941 Diatomite filter aids Production facility; and fillers Plant #1-1 multi-story production building and 7 one-story buildings. Plant #2-1 multi-story production building and 6 one-story buildings. Murat, Department of 77,000 Diatomite filter aids Cantal, France Production facility; 1 one-story manufacturing building; 2 one-story warehouses; and 1 one-story office building.
-54- 55
Location and Approximate Product Nature of Property Square Footage or Use ------------------ -------------- ------ Nanterre, France 6,000 Sales and 1 single floor. administrative offices Guadalajara, Mexico 116,610 Diatomite filter aids Production facility; and fillers 2 multi-story production buildings; 2 multi-story pollution-control buildings; and 20 one-story buildings. Mexico City, Mexico 2,700 Sales and 1 single floor condominium. administrative offices Arica, Chile 50,000 Diatomite filter aids Production facility; 1 calcined line (currently being expanded to two lines); 1 natural line; 1 administration building; 1 laboratory; 1 warehouse building; 1 changing room building; 1 maintenance workshop; and 1 product warehouse. Santiago, Chile 1,682 Offices 1 single floor in a multi-story, rented office building. Alicante, Spain 70,777 Diatomite filter aids Production facility; and fillers 2 multi-story manufacturing buildings; 3 one-story warehouses; 2 one-story office buildings; 1 two-story laboratory; and 3 miscellaneous buildings.
-55- 56
Location and Approximate Product Nature of Property Square Footage or Use ------------------ -------------- ------ Changbai County, 95,000 Diatomite filter aids Jilin Province, PRC Production facility; 1 multi-story processing facility; 4 one-story warehouse buildings; 1 multi-story office building; and 4 one-story miscellaneous buildings. Linjiang County, 74,665 Diatomite filter aids Jilin Province, PRC Production facility; 1 multi-story production facility; 1 two-story office building; 3 one-story warehouse buildings; and 3 one-story miscellaneous buildings. Linjiang County, 142,000 Diatomite filter aids Jilin Province, PRC Production facility; 3 multi-story production facilities; 1 one-story office building; 2 one-story warehouse buildings; and 5 one-story miscellaneous buildings. HARBORLITE: Antonito, CO 9,780 Warehouse facilities 1 one-story for perlite ore manufacturing building and warehouse; 1 one-story office building; and 1 one-story warehouse.
-56- 57
Location and Approximate Product Nature of Property Square Footage or Use ------------------ -------------- ------ No Agua, NM 40,550 Perlite ore Production facility; 1 six-story mill building; 1 one-story office and shop building; and 8 miscellaneous one-story buildings. Superior, AZ 6,900 Perlite ore Production facility; 1 one-story warehouse building; and 1 one-story office building. Escondido, CA 8,450 Perlite filter aids 1 one-story warehouse building; and 1 one-story office building. Green River, WY 17,300 Perlite filter aids 1 one-story warehouse building; and 1 one-story office building. Vicksburg, MI 25,050 Perlite filter aids 2 one-story warehouse buildings; and 1 one-story office building. Youngsville, NC 22,500 Perlite filter aids 1 one-story warehouse building; 1 one-story manufacturing building; and 1 one-story office building.
-57- 58
Location and Approximate Product Nature of Property Square Footage or Use ------------------ -------------- ------ Quincy, FL 18,450 Perlite filter aids 1 one-story warehouse building; 1 one-story manufacturing building; and 1 one-story office building. LaPorte, TX 23,000 Perlite filter aids and 1 one-story expansion fillers warehouse and office building. Wissembourg, France 5,000 Perlite filter aids and a portion of 1 fillers multi-story production and warehouse building. Hessle, Humberside, 36,700 Perlite filter aids and United Kingdom fillers 1 one-story manufacturing building; and 1 two-story office building. Dikili, Turkey 63,200 Perlite crushing mill Production facility; 1 four-story manufacturing building; 1 one-story warehouse building; 1 one-story raw material warehouse; 1 one-story office building; and 1 one-story maintenance shop. Izmir, 1,000 Sales and Turkey administrative offices 1 single floor.
-58- 59
Location and Approximate Product Nature of Property Square Footage or Use ------------------ -------------- ------ EUROPERLITE: Barcelona, Spain 70,300 Perlite filter aids and Production facility; fillers 1 one-story manufacturing and warehouse building; 1 one-story raw material warehouse; and 1 two-story office building. Milan, Italy 68,600 Perlite filter aids Production facility; 1 one-story manufacturing/ warehouse building; 1 one-story raw material warehouse; and 1 two-story office building. WORLD MINERALS: Santa Barbara, CA 13,000 Headquarters office 1 one-story rented building.
Celite's largest mine is located on owned property immediately adjacent to the City of Lompoc, California, and is the site of one of the most unusual marine diatomite deposits in the world. The mine celebrated its 100th anniversary of production in 1993 and has been in continuous operation for more than 60 years. Reserves are believed to be sufficient for the operation of the plant for at least 20 more years at the current rate of utilization. The Lompoc production facility has a rated capacity in excess of 200,000 tons annually and currently supplies more than 25 different grades of products to the filtration and filler markets. The facility also houses World Minerals' research and development, and health, safety and environmental departments and Celite's quality control laboratories. World Minerals, Celite, Harborlite and Europerlite also lease warehouses, office space and other facilities in the United States and abroad. A joint venture between Celite and the Government of Iceland has rights to mine diatomaceous earth in sections of Lake Myvatn, Iceland, and Celite's joint ventures in PRC have rights to mine diatomaceous earth in sections of Jilin Province, PRC. -59- 60 The operations of Alleghany's Heads and Threads division are conducted in 16 states at 19 locations. There are either warehouses, or combined warehouses and sales offices, at such locations; two locations are owned and the remainder are leased. Heads and Threads' headquarters in Northbrook, Illinois is owned by Alleghany. API's headquarters is located in leased premises of approximately 2,500 square feet in Sacramento, California. API or its subsidiary owns 30 properties in fee in California. Such properties are comprised primarily of improved and unimproved commercial land (office, retail and industrial) and improved and unimproved commercial and residential lots. In addition, 112.3 acres of commercial/residential unimproved land located in Roseville, California, which is subject to a first deed of trust, is held by a joint venture in dissolution in which API has an interest, but the liquidation of such joint venture has not yet been completed. -60- 61 Item 3. Legal Proceedings. Alleghany's subsidiaries and division are parties to pending litigation and claims in connection with the ordinary course of their businesses. Each such operating unit makes provision on its books, in accordance with generally accepted accounting principles, for estimated losses to be incurred in such litigation and claims, including legal costs. In the opinion of management, such provision is adequate under generally accepted accounting principles as of December 31, 1997. -61- 62 Item 4. Submission of Matters to a Vote of Security Holders. No matter was submitted to a vote of security holders during the fourth quarter of 1997. Supplemental Item. Executive Officers of Registrant. The name, age, current position, date elected and five-year business history of each executive officer of Alleghany are as follows:
Business Experience Name Age Current Position During Last 5 Years - ---- --- ---------------- ------------------- F.M. Kirby 78 Chairman of the Board Chairman of the Board, Alleghany. John J. Burns, Jr. 66 President, chief President, chief executive officer and executive officer and chief operating officer chief operating officer, Alleghany. David B. Cuming 65 Senior Vice President Senior Vice President and chief financial and chief financial officer officer, Alleghany. Robert M. Hart 53 Senior Vice President, Senior Vice President General Counsel and and General Counsel Secretary since September 1994 and Secretary since January 1995; Partner, Donovan Leisure Newton & Irvine, prior thereto. Peter R. Sismondo 42 Vice President, Vice President, Controller, Treasurer, Controller, Treasurer, Assistant Secretary and Assistant Secretary and principal accounting principal accounting officer officer, Alleghany, since January 1995; Vice President, Controller, Assistant Secretary and principal accounting officer, Alleghany, prior thereto.
-62- 63 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters. The information required by this Item with respect to the market price of and dividends on Alleghany's common stock and related stockholder matters is incorporated by reference from page 18 of Alleghany's Annual Report to Stockholders for the year 1997, filed as Exhibit 13 hereto. Recent Sales of Unregistered Securities Other than unregistered issuances of Alleghany common stock previously reported in Alleghany's Quarterly Reports on Form 10-Q for the quarters ending March 31, 1997, June 30, 1997 and September 30, 1997 and such issuances that did not involve a sale consisting of issuances of common stock and other securities pursuant to employee incentive plans, Alleghany did not sell any Alleghany common stock during 1997 that was not registered under the Securities Act. Item 6. Selected Financial Data. The information required by this Item 6 is incorporated by reference from page 18 of Alleghany's Annual Report to Stockholders for the year 1997, filed as Exhibit 13 hereto. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information required by this Item 7 is incorporated by reference from pages 1 through 4, from pages 6 through 16, and from pages 19 and 21, of Alleghany's Annual Report to Stockholders for the year 1997, filed as Exhibit 13 hereto. Item 8. Financial Statements and Supplementary Data. The information required by this Item 8 is incorporated by reference from pages 22 through 38 of Alleghany's Annual Report to Stockholders for the year 1997, filed as Exhibit 13 hereto. Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. Not applicable. -63- 64 PART III Item 10. Directors and Executive Officers of Registrant. As permitted by General Instruction G(3), information concerning the executive officers of Alleghany is set forth as a supplemental item included in Part I of this Form 10-K Report under the caption "Executive Officers of Registrant." Information concerning the directors of Alleghany is incorporated by reference from pages 5 through 9 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 24, 1998. Information concerning compliance with the reporting requirements under Section 16 of the Securities Exchange Act of 1934, as amended, is incorporated by reference from page 11 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 24, 1998. Item 11. Executive Compensation. The information required by this Item 11 is incorporated by reference from pages 11 through page 19 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 24, 1998. The information set forth beginning with the first full paragraph of page 19 through page 25 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 24, 1998, is not "filed" as a part hereof. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required by this Item 12 is incorporated by reference from pages 2 through 5, and from pages 10 through 11, of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 24, 1998. Item 13. Certain Relationships and Related Transactions. The information required by this Item 13 is incorporated by reference from page 13 of Alleghany's Proxy Statement, filed or to be filed in connection with its Annual Meeting of Stockholders to be held on April 24, 1998. -64- 65 PART IV Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K. (a) 1. Financial Statements. The consolidated financial statements of Alleghany and subsidiaries, together with the report thereon of KPMG Peat Marwick LLP, independent certified public accountants, are incorporated by reference from the Annual Report to Stockholders for the year 1997 into Item 8 of this Report. 2. Financial Statement Schedules. The schedules relating to the consolidated financial statements of Alleghany and subsidiaries, together with the report thereon of KPMG Peat Marwick LLP, independent certified public accountants, are detailed in a separate index herein. 3. Exhibits. The following are filed as exhibits to this Report:
Exhibit Number Description - -------------- ----------- 3.01 Restated Certificate of Incorporation of Alleghany, as amended by Amendment accepted and received for filing by the Secretary of State of the State of Delaware on June 23, 1988, filed as Exhibit 20 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 3.02 By-Laws of Alleghany as amended April 18, 1995, filed as Exhibit 3.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, is incorporated herein by reference. *10.01 Description of Alleghany Management Incentive Plan, filed as Exhibit 10.01 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.
- -------- * Compensatory plan or arrangement. -65- 66 *10.02 Alleghany Corporation Deferred Compensation Plan as amended and restated as of December 15, 1992, filed as Exhibit 10.03 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1992, is incorporated herein by reference. *10.03 Alleghany 1993 Long-Term Incentive Plan, as amended and restated effective as of January 1, 1994, filed as Exhibit 10.06(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. *10.04 Alleghany Supplemental Death Benefit Plan dated as of May 15, 1985 and effective as of January 1, 1985, filed as Exhibit 10.08 to Old Alleghany's Annual Report on Form 10-K for the year ended December 31, 1985, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). *10.05(a) Trust Agreement Amendment made as of July 8, 1994 between Alleghany and Chemical Bank, filed as Exhibit 10.08(a) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. *10.05(b) Alleghany Retirement Plan, as amended and restated on March 14, 1995, filed as Exhibit 10.08(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. *10.05(c) Amendments to Alleghany Retirement Plan, effective as of January 1, 1996, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996, is incorporated herein by reference. *10.05(d) Amendments to Alleghany Retirement Plan, effective as of January 1, 1998.
- -------- * Compensatory plan or arrangement. -66- 67 * 10.06 Alleghany Retirement COLA Plan dated and effective as of January 1, 1992, as adopted on March 17, 1992, filed as Exhibit 10.7 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). *10.07 Description of Alleghany Group Long Term Disability Plan effective as of July 1, 1995, filed as Exhibit 10.10 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. *10.08 Alleghany Amended and Restated Directors' Stock Option Plan effective as of April 20, 1993, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, is incorporated herein by reference. *10.09 Alleghany Directors' Equity Compensation Plan, effective as of January 16, 1995, filed as Exhibit 10.11 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. *10.10 Alleghany Non-Employee Directors' Retirement Plan effective July 1, 1990, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). *10.11(a) Description of compensatory arrangement between Alleghany and Paul F. Woodberry.
- -------- * Compensatory plan or arrangement. -67- 68 *10.11(b) Description of long-term incentive arrangement between Alleghany and Paul F. Woodberry, filed as Exhibit 10.21(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. 10.12 Revolving Credit Loan Agreement dated as of June 14, 1995 among Alleghany and Chemical Bank, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, is incorporated herein by reference. 10.13(a) Stock Purchase Agreement dated as of June 18, 1985 by and among Old Alleghany, Alleghany, Alleghany Capital Corporation and Lincoln National Corporation (the "CT&T Stock Purchase Agreement"), filed as Exhibit (2)(i) to Old Alleghany's Current Report on Form 8-K dated July 11, 1985, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.13(b) List of Contents of Schedules to the CT&T Stock Purchase Agreement, filed as Exhibit (2)(ii) to Old Alleghany's Current Report on Form 8-K dated July 11, 1985, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.13(c) Amendment No. 1 dated December 20, 1985 to the CT&T Stock Purchase Agreement, filed as Exhibit 10.12(c) to Old Alleghany's Annual Report on Form 10-K for the year ended December 31, 1985, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371).
- -------- * Compensatory plan or arrangement. -68- 69 10.14 Distribution Agreement dated as of May 1, 1987 between Alleghany and MSL Industries, Inc., filed as Exhibit 10.21 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1987, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.15 Amendment to Distribution Agreement dated June 29, 1987, effective as of May 1, 1987, between Alleghany and MSL Industries, Inc., filed as Exhibit 10.22 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1987, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.16(a) Stock Purchase Agreement dated as of May 18, 1994 by and between First Interstate Bank of California and Alleghany (the "Sacramento Savings Stock Purchase Agreement"), filed as Exhibit 10.1(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, is incorporated herein by reference. 10.16(b) List of Contents of Exhibits and Schedules to the Sacramento Savings Stock Purchase Agreement, filed as Exhibit 10.1(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, is incorporated herein by reference.
-69- 70 10.17(a) Note Purchase Agreement dated as of January 15, 1995 by and among Alleghany Properties, Inc., Alleghany and Hartford Life Insurance Company Separate Account CRC (the "Alleghany Properties Note Purchase Agreement"), filed as Exhibit 10.28(a) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. Agreements dated as of January 15, 1995 among Alleghany Properties, Inc., Alleghany and each of Transamerica Life Insurance & Annuity Company, Transamerica Occidental Life Insurance Company, United of Omaha Life Insurance Company, Mutual of Omaha Insurance Company, The Lincoln National Life Insurance Company, Knights of Columbus and Woodmen Accident and Life Company are omitted pursuant to Instruction 2 of Item 601 of Regulation S-K. 10.17(b) List of Contents of Annexes and Exhibits to the Alleghany Properties Note Purchase Agreement, filed as Exhibit 10.28(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. 10.17(c) Amendment to Alleghany Properties Note Purchase Agreement dated as of June 23, 1995 among Alleghany, Alleghany Properties, Inc. and the Purchasers listed on Annex 1 to the Alleghany Properties Note Purchase Agreement, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, is incorporated herein by reference. 10.17(d) Amendment No. 2 to Alleghany Properties Note Purchase Agreement dated as of November 6, 1995 among Alleghany, Alleghany Properties, Inc. and the Purchasers listed on Annex 1 to the Alleghany Properties Note Purchase Agreement, filed as Exhibit 10.28(d) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference.
-70- 71 10.18(a) Installment Sales Agreement dated December 8, 1986 by and among Alleghany, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch & Co., Inc., filed as Exhibit 10.10 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1986, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.18(b) Intercreditor and Collateral Agency Agreement dated as of October 20, 1997 among The Chase Manhattan Bank, Barclays Bank PLC and Alleghany Funding Corporation, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.18(c) Master Agreement dated as of October 20, 1997 between Barclays Bank PLC and Alleghany Funding Corporation, and related Amended Confirmation dated October 24, 1997 between Barclays Bank PLC and Alleghany Funding Corporation, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, are incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.18(d) Indenture dated as of October 20, 1997 between Alleghany Funding Corporation and The Chase Manhattan Bank, filed as Exhibit 10.3 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.19(a) Amended and Restated Credit Agreement dated as of December 30, 1993 among CT&T, certain commercial lending institutions and Continental Bank, N.A. as agent, filed as Exhibit 10.28(d) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference.
-71- 72 10.19(b) Letter Agreement dated May 2, 1991 between CT&T and Continental Bank, N.A. relating to an interest rate swap effective May 6, 1991, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.19(c) Letter Agreement dated December 13, 1994 between CT&T and Bank of America Illinois (previously known as Continental Bank) relating to the transfer of Continental Bank's risk management business to Bank of America National Trust and Savings Association, filed as Exhibit 10.31(f) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. 10.20(a) Stock Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville International, B.V. (the "Celite Stock Purchase Agreement"), filed as Exhibit 10.2(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.20(b) List of Contents of Exhibits and Schedules to the Celite Stock Purchase Agreement, filed as Exhibit 10.2(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.21(a) Joint Venture Stock Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville Corporation (the "Celite Joint Venture Stock Purchase Agreement"), filed as Exhibit 10.3(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371).
-72- 73 10.21(b) List of Contents of Exhibits and Schedules to the Celite Joint Venture Stock Purchase Agreement, filed as Exhibit 10.3(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.22(a) Asset Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville Sales Corporation (the "Celite Asset Purchase Agreement"), filed as Exhibit 10.4(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.22(b) List of Contents of Exhibits and Schedules to the Celite Asset Purchase Agreement, filed as Exhibit 10.4(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.22(c) Amendment No. 1 dated as of July 31, 1991 to the Celite Asset Purchase Agreement, filed as Exhibit 10.32(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.23(a) Acquisition Related Agreement dated as of July 1, 1991, by and between Celite Holdings Corporation, Celite Corporation and Manville Corporation (the "Celite Acquisition Related Agreement"), filed as Exhibit 10.5(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371).
-73- 74 10.23(b) List of Contents of Exhibits to the Celite Acquisition Related Agreement, filed as Exhibit 10.5(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.23(c) Amendment dated as of July 31, 1991 to Celite Acquisition Related Agreement, filed as Exhibit 10.33(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.24(a) Amended and Restated Credit Agreement dated as of March 10, 1995 (the "World Minerals Credit Agreement") among Mineral Holdings Inc., World Minerals, the banks named therein, NationsBank, N.A. (Carolinas), Bank of America National Trust and Savings Association and Chemical Bank, filed as Exhibit 10.36(a) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. 10.24(b) List of Contents of Exhibits and Annexes to World Minerals Credit Agreement, filed as Exhibit 10.36(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. 10.24(c) Letter Agreement dated January 23, 1992 between Celite and Bank of America National Trust and Savings Association relating to an interest rate swap effective January 16, 1992, filed as Exhibit 10.37 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371).
-74- 75 10.24(d) Letter Agreement dated January 13, 1992 between Celite and Chemical Bank relating to an interest rate swap effective January 13, 1992, filed as Exhibit 10.38 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.25(a) Stock Purchase Agreement dated as of July 28, 1993 (the "Underwriters Stock Purchase Agreement") among Alleghany, The Continental Corporation, Goldman, Sachs & Co. and certain funds which Goldman, Sachs & Co. either control or of which they are general partner, Underwriters Re Holdings Corp. and Underwriters Re Corporation, filed as Exhibit 10.3(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, is incorporated herein by reference. 10.25(b) List of Contents of Exhibits and Schedules to the Underwriters Stock Purchase Agreement, filed as Exhibit 10.3(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, is incorporated herein by reference. 10.26(a) Credit Agreement dated as of October 23, 1996 among URC Holdings Corp. (now known as Underwriters Re Group, Inc.) the Lenders named therein and The First National Bank of Chicago, as Agent, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, is incorporated herein by reference. 10.26(b) Indenture dated as of June 25, 1996 between URC Holdings Corp. (now known as Underwriters Re Group, Inc.) and The First National Bank of Chicago, as trustee, relating to the 7-7/8% Senior Notes due 2006, filed as Exhibit 10.30(j) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1996, is incorporated herein by reference.
-75- 76 10.27(a) Agreement and Plan of Merger dated as of August 31, 1995, among Credit Data Reporting Services, Inc., Credit Data of Hudson Valley Inc., The Juhl Corporation (collectively, the "Companies"), Alleghany Acquisition Corporation, Alleghany and each of the shareholders of the Companies (the "Credit Data Merger Agreement"), filed as Exhibit 2.1 to Alleghany's Registration Statement on Form S-3 (Registration No. 33-62477), is incorporated herein by reference. 10.27(b) List of Contents of Exhibits to the Credit Data Merger Agreement, filed as Exhibit 2.2 to Alleghany's Registration Statement on Form S-3 (Registration No. 33-62477), is incorporated herein by reference. 10.28(a) Agreement and Plan of Merger, dated as of July 1, 1996, among Market Intelligence, Inc. ("Market Intelligence"), Alleghany Acquisition Corporation, Alleghany and each of the shareholders of Market Intelligence (the "Market Intelligence Merger Agreement"), filed as Exhibit 2.1 to Alleghany's Registration Statement on Form S-3 (Registration No. 333-9881), is incorporated herein by reference. 10.28(b) List of Contents of Exhibits to the Market Intelligence Merger Agreement, filed as Exhibit 2.2 to Alleghany's Registration Statement on Form S-3 (Registration No. 333-9881), is incorporated herein by reference. 10.29(a) Agreement and Plan of Merger dated as of August 22, 1996 among Chicago Title of Colorado, Inc. ("CT of Colorado"), Alleghany Acquisition Corporation, Alleghany and each of the shareholders of CT of Colorado (the "CT of Colorado Merger Agreement"), filed as Exhibit 2.1 to Alleghany's Registration Statement on Form S-3 (Registration No. 333-13971), is incorporated herein by reference.
-76- 77 10.29(b) List of Contents of Exhibits to the CT of Colorado Merger Agreement, filed as Exhibit 2.2 to Alleghany's Registration Statement on Form S-3 (Registration No. 333-13971), is incorporated herein by reference. 13 Pages 1 through 4, pages 6 through 16, and pages 18 through 38 of the Annual Report to Stockholders of Alleghany for the year 1997. 21 List of subsidiaries of Alleghany. 23 Consent of KPMG Peat Marwick LLP, independent certified public accountants, to the incorporation by reference of their reports relating to the financial statements and related schedules of Alleghany and subsidiaries in Alleghany's Registration Statements on Form S-8 (Registration No. 33-27598), Form S-8 (Registration No. 333-323), Form S-3 (Registration No. 33-55707), Form S-3 (Registration No. 33-62477), Form S-3 (Registration No. 333-9981), Form S-3 (Registration No. 333-13971) and Form S-8 (Registration No. 333-37237). 27 Financial Data Schedule.
(b) Reports on Form 8-K. Alleghany filed a report on Form 8-K dated December 17, 1997, to report in Item 5 that Alleghany issued a press release announcing the spin-off of the title insurance and real estate-related services businesses conducted by CT&T. -77- 78 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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. ALLEGHANY CORPORATION (Registrant) Date: March 17, 1998 By /s/ John J. Burns, Jr. -------------- ---------------------- John J. Burns, Jr. President Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Date: March 17, 1998 By /s/ John J. Burns, Jr. -------------- ------------------------------ John J. Burns, Jr. President and Director (principal executive officer) Date: March 17, 1998 By /s/ Dan R. Carmichael -------------- ------------------------------ Dan R. Carmichael Director Date: March 17, 1998 By /s/ David B. Cuming -------------- ------------------------------ David B. Cuming Senior Vice President (principal financial officer) Date: March 17, 1998 By /s/ Thomas S. Johnson -------------- ------------------------------ Thomas S. Johnson Director Date: March 17, 1998 By /s/ Allan P. Kirby, Jr. -------------- ------------------------------ Allan P. Kirby, Jr. Director -78- 79 Date: March 17, 1998 By /s/ F.M. Kirby -------------- ------------------------------ F.M. Kirby Chairman of the Board and Director Date: March 17, 1998 By /s/ William K. Lavin -------------- ------------------------------ William K. Lavin Director Date: March 17, 1998 By /s/ Roger Noall -------------- ------------------------------ Roger Noall Director Date: March 17, 1998 By /s/ Peter R. Sismondo -------------- ------------------------------ Peter R. Sismondo Vice President, Controller, Treasurer and Assistant Secretary (principal accounting officer) Date: March 17, 1998 By /s/ James F. Will -------------- ------------------------------ James F. Will Director Date: March 17, 1998 By /s/ Paul F. Woodberry -------------- ------------------------------ Paul F. Woodberry Director -79- 80 ALLEGHANY CORPORATION AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENT SCHEDULES I SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES II CONDENSED FINANCIAL INFORMATION OF REGISTRANT III SUPPLEMENTARY INSURANCE INFORMATION IV REINSURANCE VI SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULES All other schedules are omitted since they are not required, are not applicable, or the required information is set forth in the financial statements or notes thereto. 81 SCHEDULE I ALLEGHANY CORPORATION AND SUBSIDIARIES SUMMARY OF INVESTMENTS -- OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1997 (in thousands)
Amount at which Fair shown in the Type of Investment Cost Value Balance Sheet ==================================================================================================================== Fixed maturities: Bonds: United States Government and government agencies and authorities $ 326,460 $ 333,866 $ 333,866 States, municipalities and political subdivisions 360,916 368,981 368,981 Foreign governments 19,264 19,337 19,337 Public utilities 3,125 3,196 3,196 All other corporate bonds 367,685 372,696 372,696 Certificates of deposit 2,500 2,500 2,500 Redeemable preferred stock 33,917 34,956 34,956 -------------- --------------- ------------ Fixed maturities 1,113,867 $ 1,135,532 1,135,532 -------------- =============== ------------ Equity securities: Common stocks: Banks, trust, and insurance companies 16,000 $ 16,000 16,000 Industrial, miscellaneous, and all other 323,888 767,433 767,433 -------------- --------------- ------------ Total equity securities 339,888 $ 783,433 783,433 -------------- =============== ------------ Other long-term investments 28,058 28,878 Short-term investments 113,156 113,156 -------------- ------------ Total investments $ 1,594,969 $ 2,060,999 ============== ============
82 SCHEDULE II ALLEGHANY CORPORATION CONDENSED BALANCE SHEETS DECEMBER 31, 1997 AND 1996 (in thousands)
1997 1996 ------------------------ ASSETS Investment securities (Cost: 1997 $218,307; 1996 $209,943) $ 499,502 $ 452,495 Cash 0 1,855 Accounts and other receivables, less allowances 20,560 18,158 Property and equipment - at cost, less accumulated depreciation 3,049 2,440 Other assets 32,118 29,378 Investment in CT&T (discontinued operations) 385,451 344,820 Investment in consolidated subsidiaries 865,131 788,679 ------------------------ $1,805,811 $1,637,825 ======================== LIABILITIES AND COMMON STOCKHOLDERS' EQUITY Other liabilities $ 76,896 $ 78,043 Net deferred tax liability 122,857 117,399 Long-term debt 35,123 19,123 ------------------------ Total liabilities 234,876 214,565 Commitments and contingent liabilities Common stockholders' equity 1,570,935 1,423,260 ------------------------ $1,805,811 $1,637,825 ========================
See accompanying Notes to Condensed Financial Statements. 83 SCHEDULE II ALLEGHANY CORPORATION CONDENSED STATEMENTS OF EARNINGS THREE YEARS ENDED DECEMBER 31, 1997 (in thousands)
1997 1996 1995 ---------------------------------- Revenues: Interest, dividend and other income $ 61,362 $ 58,647 $59,967 Net (loss) gain on investment transactions (11,280) 801 37,836 ---------------------------------- Total revenues 50,082 59,448 97,803 ---------------------------------- Costs and Expenses: Interest expense 4,466 3,444 5,832 General and administrative 73,908 67,192 69,694 ---------------------------------- Total costs and expenses 78,374 70,636 75,526 ---------------------------------- Operating (loss) income (28,292) (11,188) 22,277 Equity in earnings of consolidated subsidiaries 93,522 68,578 61,976 ---------------------------------- Earnings from continuing operations, before income taxes 65,230 57,390 84,253 Income taxes 13,830 16,920 23,887 ---------------------------------- Earnings from continuing operations 51,400 40,470 60,366 Earnings from discontinued operations, net of tax 54,267 46,578 24,934 ---------------------------------- Net earnings $ 105,667 $ 87,048 $85,300 ==================================
See accompanying Notes to Condensed Financial Statements. 84 SCHEDULE II ALLEGHANY CORPORATION CONDENSED STATEMENTS OF CASH FLOWS THREE YEARS ENDED DECEMBER 31, 1997 (in thousands)
1997 1996 1995 ------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES Earnings from continuing operations $ 51,400 $ 40,470 $ 60,366 Adjustments to reconcile earnings from continuing operations to cash provided by (used in) continuing operations: Depreciation and amortization 501 463 539 Net loss (gain) loss on investment transactions 11,280 (801) (37,836) (Increase) decrease in accounts and other receivables, less allowances (2,402) 884 (1,852) Decrease (increase) in other assets (2,874) 3,554 (2,973) (Decrease) increase in other liabilities (7,375) (12,268) 20,638 Other operating, net 1,226 (1,625) 2,644 Equity in undistributed net earnings of consolidated subsidiaries (64,007) (46,731) (44,925) ------------------------------------ Net adjustments (63,651) (56,524) (63,765) ------------------------------------ Cash used in continuing operations (12,251) (16,054) (3,399) ------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments (250,930) (7,502) (92,005) Sales of investments 226,032 6,469 124,110 Capital contributions to consolidated subsidiaries (1,171) (446) (33,700) Cash dividends from consolidated subsidiaries 14,362 4,441 43,903 Purchase of property and equipment (976) (333) (354) Disposition of property and equipment 0 18 1 ------------------------------------ Net cash provided by investing activities (12,683) 2,647 41,955 ------------------------------------ CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on long-term debt 0 (35,000) (129,600) Proceeds of long-term debt 16,000 35,000 70,000 Cash provided by discontinued operations 18,805 30,000 25,313 Other, net (11,726) (15,570) (4,932) ------------------------------------ Net cash provided by (used in) financing activities 23,079 14,430 (39,219) ------------------------------------ Net (decrease) increase in cash (1,855) 1,023 (663) Cash at beginning of year 1,855 832 1,495 ------------------------------------ CASH AT END OF YEAR $ 0 $ 1,855 $ 832 ==================================== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest $ 4,869 $ 3,443 $ 5,982 Income taxes $ 34,100 $ 54,822 $ 11,979
Supplemental disclosure of noncash investing and financing activities: In 1996, Alleghany made a noncash capital contribution to its consolidated subsidiaries by contributing two newly-acquired companies with a combined cost basis of $994. In 1995, Alleghany made a noncash capital contribution to its consolidated subsidiaries by contributing a newly-acquired company with a cost basis of $4,480. See accompanying Notes to Condensed Financial Statements. 85 SCHEDULE II ALLEGHANY CORPORATION NOTES TO CONDENSED FINANCIAL STATEMENTS (in thousands) 1. INVESTMENT IN CONSOLIDATED SUBSIDIARIES. Reference is made to Note 2 of the Notes to Consolidated Financial Statements incorporated herein by reference for information regarding the spin-off of Chicago Title and Trust. 2. LONG-TERM DEBT. Reference is made to Note 6 of the Notes to Consolidated Financial Statements incorporated herein by reference for information regarding the significant provisions of the revolving credit loan agreement of Alleghany. Included in long-term debt in the accompanying condensed balance sheets is $19,123 in 1997 and 1996 of intercompany notes payable due to Alleghany Funding. 3. INCOME TAXES. Reference is made to Note 7 of the Notes to Consolidated Financial Statements incorporated herein by reference. 4. COMMITMENTS AND CONTINGENCIES. Reference is made to Note 12 of the Notes to Consolidated Financial Statements incorporated herein by reference. 5. STOCKHOLDERS' EQUITY. Reference is made to Note 8 of the Notes to Consolidated Financial Statements incorporated herein by reference with respect to stockholders' equity and surplus available for dividend payments to Alleghany from its subsidiaries. 86 SCHEDULE III ALLEGHANY CORPORATION AND SUBSIDIARIES SUPPLEMENTARY INSURANCE INFORMATION (in thousands)
AT DECEMBER 31 ------------------------------------------- FUTURE POLICY OTHER BENEFITS, POLICY DEFERRED LOSSES, CLAIMS POLICY CLAIMS AND ACQUISITION AND LOSS UNEARNED BENEFITS YEAR SEGMENT COST EXPENSES PREMIUMS PAYABLE - ------ ------------ ------------------------------------------- 1997 Property and casualty reinsurance $29,644 $1,159,070 $136,288 $0 =========================================== 1996 Property and casualty reinsurance $20,771 $1,110,020 $ 95,472 $0 =========================================== 1995 Property and casualty reinsurance $16,951 $1,014,000 $ 74,561 $0 ===========================================
FOR THE YEAR ENDED DECEMBER 31 ------------------------------------------------------------------- BENEFITS, CLAIMS, AMORTIZATION LOSSES OF DEFERRED NET AND POLICY OTHER PREMIUM INVESTMENT SETTLEMENT ACQUISITION OPERATING PREMIUMS YEAR SEGMENT REVENUE INCOME EXPENSES COSTS EXPENSES WRITTEN - ------ ------------ ------------------------------------------------------------------- 1997 Property and casualty reinsurance $376,672 $75,531 $261,828 $94,444 $51,769 $414,191 =================================================================== 1996 Property and casualty reinsurance $346,777 $63,184 $243,725 $88,895 $40,373 $360,305 =================================================================== 1995 Property and casualty reinsurance $277,507 $50,173 $203,108 $63,617 $29,833 $291,995 ===================================================================
87 SCHEDULE IV ALLEGHANY CORPORATION AND SUBSIDIARIES REINSURANCE THREE YEARS ENDED DECEMBER 31, 1997 (in thousands)
PERCENTAGE CEDED TO ASSUMED OF AMOUNT GROSS OTHER FROM OTHER NET ASSUMED YEAR SEGMENT AMOUNT COMPANIES COMPANIES AMOUNT TO NET - ------ ---------------------- ------------------------------------------------------ 1997 Property and casualty reinsurance premiums $112,158 $88,416 $352,930 $376,672 94% ====================================================== 1996 Property and casualty reinsurance premiums $ 85,437 $65,968 $327,308 $346,777 94.39% ====================================================== 1995 Property and casualty reinsurance premiums $ 42,413 $85,234 $320,328 $277,507 115.43% ======================================================
88 SCHEDULE VI ALLEGHANY CORPORATION AND SUBSIDIARIES SUPPLEMENTAL INFORMATION CONCERNING PROPERTY-CASUALTY INSURANCE OPERATIONS (in thousands)
DISCOUNT, IF ANY, RESERVES DEDUCTED CLAIMS AND CLAIM FOR IN RESERVES ADJUSTMENT EXPENSES UNPAID FOR UNPAID INCURRED RELATED TO DEFERRED CLAIMS CLAIMS ------------------- AFFILIATION POLICY AND CLAIM AND CLAIM NET (1) (2) WITH ACQUISITION ADJUSTMENT ADJUSTMENT UNEARNED EARNED INVESTMENT CURRENT PRIOR REGISTRANT COST EXPENSES EXPENSES PREMIUMS PREMIUMS INCOME YEAR YEAR - ------------ ----------------------------------------------------------------------------------------- 1997 Consolidated property- casualty entities $29,644 $1,159,070 $0 $136,288 $376,672 $75,531 267,530 ($5,702) ========================================================================================= 1996 Consolidated property- casualty entities $20,771 $1,110,020 $0 $ 95,472 $346,777 $63,184 242,332 $1,393 ========================================================================================= 1995 Consolidated property- casualty entities $16,951 $1,014,000 $0 $ 74,561 $277,507 $50,173 199,783 $3,325 =========================================================================================
AMORTIZATION OF DEFERRED PAID CLAIMS AFFILIATION POLICY AND CLAIM WITH ACQUISITION ADJUSTMENT PREMIUMS REGISTRANT COSTS EXPENSES WRITTEN - ------------ ----------------------------------- 1997 Consolidated property- casualty entities $94,444 $210,015 $414,191 =================================== 1996 Consolidated property- casualty entities $88,895 $139,689 $360,305 =================================== 1995 Consolidated property- casualty entities $63,617 $111,005 $291,995 ===================================
89 INDEPENDENT AUDITORS' REPORT The Board of Directors and Stockholders Alleghany Corporation: Under date of February 20, 1998, we reported on the consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 1997 and 1996 and the related consolidated statements of earnings, changes in stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997 as contained in the 1997 annual report to stockholders. These consolidated financial statements and our report thereon are incorporated by reference in the Annual Report on Form 10-K for the year 1997. In connection with our audits of the aforementioned consolidated financial statements, we also have audited the related financial statements schedules as listed in the accompanying index. These financial statements schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements schedules based on our audits. In our opinion, such financial statements schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein. /s/ KPMG Peat Marwick LLP -------------------------------------- KPMG Peat Marwick LLP New York, New York February 20, 1998 90 EXHIBIT INDEX Exhibit Number Description 3.01 Restated Certificate of Incorporation of Alleghany, as amended by Amendment accepted and received for filing by the Secretary of State of the State of Delaware on June 23, 1988, filed as Exhibit 20 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1988, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 3.02 By-Laws of Alleghany as amended April 18, 1995, filed as Exhibit 3.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 1995, is incorporated herein by reference. *10.01 Description of Alleghany Management Incentive Plan, filed as Exhibit 10.01 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference. *10.02 Alleghany Corporation Deferred Compensation Plan as amended and restated as of December 15, 1992, filed as Exhibit 10.03 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1992, is incorporated herein by reference. *10.03 Alleghany 1993 Long-Term Incentive Plan, as amended and restated effective as of January 1, 1994, filed as Exhibit 10.06(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. * Compensatory plan or arrangement. 91 *10.04 Alleghany Supplemental Death Benefit Plan dated as of May 15, 1985 and effective as of January 1, 1985, filed as Exhibit 10.08 to Old Alleghany's Annual Report on Form 10-K for the year ended December 31, 1985, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). *10.05(a) Trust Agreement Amendment made as of July 8, 1994 between Alleghany and Chemical Bank, filed as Exhibit 10.08(a) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. *10.05(b) Alleghany Retirement Plan, as amended and restated on March 14, 1995, filed as Exhibit 10.08(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. *10.05(c) Amendments to Alleghany Retirement Plan, effective as of January 1, 1996, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 1996, is incorporated herein by reference. *10.05(d) Amendments to Alleghany Retirement Plan, effective as of January 1, 1998. *10.06 Alleghany Retirement COLA Plan dated and effective as of January 1, 1992, as adopted on March 17, 1992, filed as Exhibit 10.7 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). *10.07 Description of Alleghany Group Long Term Disability Plan effective as of July 1, 1995, filed as Exhibit 10.10 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. * Compensatory plan or arrangement. 92 *10.08 Alleghany Amended and Restated Directors' Stock Option Plan effective as of April 20, 1993, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, is incorporated herein by reference. *10.09 Alleghany Directors' Equity Compensation Plan, effective as of January 16, 1995, filed as Exhibit 10.11 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. *10.10 Alleghany Non-Employee Directors' Retirement Plan effective July 1, 1990, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1990, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). *10.11(a) Description of compensatory arrangement between Alleghany and Paul F. Woodberry. *10.11(b) Description of long-term incentive arrangement between Alleghany and Paul F. Woodberry, filed as Exhibit 10.21(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. 10.12 Revolving Credit Loan Agreement dated as of June 14, 1995 among Alleghany and Chemical Bank, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1995, is incorporated herein by reference. * Compensatory plan or arrangement. 93 10.13(a) Stock Purchase Agreement dated as of June 18, 1985 by and among Old Alleghany, Alleghany, Alleghany Capital Corporation and Lincoln National Corporation (the "CT&T Stock Purchase Agreement"), filed as Exhibit (2)(i) to Old Alleghany's Current Report on Form 8-K dated July 11, 1985, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.13(b) List of Contents of Schedules to the CT&T Stock Purchase Agreement, filed as Exhibit (2)(ii) to Old Alleghany's Current Report on Form 8-K dated July 11, 1985, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.13(c) Amendment No. 1 dated December 20, 1985 to the CT&T Stock Purchase Agreement, filed as Exhibit 10.12(c) to Old Alleghany's Annual Report on Form 10-K for the year ended December 31, 1985, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.14 Distribution Agreement dated as of May 1, 1987 between Alleghany and MSL Industries, Inc., filed as Exhibit 10.21 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1987, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.15 Amendment to Distribution Agreement dated June 29, 1987, effective as of May 1, 1987, between Alleghany and MSL Industries, Inc., filed as Exhibit 10.22 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1987, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.16(a) Stock Purchase Agreement dated as of May 18, 1994 by and between First Interstate Bank of California and Alleghany (the "Sacramento Savings Stock Purchase Agreement"), filed as Exhibit 10.1(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, is incorporated herein by reference. 94 10.16(b) List of Contents of Exhibits and Schedules to the Sacramento Savings Stock Purchase Agreement, filed as Exhibit 10.1(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1994, is incorporated herein by reference. 10.17(a) Note Purchase Agreement dated as of January 15, 1995 by and among Alleghany Properties, Inc., Alleghany and Hartford Life Insurance Company Separate Account CRC (the "Alleghany Properties Note Purchase Agreement"), filed as Exhibit 10.28(a) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. Agreements dated as of January 15, 1995 among Alleghany Properties, Inc., Alleghany and each of Transamerica Life Insurance & Annuity Company, Transamerica Occidental Life Insurance Company, United of Omaha Life Insurance Company, Mutual of Omaha Insurance Company, The Lincoln National Life Insurance Company, Knights of Columbus and Woodmen Accident and Life Company are omitted pursuant to Instruction 2 of Item 601 of Regulation S-K. 10.17(b) List of Contents of Annexes and Exhibits to the Alleghany Properties Note Purchase Agreement, filed as Exhibit 10.28(b) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. 10.17(c) Amendment to Alleghany Properties Note Purchase Agreement dated as of June 23, 1995 among Alleghany, Alleghany Properties, Inc. and the Purchasers listed on Annex 1 to the Alleghany Properties Note Purchase Agreement, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1995, is incorporated herein by reference. 95 10.17(d) Amendment No. 2 to Alleghany Properties Note Purchase Agreement dated as of November 6, 1995 among Alleghany, Alleghany Properties, Inc. and the Purchasers listed on Annex 1 to the Alleghany Properties Note Purchase Agreement, filed as Exhibit 10.28(d) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. 10.18(a) Installment Sales Agreement dated December 8, 1986 by and among Alleghany, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Merrill Lynch & Co., Inc., filed as Exhibit 10.10 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1986, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.18(b) Intercreditor and Collateral Agency Agreement dated as of October 20, 1997 among The Chase Manhattan Bank, Barclays Bank PLC and Alleghany Funding Corporation, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.18(c) Master Agreement dated as of October 20, 1997 between Barclays Bank PLC and Alleghany Funding Corporation, and related Amended Confirmation dated October 24, 1997 between Barclays Bank PLC and Alleghany Funding Corporation, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, are incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.18(d) Indenture dated as of October 20, 1997 between Alleghany Funding Corporation and The Chase Manhattan Bank, filed as Exhibit 10.3 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 96 10.19(a) Amended and Restated Credit Agreement dated as of December 30, 1993 among CT&T, certain commercial lending institutions and Continental Bank, N.A. as agent, filed as Exhibit 10.28(d) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1993, is incorporated herein by reference. 10.19(b) Letter Agreement dated May 2, 1991 between CT&T and Continental Bank, N.A. relating to an interest rate swap effective May 6, 1991, filed as Exhibit 10.2 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended March 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.19(c) Letter Agreement dated December 13, 1994 between CT&T and Bank of America Illinois (previously known as Continental Bank) relating to the transfer of Continental Bank's risk management business to Bank of America National Trust and Savings Association, filed as Exhibit 10.31(f) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1994, is incorporated herein by reference. 10.20(a) Stock Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville International, B.V. (the "Celite Stock Purchase Agreement"), filed as Exhibit 10.2(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.20(b) List of Contents of Exhibits and Schedules to the Celite Stock Purchase Agreement, filed as Exhibit 10.2(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 97 10.21(a) Joint Venture Stock Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville Corporation (the "Celite Joint Venture Stock Purchase Agreement"), filed as Exhibit 10.3(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.21(b) List of Contents of Exhibits and Schedules to the Celite Joint Venture Stock Purchase Agreement, filed as Exhibit 10.3(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.22(a) Asset Purchase Agreement dated as of July 1, 1991 among Celite Holdings Corporation, Celite Corporation and Manville Sales Corporation (the "Celite Asset Purchase Agreement"), filed as Exhibit 10.4(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.22(b) List of Contents of Exhibits and Schedules to the Celite Asset Purchase Agreement, filed as Exhibit 10.4(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.22(c) Amendment No. 1 dated as of July 31, 1991 to the Celite Asset Purchase Agreement, filed as Exhibit 10.32(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 98 10.23(a) Acquisition Related Agreement dated as of July 1, 1991, by and between Celite Holdings Corporation, Celite Corporation and Manville Corporation (the "Celite Acquisition Related Agreement"), filed as Exhibit 10.5(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.23(b) List of Contents of Exhibits to the Celite Acquisition Related Agreement, filed as Exhibit 10.5(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.23(c) Amendment dated as of July 31, 1991 to Celite Acquisition Related Agreement, filed as Exhibit 10.33(c) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.24(a) Amended and Restated Credit Agreement dated as of March 10, 1995 (the "World Minerals Credit Agreement") among Mineral Holdings Inc., World Minerals, the banks named therein, NationsBank, N.A. (Carolinas), Bank of America National Trust and Savings Association and Chemical Bank, filed as Exhibit 10.36(a) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. 10.24(b) List of Contents of Exhibits and Annexes to World Minerals Credit Agreement, filed as Exhibit 10.36(b) to Allegheny's Annual Report on Form 10-K for the year ended December 31, 1995, is incorporated herein by reference. 99 10.24(c) Letter Agreement dated January 23, 1992 between Celite and Bank of America National Trust and Savings Association relating to an interest rate swap effective January 16, 1992, filed as Exhibit 10.37 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.24(d) Letter Agreement dated January 13, 1992 between Celite and Chemical Bank relating to an interest rate swap effective January 13, 1992, filed as Exhibit 10.38 to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1991, is incorporated herein by reference (Securities and Exchange Commission File No. 1-9371). 10.25(a) Stock Purchase Agreement dated as of July 28, 1993 (the "Underwriters Stock Purchase Agreement") among Alleghany, The Continental Corporation, Goldman, Sachs & Co. and certain funds which Goldman, Sachs & Co. either control or of which they are general partner, Underwriters Re Holdings Corp. and Underwriters Re Corporation, filed as Exhibit 10.3(a) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, is incorporated herein by reference. 10.25(b) List of Contents of Exhibits and Schedules to the Underwriters Stock Purchase Agreement, filed as Exhibit 10.3(b) to Alleghany's Quarterly Report on Form 10-Q for the quarter ended June 30, 1993, is incorporated herein by reference. 10.26(a) Credit Agreement dated as of October 23, 1996 among URC Holdings Corp. (now known as Underwriters Re Group, Inc.) the Lenders named therein and The First National Bank of Chicago, as Agent, filed as Exhibit 10.1 to Alleghany's Quarterly Report on Form 10-Q for the quarter ended September 30, 1996, is incorporated herein by reference. 100 10.26(b) Indenture dated as of June 25, 1996 between URC Holdings Corp. (now known as Underwriters Re Group, Inc.) and The First National Bank of Chicago, as trustee, relating to the 7-7/8% Senior Notes due 2006, filed as Exhibit 10.30(j) to Alleghany's Annual Report on Form 10-K for the year ended December 31, 1996, is incorporated herein by reference. 10.27(a) Agreement and Plan of Merger dated as of August 31, 1995, among Credit Data Reporting Services, Inc., Credit Data of Hudson Valley Inc., The Juhl Corporation (collectively, the "Companies"), Alleghany Acquisition Corporation, Alleghany and each of the shareholders of the Companies (the "Credit Data Merger Agreement"), filed as Exhibit 2.1 to Alleghany's Registration Statement on Form S-3 (Registration No. 33-62477), is incorporated herein by reference. 10.27(b) List of Contents of Exhibits to the Credit Data Merger Agreement, filed as Exhibit 2.2 to Alleghany's Registration Statement on Form S-3 (Registration No. 33-62477), is incorporated herein by reference. 10.28(a) Agreement and Plan of Merger, dated as of July 1, 1996, among Market Intelligence, Inc. ("Market Intelligence"), Alleghany Acquisition Corporation, Alleghany and each of the shareholders of Market Intelligence (the "Market Intelligence Merger Agreement"), filed as Exhibit 2.1 to Alleghany's Registration Statement on Form S-3 (Registration No. 333-9881), is incorporated herein by reference. 10.28(b) List of Contents of Exhibits to the Market Intelligence Merger Agreement, filed as Exhibit 2.2 to Alleghany's Registration Statement on Form S-3 (Registration No. 333-9881), is incorporated herein by reference. 101 10.29(a) Agreement and Plan of Merger dated as of August 22, 1996 among Chicago Title of Colorado, Inc. ("CT of Colorado"), Alleghany Acquisition Corporation, Alleghany and each of the shareholders of CT of Colorado (the "CT of Colorado Merger Agreement"), filed as Exhibit 2.1 to Alleghany's Registration Statement on Form S-3 (Registration No. 333-13971), is incorporated herein by reference. 10.29(b) List of Contents of Exhibits to the CT of Colorado Merger Agreement, filed as Exhibit 2.2 to Alleghany's Registration Statement on Form S-3 (Registration No. 333-13971), is incorporated herein by reference. 13 Pages 1 through 4, pages 6 through 16, and pages 18 through 38 of the Annual Report to Stockholders of Alleghany for the year 1997. 21 List of subsidiaries of Alleghany. 23 Consent of KPMG Peat Marwick LLP, independent certified public accountants, to the incorporation by reference of their reports relating to the financial statements and related schedules of Alleghany and subsidiaries in Alleghany's Registration Statements on Form S-8 (Registration No. 33-27598), Form S-8 (Registration No. 333-323), Form S-8 (Registration No. 333-37237), Form S-3 (Registration No. 33-55707), Form S-3 (Registration No. 33-62477), Form S-3 (Registration No. 333-9981), and Form S-3 (Registration No. 333-13971). 27 Financial Data Schedule. EX-10.05.D 2 AMENDMENTS TO ALLEGHANY RETIREMENT PLAN 1 Exhibit 10.05(d) AMENDMENTS TO THE ALLEGHANY CORPORATION RETIREMENT PLAN The Alleghany Corporation Retirement Plan (the "Plan") is amended effective January 1, 1998, as follows: 1. Article I of the Plan is amended by revising Section 1.03, "Average Salary," to read in its entirety as follows: 1.03. "Average Salary" means the sum of (i) the average of a Participant's Base Compensation for the three consecutive calendar years of the ten calendar years ending with the calendar year in which occurs his date of death or other separation from service which results in the highest average annual Base Compensation for any such three year period and (ii) one-half (1/2) of the average of a Participant's Incentive Compensation for the five consecutive calendar years of the ten calendar years ending with the calendar year in which occurs his date of death or other separation from service which results in the highest average annual Incentive Compensation for any such five year period. If at such a date a Participant has less than three years of service or five years of service, as the case may be, then his Average Salary shall be computed using the average of his Base Compensation or one-half of the average of his Incentive Compensation, respectively, for all such full calendar years of service, or if he has no full calendar year of service, then for all such service. 2. Article I of the Plan is amended by the addition of a section denominated Section 1.35, "Incentive Compensation," which reads as follows: 2 1.35. Incentive Compensation means the amount of the cash bonus payable to an Employee in respect of the relevant period (whether or not such amount is currently paid or deferred) under the Company's Management Incentive Plan (or any plan adopted by the Board in replacement of such plan). An Employee who becomes Totally Disabled shall be considered as earning Incentive Compensation for each calendar year (or fraction thereof) he is Totally Disabled equal to his average annual rate of Incentive Compensation on the date he first became Totally Disabled. An Employee's average annual rate of Incentive Compensation for this purpose shall mean the average of the Incentive Compensation payable to the Employee in respect of the five consecutive calendar years of the ten calendar years (or the period during which he was employed, if less) immediately preceding the date he first became Totally Disabled which results in the highest average annual Incentive Compensation for any such five year period. Such average annual rate of Incentive Compensation shall be adjusted for each calendar year thereafter in which the Employee remains Totally Disabled to take into account the percentage increase, if any, in the CPIU (as defined in Section 1.09) over the applicable period. 3. Article I of the Plan is amended by changing the word "Compensation" appearing in Section 1.09 to the words "Base Compensation," and by replacing all subsequent references in the Plan to the word "Compensation" with the words "Base Compensation." EX-10.11.A 3 DESCRIPTION OF COMPENSATORY ARRANGEMENT 1 Exhibit 10.11(a) DESCRIPTION OF COMPENSATORY ARRANGEMENT BETWEEN ALLEGHANY CORPORATION AND PAUL F. WOODBERRY Effective January 1, 1998, Mr. Woodberry receives $340,000 per year from Alleghany for consulting services relating to (i) possible investments and acquisitions which may be made by Alleghany and/or its subsidiaries and (ii) the management of the real estate and real estate-related assets of Alleghany's subsidiaries Alleghany Properties, Inc. and Sacramento Properties Holdings, Inc. Prior thereto, Mr. Woodberry received $290,000 per year from Alleghany. EX-13 4 CERTAIN PAGES OF THE ANNUAL REPORT TO STOCKHOLDERS 1 Exhibit 13 TO OUR STOCKHOLDERS 1997 was a successful year for Alleghany Corporation. Our net earnings were $105.7 million, or $14.50 per share, in 1997 compared with $87.0 million, or $11.82 per share, in 1996. Financial highlights of both years are summarized in the first table on page 5 of this report. All of our operating units reported increased earnings over the prior year. Chicago Title and Trust Company, Alleghany Asset Management, Inc., Underwriters Re Group, Inc. and World Minerals Inc. experienced record earnings. Of particular significance to our stockholders, on December 17, 1997, we announced our intention to establish the title insurance and real estate-related services business now conducted by CT&T as an independent, publicly traded company. This is to be accomplished by a spin-off to Alleghany stockholders of shares of a newly formed holding company for CT&T to be called Chicago Title Corporation. The spin-off, which is expected to occur in the second quarter of 1998, is subject to receipt of an IRS ruling to the effect that the spin-off will not be taxable. The common stock of the new Chicago Title Corporation is expected to be listed on the New York Stock Exchange. The financial services business conducted through Alleghany Asset Management, currently a subsidiary of CT&T, will not be part of the distribution and will remain with Alleghany. The title insurance industry is undergoing a period of consolidation and rapid change. We believe that establishing CT&T as an independent company will enhance its ability to focus on operating efficiencies and strategic initiatives that are required to respond to a changing marketplace. Moreover, in the current competitive environment, it is more important than ever to foster development of an entrepreneurial culture at CT&T. As an independent public company, CT&T will be able to provide equity-based compensation and incentives that should enable it to retain and recruit senior management and motivate employees throughout the organization. After the distribution, the new Chicago Title Corporation will continue under its current management. In light of the proposed spin-off of CT&T, Alleghany is required to classify the operation to be spun-off as a "discontinued operation." Accordingly, our financial statements will report the results of such business as a single net number. More detailed information on CT&T's results is included in Note 2 to the Consolidated Financial Statements. CT&T (excluding Alleghany Asset Management) contributed net earnings of $54.3 million, representing a 16.5 percent increase from 1996's net earnings contribution of $46.5 million. The improved results reflect exceptionally strong activity in commercial real estate markets and an increase in residential purchase and refinancings in the second half of 1997. In 1997, CT&T undertook a major analysis of its operations, resulting in a realignment of its strategy, to focus on three distinct markets: core local business requiring flexibility and respon- [GRAPH -- SEE EDGAR APPENDIX]
Year-End Closing Stock Prices* (in dollars) 1988 59.40 1989 78.10 1990 74.11 1991 98.56 1992 121.14 1993 132.57 1994 143.23 1995 190.32 1996 207.84 1997 284.75
*Adjusted for 2% stock dividends 1 2 siveness, institutional residential lenders requiring efficient title production centers that can handle high-volume orders at competitive prices, and commercial and industrial businesses requiring nationwide service. Execution of the new strategy will be a high priority of the new Chicago Title Corporation in 1998. Alleghany Asset Management and its subsidiaries, The Chicago Trust Company, Montag & Caldwell, Inc. and Chicago Deferred Exchange Corporation, contributed pre-tax earnings of $19.8 million in 1997, an increase of 104 percent over 1996. The improved results of Alleghany Asset Management primarily are due to an increase in assets under management, largely at Montag & Caldwell reflecting the strong performance record of Montag & Caldwell in managing equity investments. Assets under management at year-end 1997 totalled $23.1 billion, compared with $14.5 billion at year-end 1996. Underwriters Re Group, Inc. contributed pre-tax earnings of $44.4 million in 1997, a 20 percent increase over its 1996 pre-tax earnings, reflecting increased business, including a 15 percent, or $53.9 million, increase in net written premiums over 1996 along with a corresponding growth in investment income resulting from an increase in invested assets. In a highly competitive and soft market, Underwriters Re Group continues to focus on coverages requiring specialized underwriting expertise or a high degree of actuarial analysis, as well as its primary insurance business conducted through its insurance subsidiaries and underwriting centers. We are pleased that Underwriters Re Group continues to concentrate on generating profitable business rather than on increasing market share. As of December 31, 1997, the statutory surplus of Underwriters Re Group's principal subsidiary, Underwriters Reinsurance Company, was $659 million, making Underwriters Reinsurance the ninth-largest domestic professional reinsurer in terms of statutory surplus, according to the Reinsurance Association of America. World Minerals contributed pre-tax earnings of $27.5 million, representing an increase of 52 percent from its 1996 pre-tax earnings. Recovering from a disappointing first quarter, 1997 proved to be a record year in terms of both revenues and earnings due to strong performance from World Minerals' non-Asian diatomite operations partially offset by continuing high costs related to World Minerals' Chinese joint ventures and the continued strength of the dollar which lowered the results of foreign operations. The earnings contribution of the Heads and Threads division of Alleghany continued to be steady in 1997 despite doing business in a highly competitive market in the last several years. Alleghany Properties, Inc. continued to benefit from improved real estate conditions in California, which resulted in an increase in the value of its properties. [GRAPH -- SEE EDGAR APPENDIX]
STOCKHOLDERS' EQUITY PER SHARE* 1988 72.27 1989 81.76 1990 90.11 1991 100.56 1992 110.34 1993 127.67 1994 139.33 1995 178.89 1996 192.69 1997 213.22
*Adjusted for 2% stock dividends 2 3 Alleghany's 1997 results included net losses on investment transactions from continuing operations before taxes totalling $10.3 million, compared with net gains of $4.3 million in 1996. The losses in 1997 principally resulted from the write-down by Alleghany of certain investment securities. The comparative contributions to Alleghany's earnings made by Alleghany's operating units, parent-company operations and discontinued operations were as follows (in millions):
Year Ended Quarter Ended December 31 December 31 ------------------------ ------------------------ 1997 1996 1997 1996 --------- --------- --------- --------- Underwriters Re Group $ 44.4 $ 37.0 $ 12.7 $ 13.1 World Minerals 27.5 18.1 9.2 3.7 Alleghany Asset Management 19.8 9.7 5.2 2.0 Parent company and other Operations $ (15.2) $ (10.8) $ (7.8) $ (4.6) Security transactions (11.3) 3.4 (8.0) 3.4 $ (26.5) $ (7.4) $ (15.8) $ (1.2) Earnings from continuing operations, before income taxes $ 65.2 $ 57.4 $ 11.3 $ 17.6 --------- --------- --------- --------- Earnings from continuing operations, net $ 51.4 $ 40.5 $ 13.3 $ 13.6 Earnings from discontinued operations, net (CT&T) 54.3 46.5 15.5 13.9 --------- --------- --------- --------- Net earnings $ 105.7 $ 87.0 $ 28.8 $ 27.5 ========= ========= ========= =========
As of March 2, 1998, Alleghany beneficially owned approximately 7.43 million shares, or 4.8 percent, of the outstanding common stock of Burlington Northern Santa Fe Corporation, which had an aggregate market value on that date of approximately $745.9 million, or $100.375 per share. The aggregate cost of such shares was approximately $253.7 million, or $34.15 per share. Having experienced a difficult first quarter as a result of severe winter weather, the performance of BNSF steadily improved over the remainder of 1997, although record volumes moved by BNSF in the fourth quarter caused it to incur additional costs, in part because of the congestion on rail lines throughout the West. BNSF continues to invest record sums ($2.0 billion in each of the years 1996, 1997 and 1998) in its railroad properties to handle the large amount of freight being tendered by its customers. A continuance of the strong earnings record experienced since 1995 should result from these expenditures. [PHOTO -- SEE EDGAR APPENDIX] Photo Caption: Seated, F.M. Kirby, Chairman of the Board. Standing, John J. Burns, Jr., President. 3 4 Alleghany common stockholders' equity per share was $213.22 at 1997 year-end, an increase of 10.5 percent over common stockholders' equity per share at 1996 year-end of $192.69, after adjustment to reflect the two percent dividend paid in common stock in 1997. Giving effect to the spin-off, Alleghany common stockholders' equity will be reduced by the common stockholder's equity of CT&T, which at December 31, 1997 was $52.32 per share. Overall, we believe 1997 was a successful year for Alleghany, as we confidently plan for the launching of the new Chicago Title Corporation as an independent company. Your management has set challenging and difficult goals for Alleghany for the year 1998 and beyond. Yours sincerely, /s/John J. Burns, Jr. /s/F.M. Kirby President Chairman of the Board March 17, 1998 4 5 CHICAGO TITLE AND TRUST COMPANY Headquartered in Chicago, CT&T provides, through its subsidiaries, title insurance and real estate-related services which facilitate residential and commercial real estate transactions. On December 17, 1997, Alleghany announced its intention to establish the title insurance and real estate-related services business conducted by CT&T as an independent, publicly traded company. This is to be accomplished by a spin-off to Alleghany stockholders of shares of a newly formed holding company for CT&T to be called Chicago Title Corporation. The spin-off is subject to receipt of an IRS ruling to the effect that the spin-off will not be taxable. The common stock of the new Chicago Title Corporation is expected to be listed on the New York Stock Exchange. The financial services business conducted through Alleghany Asset Management, currently a subsidiary of CT&T, will not be part of the spin-off and will remain with Alleghany. The spin-off will give Alleghany stockholders a direct investment in CT&T in addition to their existing investment in Alleghany. It is currently expected that owners of Alleghany common stock as of the close of business on the record date, to be determined, will receive three shares of common stock of the new Chicago Title Corporation for each share of Alleghany common stock that they own. No Alleghany stockholder action is required, and Alleghany stockholders do not need to surrender any shares of Alleghany common stock to receive the common stock of the new Chicago Title Corporation. Alleghany stockholders will continue to hold the same number of shares of Alleghany common stock after the spin-off. As discussed above, CT&T (excluding Alleghany Asset Management) is classified as a "discontinued operation" and the financial statements presented herein report the results of its business as a single net number. More detailed information on CT&T's results is included below and in Note 2 to the Consolidated Financial Statements. Highlights of CT&T (excluding Alleghany Asset Management) are as follows (in millions, except for shares and per share amounts):
YEAR ENDED DECEMBER 31 --------------------------- OPERATING DATA 1997 1996 --------- --------- Revenues $ 1,465.2 $ 1,327.7 --------- --------- Earnings before income taxes $ 81.4 $ 69.7 --------- --------- Net earnings $ 54.3 $ 46.5 --------- --------- Net basic earnings per share of Alleghany common stock* Operations $ 7.32 $ 6.19 Security gains 0.13 0.13 $ 7.45 $ 6.32 --------- --------- Average number of shares of Alleghany common stock* 7,287,459 7,360,584 ========= =========
*Adjusted to reflect dividends of common stock declared in 1996 and 1997.
DECEMBER 31 BALANCE SHEET --------------------------- 1997 1996 --------- --------- Total assets $ 1,683.3 $ 1,467.3 --------- --------- Long-term debt $ 32.4 $ 43.3 --------- --------- Common stockholder's equity $ 385.5 $ 344.8 --------- --------- Common stockholder's equity per share of Alleghany common stock $ 52.32 $ 46.68 ========= =========
6 6 The title insurance industry is undergoing a period of consolidation and rapid change, and Alleghany believes that establishing CT&T as an independent company will enhance its ability to focus on operating efficiencies and strategic initiatives that are required to respond to a changing marketplace. The new Chicago Title Corporation will be able to tie more closely compensation incentives for senior management and employees to the performance of its common stock. Upon the spin-off, it is expected that stock and option awards will be granted to employees in respect of about 7 percent of the new Chicago Title Corporation stock. [GRAPH -- SEE EDGAR APPENDIX]
CT&T CT&T Revenues Pre-Tax Earnings (Dollars in millions) (Dollars in millions) 1993 1,416.3 1993 82.8 1994 1,323.4 1994 59.0 1995 1,132.4 1995 36.8 1996 1,327.7 1996 69.7 1997 1,465.2 1997 81.4
CT&T (excluding Alleghany Asset Management) contributed net earnings of $54.3 million in 1997, representing a 16.5 percent increase from 1996's net earnings of $46.5 million. In 1995, CT&T's net earnings totalled $24.9 million. The improved results reflect exceptionally strong activity in commercial real estate markets and an increase in residential purchase and refinancings in the second half of 1997. CT&T's 1996 results included a $4.2 million pre-tax charge to write down the carrying value of title plants and goodwill in connection with the implementation of Financial Accounting Standards Board Statement No. 121 and pre-tax income of $8.0 million in respect of a reduction in title claims reserves. The reduction in reserves reflected the continuing decrease in claims paid and consideration of the assumed lower risk level of the mix of business written between 1993 and 1996. CT&T's title insurance subsidiaries, consisting of Chicago Title Insurance Company, Security Union Title Insurance Company and Ticor Title Insurance Company and their respective subsidiaries, comprise one of the largest title insurance organizations in the world with approximately 300 full-service offices, 8,100 employees and more than 3,800 policy-issuing agents in 49 states, Puerto Rico, the Virgin Islands, Guam and Canada. The title insurance industry is highly dependent upon the volume of real estate transactions, which is highly sensitive to interest rate levels and general economic conditions. Because these factors can be very volatile, revenue levels for the title industry also can be very volatile. High short-term interest rates reduced the volume of real estate transactions in the first half of 1995. Lower interest rates in the second half of 1995 prompted an increase in refinancing and commercial transactions. The refinance volume remained strong in the first quarter of 1996 but diminished as interest rates leveled off. Interest rates remained relatively stable for the remainder of 1996 resulting in an increase in the volume of real estate construction and resale activity. 1997, particularly the second half of the year, was marked by low inflation, unemployment rates and interest rates in the United States resulting in exceptional growth in the commercial and industrial segment and 7 7 a resurgence in the second half of 1997 in residential purchase and refinancing transactions. The stronger year of 1996, however, also gave rise to increased labor related expenses. The increase in the volume of business by CT&T resulted in additional hires, and increased profitability resulted in higher employee incentive and profit sharing expenses. In 1997, labor related expenses increased in line with the increase in business. [GRAPH -- SEE EDGAR APPENDIX]
CT&T CT&T Stockholders' Equity Closing Reserves (Dollars in millions) (Dollars in millions) 1993 349.6 1993 532.1 1994 308.8 1994 536.1 1995 329.1 1995 530.0 1996 344.8 1996 533.1 1997 385.5 1997 564.5
CT&T is proud of its investment portfolio, which backs its title loss reserves and provides a growing stream of investment income. Pre-tax investment income totalled $67.9 million in 1997, compared with $60.8 million in 1996 and $57.2 million in 1995, reflecting an increase in invested assets in 1997 offset by lower short-term interest rates. CT&T also recorded a pre-tax gain of $1.5 million on investment transactions in 1997, compared with a pre-tax gain of $1.4 million in 1996 and $3.7 million in 1995. As CT&T's title insurance operations have grown, CT&T has sought to improve the effectiveness and efficiency of the company as a whole. In 1997, CT&T realigned its strategy to focus on three distinct markets: core local business requiring flexibility and responsiveness, institutional residential lenders requiring efficient title production centers that can handle high-volume orders at competitive prices, and commercial and industrial businesses requiring nationwide service. As part of its strategy, CT&T is in the process of developing an "electronic spine" or customer interface to allow customers to order and receive electronically all of CT&T's products from any location. These enhancements are designed to meet the needs of mortgage lenders seeking cost efficiencies by requiring vendors to provide many different services related to real estate transactions in an electronic format. Such services include not only the traditional title insurance and escrow services provided by CT&T and its subsidiaries, but new services such as flood certifications, credit information, property valuations, appraisals and inspections, and foreclosure and reconveyance services. CT&T also has expanded its real estate-related services through a number of acquisitions. Most recently in 1998, CT&T acquired Chicago Title Field Services Inc. (formerly Universal Mortgage Services, Inc.), a field inspection services business, and Consolidated Reconveyance Company, a foreclosure and reconveyance services business. In 1997, CT&T created the CastleLink(SM) division to market CT&T's title and real estate-related products and services, allowing customers to order title, credit, flood, property valuation, escrow and closing services through a single source. 8 8 ALLEGHANY ASSET MANAGEMENT, INC. Alleghany Asset Management conducts a financial services business through its subsidiaries, The Chicago Trust Company, a Chicago-based independent investment firm with trust powers, Montag & Caldwell, Inc., an Atlanta-based investment counseling firm, and Chicago Deferred Exchange Corporation, which facilitates certain tax-deferred property exchanges. As described above, Alleghany Asset Management and its subsidiaries will not be part of the spin-off of CT&T and will remain with Alleghany. Alleghany Asset Management posted the following results (in millions):
1997 1996 1995 ------- ------- ------ Revenues $ 78.8 $ 53.3 $ 40.3 Earnings before taxes $ 19.8 $ 9.7 $ 9.4 Assets under management (in billions) $ 23.1 $ 14.5 $ 10.1 ======= ======= ======
Growth in profitability of Alleghany Asset Management is largely dependent on growth in assets under management, which results from market appreciation of existing assets and new business. Approximately 80 percent of Alleghany Asset Management's assets under management are for institutional clients where competition is intense and success is driven by investment performance. Both Montag & Caldwell and Chicago Trust have strong investment records and have received high ratings in various consultant and mutual fund informational service data bases. The $8.6 billion growth in assets under management from 1996 to 1997 included new business of approximately $4.2 billion. [GRAPH -- SEE EDGAR APPENDIX]
Assets Under Management (Dollars in millions) Montag & Caldwell* Chicago Trust+ ------------------ -------------- 1993 3.1 4.0 1994 5.0 3.8 1995 8.4 5.1 1996 15.4 6.1 1997 7.7
*Montag & Caldwell was acquired by Alleghany in July 1994. +Business conducted by the financial services group of CT&T. Alleghany Asset Management provides distribution and marketing services to its investment managers through the 401(k) services offered by Chicago Trust and the Alleghany Funds (formerly CT&T Funds), a mutual fund family offering eight no-load mutual funds. Chicago Trust's full service 401(k) administration group provides trustee, plan design, investment management and other administrative services to companies primarily in the Midwest and South. Such services are marketed through internal sales forces in Chicago and Atlanta as well as consultants and brokerage sources. The Alleghany Funds had approximately $1.9 billion in assets under management at December 31, 1997. The mutual funds are marketed primarily through registered investment advisers, broker-dealers and direct sales to institutional clients. 9 9 MONTAG & CALDWELL Founded in 1945, Montag & Caldwell, one of the Southeast's oldest investment management firms, concentrates on managing large capitalization growth equity and balanced portfolios for institutional, mutual fund and high net worth clients. Montag & Caldwell believes that success in the institutional investment business is dependent upon a disciplined and consistently applied investment process translating into outstanding investment results. Montag & Caldwell's equity results have consistently placed the firm among the top money managers in its category. Montag & Caldwell's assets under management have increased significantly driven by excellent equity returns and strong new business activity. At year-end 1997, Montag & Caldwell had assets under management of $15.45 billion, compared to $8.39 billion at year-end 1996 and $5.01 billion at year-end 1995. Montag & Caldwell targets separate accounts of $40 million and higher, accessed through independent consultants or direct calls to prospective clients. Its investment expertise is also available through the Alleghany Funds. Montag & Caldwell advises two of the Alleghany Funds' mutual funds with approximately $950 million in assets under management at year-end 1997. CHICAGO TRUST Chicago Trust, and its predecessors, has managed assets for investors since 1887. Chicago Trust is an independent investment firm with full trust powers and is engaged in the following lines of business: institutional investment management, full service 401(k) administration, personal trust and investment services and administration of the Alleghany Funds. Chicago Trust manages about $4.5 billion in institutional equity and fixed income accounts of which about $2.2 billion comprise the investment portfolios of CT&T and Underwriters Re Group. Chicago Trust specializes in fixed income money management for institutional clients. Chicago Trust's fixed income results have consistently placed Chicago Trust among the top money managers in its category. Chicago Trust markets its fixed income and equity products through pension consultants and directly to plan sponsors. Chicago Trust also advises six of the Alleghany Funds' mutual funds with approximately $900 million in assets under management at year-end 1997. Chicago Trust's personal trust and investment services business serves the investment and estate planning needs of individuals and families, mainly in the greater Chicago area, and had about $1.5 billion in assets under management at year-end 1997. Chicago Trust believes that the business is well-positioned to benefit from growth in family wealth and the demographics of an aging baby boom generation. Chicago Trust also provides through its San Diego-based subsidiary, Security Trust Company, trust and tax-deferred property exchange services (as described below) in California. CHICAGO DEFERRED EXCHANGE Chicago Deferred Exchange was established in 1989 and facilitates, with the assistance of Chicago Trust, tax-deferred exchanges of like-kind property. In 1997, Chicago Deferred Exchange facilitated more than 2,000 exchanges. Chicago Deferred Exchange acts as a qualified intermediary, holding and investing the cash proceeds from the sale of property relinquished by a taxpayer in a qualified trust account, of which Chicago Trust acts as trustee, until replacement property is acquired. 10 10 UNDERWRITERS RE GROUP, INC. Underwriters Re Group, headquartered in Woodland Hills, California, provides reinsurance through its principal subsidiary, Underwriters Reinsurance Company, to property and casualty insurers and reinsurers. Although it writes many lines of business, Underwriters Reinsurance concentrates on coverages requiring specialized underwriting expertise or a high degree of actuarial analysis. Underwriters Reinsurance operates throughout the United States, including Puerto Rico and the District of Columbia, and Canada, either as a licensed carrier or accredited reinsurer, and has branch offices in Chicago, Houston, New York and Woodland Hills. Underwriters Re Group also provides primary insurance through its insurance subsidiaries and underwriting centers. Underwriters Re Group contributed pre-tax earnings of $44.4 million on revenues of $453.1 million in 1997, compared with $37.0 million on revenues of $410.9 million in 1996 and $24.8 million on revenues of $322.2 million in 1995. Underwriters Re Group's results in 1997 reflect increased business (including a 15 percent, or $53.9 million, increase in net written premiums over 1996) along with a corresponding growth in investment income resulting from an increase in invested assets. The increase in premiums is attributable to growth in its insurance subsidiaries. Results for 1997 reflect a slowing in growth; Underwriters Re Group recorded in 1996 a 23 percent, or $68.3 million, increase in net written premiums from 1995. The rate of increase is expected to decline in 1998 and 1999. Commissions and brokerage expenses increased in line with the increase in business written. In addition, the increasing emphasis placed on the growth of its primary insurance business increased other insurance expenses during 1997. Underwriters Re Group posted the following results (in millions):
1997 1996 1995 ------- ------- ------- Net written premiums of the reinsurance company $ 369.0 $ 335.0 $ 275.7 Net written premiums of the insurance companies 45.2 25.3 16.3 ------- ------- ------- Net written premiums $ 414.2 $ 360.3 $ 292.0 ======= ======= =======
Pre-tax investment income totalled $75.6 million in 1997, compared with $63.2 million in 1996 and $50.2 million in 1995, reflecting the increase in invested assets. In addition, Underwriters Re Group recorded a pre-tax gain of $932 thousand on investment transactions during 1997, compared with a pre-tax gain of $910 thousand in 1996 and a pre-tax loss of $5.5 million in 1995. 1997 results reflect a pre-tax gain of $1.8 million on a sale of an equity investment offset by the write-down in the fourth quarter of the carrying value of an investment. Most of the losses in 1995 were due to portfolio restructurings to respond to changes in interest rates and the write-down of the carrying value of an investment. 11 11 REINSURANCE Underwriters Reinsurance carries an "A+ (Superior)" rating from A.M. Best Company, Inc. and a claims-paying ability rating of "AA-" from Standard & Poor's. As of December 31, 1997, the statutory surplus of Underwriters Reinsurance was $659 million, making Underwriters Reinsurance the ninth-largest domestic professional reinsurer in terms of statutory surplus, according to the Reinsurance Association of America. Brokers are the principal source of the reinsurance business of Underwriters Reinsurance; the remainder of its reinsurance business is obtained directly from ceding companies. By working primarily through brokers, Underwriters Reinsurance does not need to maintain a large sales organization which, during periods of reduced premium volume, could result in significant non-productive overhead. In addition, Underwriters Reinsurance believes that submissions from the broker market, including those for certain targeted specialty coverages, are more numerous and diverse than would be available through a salaried sales organization. Consequently, Underwriters Reinsurance is able to exercise greater selectivity than usually would be possible in dealing directly with ceding companies. [GRAPH -- SEE EDGAR APPENDIX]
Underwriters Re Group Underwriters Reinsurance Revenues Policy Holders Surplus (Dollars in millions) (Dollars in millions) 1993 40.7 1993 250.0 1994 225.4 1994 361.0 1995 322.2 1995 458.0 1996 410.9 1996 614.0 1997 453.1 1997 659.0
*1993 shows results for three months Underwriters Reinsurance maintains a disciplined underwriting program with a focus on generating profitable business rather than on increasing market share. An important element of this program is to respond quickly to market opportunities (such as increased demand or more favorable pricing) by adjusting the mix of property and casualty business it writes. Underwriters Reinsurance concentrates on coverages which require a high degree of underwriting or actuarial expertise. Such expertise is also required for certain business that Underwriters Reinsurance has developed in nontraditional areas, such as providing capital in combination with reinsurance and providing reinsurance to alternative risk markets, including risk retention groups, captives, underwriting syndicates and self-insured funds and associations. Nontraditional reinsurance also may refer to reinsurance contracts which limit exposure to loss through the use of aggregate loss limits, loss ratio caps or other loss containment features. Underwriters Reinsurance believes that coverages which require high levels of underwriting or actuarial expertise offer greater potential for favorable results than more general coverages, based on current market conditions. Representative offices were established in Barbados at the end of 1995 and in London in 1996 to capitalize on international underwriting opportunities. In addition, Underwriters Re Group made investments in reinsurance and insurance companies in Barbados and Bermuda. 12 12 PRIMARY INSURANCE Underwriters Re Group established Commercial Underwriters Insurance Company at the end of 1992, acquired an inactive Nebraska insurance company which was renamed Underwriters Insurance Company in 1994, and established Newmarket Underwriters Insurance Company in 1996 to capitalize on advantageous market conditions for certain primary insurance business lines. Commercial Underwriters, Underwriters Insurance and Newmarket Underwriters are rated "A+ (Superior)" by Best's because Underwriters Reinsurance reinsures a significant share of their business. Commercial Underwriters, Underwriters Insurance and Newmarket Underwriters are property and casualty insurance companies. Commercial Underwriters focuses on specialized primary insurance lines in California and New York on an admitted basis and in 44 other states and Guam and the District of Columbia on an approved nonadmitted basis. Underwriters Insurance, licensed in 48 states and the District of Columbia, focuses on marine insurance, primary liability policies for medium- to large-sized businesses and certain professional liability coverages. Newmarket Underwriters, licensed in New Hampshire and qualified on a nonadmitted basis in New York and California, will focus on general liability policies for medium- to large-sized businesses. The Center Insurance Services, Inc. was also established in 1995. The Center acts as agent and underwrites business on behalf of Commercial Underwriters, Underwriters Insurance and Newmarket Underwriters and at present, to a lesser extent, non-affiliated insurers. Business underwritten by The Center includes marine insurance, products liability insurance and general liability insurance for certain insureds with self-insured retentions. 13 13 WORLD MINERALS INC. World Minerals, headquartered in Santa Barbara, California, conducts a worldwide industrial minerals business through its own operations and those of its subsidiaries, Celite Corporation, Harborlite Corporation and Europerlite Acquisition Corporation. World Minerals contributed pre-tax earnings of $27.5 million on revenues of $203.3 million in 1997, compared with $18.1 million on revenues of $198.5 million in 1996 and $26.1 million on revenues of $178.7 million in 1995. Recovering from a disappointing first quarter, 1997 proved to be a record year in terms of both revenues and earnings for World Minerals. Revenues and pre-tax earnings increased in 1997 from the prior year due to increased sales and profit margins achieved by Celite's non-Asian diatomite operations. Improved results in 1997 from the diatomite operations were partially offset by continuing high costs related to Celite's Chinese joint ventures and the continued strength of the dollar which lowered the results of foreign operations. Results in 1996 included a charge related to the purchase of a minority interest in Harborlite, severance costs and expenses related to the relocation of World Minerals' headquarters which, in aggregate, totalled approximately $4.0 million. [PHOTO -- SEE EDGAR APPENDIX] Photo caption: Above: Actual diatoms magnified 1,000 times. Below: The Research and Development group emphasizes new product development. The period from 1994 through 1997 was one of resurgent economic activity in most world markets, especially the United States and Latin America. World Minerals was positioned to take advantage of this economic growth as a result of programs instituted by management that strengthened the organization. Since 1993, financial systems and controls have been upgraded and the Celite, Harborlite and Europerlite sales, operations and financial groups have been consolidated to improve efficiency and to take advantage of synergies. In addition, World Minerals enhanced its position in both of its core businesses, diatomite and perlite, during 1995, 1996 and 1997 through acquisitions and strategic investments. Celite invested in diatomaceous earth mining, processing, distribution and/or sales facilities in China, South Korea, Peru, Japan and Brazil. Its China operations consist of controlling interests through various subsidiaries of Celite in three joint ventures which are engaged in the mining and processing of diatomite in Jilin Province, China. With respect to World Minerals' perlite business, Harborlite acquired perlite ore reserves in Turkey and Mexico, and built a new perlite expansion plant in Youngsville, North Carolina; Europerlite acquired perlite expansion plants in Spain and Italy; and World Minerals acquired minority interests in Harborlite. Celite is believed to be the world's largest producer of filter-aid grade diatomite, a silica-based mineral consisting of the fossilized remains of microscopic freshwater or marine plants. 14 14 Diatomite is used as a filter aid in the production of beer, fruit juice, wine, water, sweeteners, fats and oils, pharmaceuticals, chemicals, lubricants and petroleum; it is also used as a filler, mainly in paints, and as an anti-block agent in plastic film. Celite is also a producer of calcium and magnesium silicate products, which are used to convert liquid, semi-solid and sticky ingredients into dry, free-flowing powders in the production of rubber, sweeteners, flavorings and pesticides. [GRAPH -- SEE EDGAR APPENDIX] World Minerals -- Dollars in millions
Pre-Tax Earnings Revenues Cash Flow* ---------------- -------- ---------- 1993 $ 8.2 $149.5 $14.7 1994 18.2 162.6 22.8 1995 26.1 178.7 28.6 1996 18.1 198.5 28.2 1997 27.5 203.3 34.8
*Net earnings after taxes, plus depreciation and amortization World Minerals believes that Harborlite and Europerlite together constitute the world's largest producer of perlite filter aids and that Harborlite, which is also engaged in the business of selling perlite ore, is one of the world's largest merchant producers of perlite ore, a volcanic rock containing a small amount of water that causes the ore to "pop" when heated, expanding it up to twenty times its original volume. Harborlite sells perlite ore to companies that expand it for use primarily in the manufacture of roofing board, formed pipe insulation, acoustical ceiling tile and filter aids. Harborlite and Europerlite also expand perlite in their own expansion plants in the United States and Europe. Most of this expanded perlite is sold as a filter aid to companies in the brewing, food, wine, sweetener, pharmaceutical, chemical and lubricant industries, or as a filler and insulating medium to companies in the construction industry. World Minerals focuses on customer and technical service. World Minerals' Research and Development group uses state of the art analytical instrumentation and techniques to seek ways to put the unique properties of its industrial minerals to work in new applications, as well as to refine minerals processing methods to yield higher purity and more consistent finished products. The Technical Services group helps identify the best possible grade of industrial minerals for each customer process and assists in optimizing the customer's manufacturing process to achieve the highest possible value from World Minerals' products. World Minerals conducts its business on a worldwide basis, with mining or processing operations in eleven countries. While World Minerals believes that the international scope of its operations gives it some competitive advantages, international operations can be subject to additional risks, such as currency fluctuations, changes in foreign legal requirements and political instability. World Minerals minimizes its exposure to the risk of foreign currency fluctuation by closely monitoring its methods of operating in each country and adopts strategies responsive to changing economic and political environments. It is not currently expected that the recent currency turmoil in Asia will have a material adverse impact on World Minerals' earnings in 1998. 15 15 HEADS AND THREADS The Heads and Threads division of Alleghany, headquartered in Northbrook, Illinois, is believed to be one of the nation's leading importers and distributors of steel fasteners. Nuts, bolts, screws, washers and other fasteners are imported and resold to fastener manufacturers and distributors through a network of sales offices and warehouses located in sixteen states. The strength of Heads and Threads lies in its five major warehouses and fourteen regional satellite warehouses, and its long years of association with suppliers and customers. Heads and Threads has been consistently profitable since its acquisition by Alleghany in 1974, despite the cyclical nature of its business and changing market conditions. Its earnings contribution to Alleghany has been steady despite a highly competitive market in the last several years. [PHOTO -- SEE EDGAR APPENDIX] Heads and Threads took a number of steps in 1997 to position itself for future growth. Heads and Threads is in the process of a complete restructuring of its computer systems, which may result in lower earnings in 1998 due to the cost of the systems. In addition, Heads and Threads hired additional management to help provide a strong base upon which to build a larger and more profitable wholesale distribution business. Since Heads and Threads imports virtually all of its fasteners, its costs are subject to fluctuations in foreign currency and import duties. Costs also will be impacted by regulations implementing the Fastener Quality Act, the effective date of which has been postponed to 1998. ALLEGHANY PROPERTIES, INC. Headquartered in Sacramento, California, Alleghany Properties and its subsidiary own and manage, among other real estate and real estate-related assets, 30 properties in fee in California. Such properties are comprised primarily of improved and unimproved commercial land (office, retail and industrial), and improved and unimproved commercial and residential lots. A major portion of Alleghany Properties' real estate assets are located in North Natomas, the only large undeveloped area in the City of Sacramento. Development in the area has been delayed by flood plain zoning and wildlife habitat issues, both of which appear to be close to resolution. 16 16 SELECTED FINANCIAL DATA Alleghany Corporation and Subsidiaries (in thousands, except for share and per share amounts)
YEARS ENDED DECEMBER 31 1997 1996 1995 1994 1993 ----------- --------- --------- --------- -------- OPERATING DATA Revenues from continuing operations $ 796,654 $ 734,482 $ 652,444 $ 503,669 $281,844 =========== ========= ========= ========= ======== Earnings from continuing operations $ 51,400 $ 40,470 $ 60,366 $ 28,236 $ 24,339 Earnings from discontinued operations 54,267 46,578 24,934 109,270 73,213 ----------- --------- --------- --------- -------- Net earnings $ 105,667 $ 87,048 $ 85,300 $ 137,506 $ 97,552 =========== ========= ========= ========= ======== Basic earnings per share of common stock:* Continuing operations $ 7.05 $ 5.50 $ 8.21 $ 3.89 $ 3.38 Discontinued operations 7.45 6.32 3.39 15.06 10.16 ----------- --------- --------- --------- -------- Net earnings $ 14.50 $ 11.82 $ 11.60 $ 18.95 $ 13.54 =========== ========= ========= ========= ======== Average number of shares of common stock* 7,287,459 7,360,584 7,354,822 7,253,093 7,204,666 ----------- --------- --------- --------- --------
DECEMBER 31 1997 1996 1995 1994 1993 ---------- --------- --------- --------- -------- BALANCE SHEET Total assets $3,700,376 $3,448,433 $3,023,583 $2,515,332 $2,324,963 ---------- --------- --------- --------- -------- Long-term debt $ 389,641 $ 404,244 $ 276,646 $ 270,632 $ 330,337 ---------- --------- --------- --------- -------- Common stockholders' equity $1,570,935 $1,423,260 $1,320,643 $1,021,193 $ 915,734 ---------- --------- --------- --------- -------- Common stockholders' equity per share of common stock* $ 213.22 $ 192.69 $ 178.89 $ 136.60 $ 122.71 ========== ========== ========== ========== ==========
The Company acquired Underwriters Re Group on October 7, 1993. The Company sold Sacramento Savings Bank on October 31, 1994 and the Company announced in 1997 its intention to spin-off to Alleghany stockholders shares of a newly-formed holding company for Chicago Title and Trust Company; accordingly, the operations of Sacramento Savings have been classified as discontinued operations for the years 1993 and 1994 and certain operations of the Chicago Title and Trust Company have been classified as discontinued operations for each of the 5 years ended in 1997. * Restated to reflect subsequent common stock dividends and the adoption of Statement of Financial Accounting Standards No. 128, "Earnings per Share." DIVIDENDS, MARKET PRICES AND RELATED SECURITY HOLDER MATTERS As of December 31, 1997, there were approximately 2,000 holders of record of Alleghany common stock. The following table indicates quarterly high and low prices of the common stock in 1997 and 1996 on the New York Stock Exchange. Alleghany's ticker symbol is Y.
QUARTER ENDED 1997 1996 ------------------ --------------- HIGH LOW HIGH LOW ---- ---- ---- ---- March 31 $210 25/32 $203 59/64 $198 $191 7/8 June 30 220 206 1/2 197 1/2 187 September 30 256 218 1/2 209 187 December 31 $290 $254 $213 $203
In each of 1996 and 1997, Alleghany's Board of Directors declared, as Alleghany' s dividend on its common stock for that year, a stock dividend consisting of one share of Alleghany common stock for every fifty shares outstanding. The 1996 and 1997 stock dividends were paid in April of each of those years. In light of the spin-off of CT&T in the second quarter, no stock dividend has been declared for 1998. Alleghany's ability to pay cash dividends is restricted by the terms of a revolving credit loan agreement. At December 31, 1997, this agreement permitted the payment of dividends aggregating approximately $250 million. Such limitation will be modified in connection with the spin-off. At that date about $1.120 billion of Alleghany's consolidated common stockholders' equity of $1.186 billion was unavailable for dividends or advances to Alleghany from its subsidiaries, due to limitations imposed by statutes and agreements with lenders to which those subsidiaries are subject. 18 17 [INDEX TO FINANCIAL STATEMENTS] Financial Condition............................. 19 Consolidated Balance Sheets..................... 22 Consolidated Statements of Earnings............. 23 Consolidated Statements of Changes in Common Stockholders' Equity................... 24 Consolidated Statements of Cash Flows........... 25 Notes to Consolidated Financial Statements...... 26 Independent Auditors' Report.................... 38 Combining Balance Sheet......................... 39 Combining Statement of Earnings from Continuing Operations, before Income Taxes........................... 39 FINANCIAL CONDITION In recent years, Alleghany has followed a policy of maintaining a relatively liquid financial condition, in the form of cash, marketable securities, available credit lines and minimal amounts of debt at the parent company. This has permitted Alleghany to expand its operations through internal growth at its subsidiaries and through acquisitions or substantial investments in well-managed operating companies. On October 20, 1997, Alleghany Funding Corporation, a wholly owned subsidiary of Alleghany, redeemed its secured notes due 1999 in the aggregate principal amount of $80 million. The 1999 Notes were primarily secured by a $91.5 million installment note issued by Merrill Lynch, Pierce, Fenner & Smith Incorporated, which Alleghany transferred to Alleghany Funding in 1990 in exchange for the common stock of Alleghany Funding. The 1999 Notes were redeemed with the proceeds from the issuance by Alleghany Funding on October 20, 1997 of secured notes due 2007 in the aggregate principal amount of $80 million. The 2007 Notes were privately placed with several institutions and are primarily secured by the installment note, the maturity of which was extended to 2007. As of March 2, 1998, Alleghany and its subsidiaries owned about 7.43 million shares, or about 4.8 percent, of the outstanding common stock of Burlington Northern Santa Fe Corporation ("BNSF") having an aggregate market value as of such date of approximately $745.9 million, or $100.375 per share. The aggregate cost of such shares was approximately $253.7 million, or $34.15 per share. As of March 2, 1998, Alleghany and its subsidiaries owned about 5.64 million shares, or about 5.3 percent, of the outstanding common stock of Armco Inc. Alleghany has declared stock dividends in lieu of cash dividends every year since 1987, which have helped to conserve Alleghany's financial strength and, in particular, the liquid assets available to finance internal growth and operating company acquisitions and investments. In light of the spin-off of CT&T in the second quarter, no stock dividend has been declared for 1998. In addition to its liquid financial assets, Alleghany has a revolving credit agreement with a bank which provides a commitment for revolving credit loans in an aggregate principal amount of $200 million. Borrowings have been repaid promptly in order to keep the facility available for future acquisitions. $16 million in borrowings were outstanding under this facility at 1997 year-end and no amounts were outstanding at 1996 year-end. This agreement will mature in July 2000. 19 18 FINANCIAL CONDITION (CONTINUED) Alleghany has announced that it may purchase shares of its common stock in open market transactions from time to time. In 1997, Alleghany purchased an aggregate of 157,174 shares of its common stock for about $33.1 million, at an average cost of about $210.47 per share. In 1996, Alleghany purchased an aggregate of 92,700 shares of its common stock for about $18.0 million, at an average cost of about $194 per share. At December 31, 1997, about $66 million of the equity of Alleghany's subsidiaries (other than CT&T) was available for dividends or advances to Alleghany. Underwriters Re Group's available funds for payout of its permitted dividends, however, may be further restricted by limitations imposed by statutes to which its subsidiaries are subject. At that date about $1.120 billion of $1.186 billion of Alleghany's equity (not including CT&T) was unavailable for dividends or advances to Alleghany from its subsidiaries, due to limitations imposed by statutes and agreements with lenders to which those subsidiaries are subject. These limitations have not affected Alleghany's ability to meet its obligations. Each of Alleghany and its subsidiaries have been conducting a comprehensive review of its computer systems to identify the systems that could be affected by the Year 2000 issue (i.e., recognizing a date using "00" as the year 1900 rather than the year 2000) and is developing an implementation plan to resolve the issue. Both internal and external resources are being used to identify, correct or reprogram, and test all systems for Year 2000 compliance. It is anticipated that all reprogramming efforts will be complete by December 31, 1998, allowing adequate time for testing. Testing and conversion of system applications is currently expected to cost less than $4.0 million. Each of Alleghany and its subsidiaries also is communicating with third parties with which it does business to coordinate action with respect to the Year 2000 issue and to receive confirmations that plans are being developed to address Year 2000 compliance. Management believes that the Year 2000 issue will not have a material impact on Alleghany's business, operations or financial condition. Financial strength is also a high priority of Alleghany's subsidiaries, whose assets stand behind their financial commitments to their customers and vendors. ALLEGHANY ASSET MANAGEMENT The financial services business of Alleghany Asset Management is not a capital intensive business and adequate funds are generated internally to provide for the currently foreseeable needs of its business. Alleghany Asset Management paid cash dividends to CT&T totalling $13.3 million in 1997 and $3.4 million in 1996. UNDERWRITERS RE GROUP On June 25, 1996, the parent company of Underwriters Reinsurance issued $200 million principal amount of 7-7/8% Senior Notes due 2006. Of the net proceeds of the offering, $120 million was contributed to the capital of Underwriters Reinsurance, $50 million was used to repay indebtedness under the parent company's credit agreement, and the remainder is being used for general corporate purposes. As of December 31, 1997, the statutory surplus of Underwriters Reinsurance was $659 million. At December 31, 1997, Underwriters Re Group's investment portfolio had a fair value of $1.5 billion and consisted primarily of high quality fixed maturity securities with an average maturity of 4.9 years and an effective duration of 3.4 years, and about 2.5 million shares of BNSF common stock with a market value of $248.4 million at March 2, 1998. Effective duration measures a portfolio's sensitivity to change in interest rates; a change within a range of plus or minus 1% in interest rates would be expected to result in an inverse change of approximately 3.4% in the value of the portfolio of Underwriters Re Group. The overall fixed maturity portfolio quality is maintained at a Moody's rating of "Aa3" or higher, with over 98 percent of all securities rated investment grade by Moody's as of December 31, 1997. Underwriters Re Group's portfolio contains no investments of a derivative nature. On October 3, 1997, Alleghany exchanged pursuant to an offer by Alleghany shares of common stock of Underwriters Re Group, representing 2.7 percent of the outstanding common stock of Underwriters Re Group, held by ten employees of Underwriters Re Group for shares of Alleghany common stock. Alleghany now owns all of the issued and outstanding shares of common stock of Underwriters Re Group. In October 1996, the parent company of Underwriters Reinsurance entered into a credit agreement with several banks which provides for a commitment for revolving credit loans in an aggregate principal amount of $50 million, at interest rates tied to the parent company's debt rating. No amounts have been drawn under this facility. WORLD MINERALS As of December 31, 1997, $64 million of indebtedness and $1.3 million of letters of credit were outstanding under World Minerals' long-term credit facility and an additional $2.3 million of short-term debt was outstanding. During 1997, World Minerals repaid $22.0 million of its long-term debt from internally generated cash flow. The amount available under the long-term facility is required 20 19 FINANCIAL CONDITION (CONTINUED) to be reduced periodically, with final maturity in December 1999. The aggregate available long-term borrowing and letter of credit amount as of December 31, 1997 was $81 million. HEADS AND THREADS Heads and Threads has a credit facility with a bank providing for letters of credit totalling up to $10 million. ALLEGHANY PROPERTIES As part of Alleghany's sale of Sacramento Savings Bank, Alleghany, through its wholly owned subsidiary Alleghany Properties, purchased real estate and real estate-related assets of Sacramento Savings for about $116 million. Accordingly, and in recognition that no general loss reserves of Sacramento Savings were transferred, Alleghany reduced the carrying value of such assets by about $20 million, net of related tax benefits. Alleghany Properties is Alleghany's only subsidiary holding substantial real estate investments. As of December 31, 1997, Alleghany Properties held 37 loans and properties having a total book value of approximately $61.0 million, as compared to 44 loans and properties having a total book value of approximately $79.2 million as of December 31, 1996, and 89 loans and properties having a total book value of approximately $90.1 million as of October 31, 1994 (the date the assets were purchased by Alleghany Properties). On February 23, 1995, Alleghany Properties issued $50 million aggregate principal amount of 8.62 percent senior notes due 2000 (the "Notes"). The Notes will be repaid in five equal annual principal amortization payments beginning on the first anniversary of their issuance. A portion of the proceeds from the sale of the Notes was used to pay a dividend of $37 million to Alleghany and to repay outstanding indebtedness of a subsidiary of Alleghany Properties in the amount of $8 million; the balance is being used for Alleghany Properties' working capital. On February 23, 1998, Alleghany Properties made its third principal payment on the Notes, including interest accrued thereon, in the amount of $11.3 million, reducing the outstanding principal to $20.0 million. The capital needs of Alleghany Properties include primarily various development costs relating to its owned properties. Adequate funds are expected to be generated internally to provide for the currently foreseeable needs of its business. CT&T Because of the announced spin-off, all CT&T (excluding Alleghany Asset Management) related financial results are reported in this report as discontinued operations. More detailed information on CT&T's results appear in Note 2 to the Consolidated Financial Statements. CT&T's principal title insurance subsidiaries each carries a claims-paying ability rating of "A" from Standard & Poor's Corporation and from Duff & Phelps Credit Rating Co. In addition, Moody's Investors Service has assigned insurance financial strength ratings of "A2" to Chicago Title Insurance Company, "A3" to Ticor Title Insurance Company and "Baa1" to Security Union Title Insurance Company. CT&T paid cash dividends to Alleghany totalling $32 million in 1997 and $30 million in 1996. After the spin-off, CT&T will not be a source of future dividends to Alleghany. At December 31, 1997, CT&T's investment portfolio had a market value of $1.07 billion and consisted primarily of short and intermediate maturity investment grade rated debt securities. Modest investment is made in preferred stocks, convertible and lower quality bonds, and publicly traded equity securities. A relatively short average portfolio maturity and effective duration of 2.9 years and 2.2 years, respectively, are maintained so that investment income may more readily respond to changes in the level of interest rates, offsetting to some degree the cyclicality of title insurance operations. Overall portfolio quality is maintained at a Moody's rating of "Aa3" or higher, with over 98 percent of all securities rated investment grade by Moody's and less than one percent in derivative instruments as of 1997 year-end. As of December 31, 1997, $32.4 million was outstanding under a loan agreement among CT&T and several banks. The loan calls for annual principal payments, with final maturity in December 2000. In light of the spin-off, CT&T is reviewing its existing loan agreement in terms of modifying or replacing it. Alleghany management believes that Alleghany and its subsidiaries have and will have adequate internally generated funds, cash resources and unused credit facilities to provide for the currently foreseeable needs of its and their businesses. Alleghany and its subsidiaries have no material commitments for capital expenditures. 21 20 CONSOLIDATED BALANCE SHEETS Alleghany Corporation and Subsidiaries
December 31, 1997 and 1996 (in thousands, except share amounts) 1997 1996 ---------- ---------- ASSETS Available for sale securities Fixed maturities (amortized cost: 1997 $1,255,081; 1996 $1,181,395) $1,277,566 $1,181,811 Equity securities (cost: 1997 $339,888; 1996 $295,532) 783,433 681,519 ---------- ---------- 2,060,999 1,863,330 ---------- ---------- CASH 45,772 36,882 Cash pledged to secure trust and escrow deposits 1,336 18,674 Notes receivable 91,536 91,536 Funds held, accounts and other receivables 255,802 224,714 Property and equipment - at cost, less accumulated depreciation and amortization 193,304 193,809 Reinsurance receivable 387,609 392,210 Other assets 278,567 282,458 Net assets of discontinued operations 385,451 344,820 ---------- ---------- $3,700,376 $3,448,433 ========== ========== LIABILITIES AND COMMON STOCKHOLDERS' EQUITY Property and casualty losses and loss adjustment expenses $1,159,070 $1,110,020 Other liabilities 443,259 379,864 Long-term debt of parent 16,000 -- Long-term debt of subsidiaries 373,641 404,244 Net deferred tax liability 133,241 109,216 Trust and escrow deposits secured by pledged assets 4,230 21,829 ---------- ---------- Total liabilities 2,129,441 2,025,173 Commitments and contingent liabilities Common stockholders' equity (common shares authorized: 1997 and 1996 - 22,000,000; common shares issued and outstanding: 1997 - 7,367,551; 1996 - 7,386,332) 1,570,935 1,423,260 ---------- ---------- $3,700,376 $3,448,433 ========== ==========
See accompanying Notes to Consolidated Financial Statements. 22 21 CONSOLIDATED STATEMENTS OF EARNINGS Alleghany Corporation and Subsidiaries
Years Ended December 31, (in thousands, except per share amounts) 1997 1996 1995 --------- -------- ------- REVENUES Trust fees $ 77,341 $ 52,259 $39,116 Net property and casualty premiums earned 376,672 346,777 277,507 Interest, dividend and other income 149,724 132,960 126,271 Net mineral and filtration sales 203,264 198,179 177,185 Net (loss) gain on investment transactions (10,347) 4,307 32,365 --------- -------- ------- Total revenues 796,654 734,482 652,444 --------- -------- ------- COSTS AND EXPENSES Commissions and brokerage expenses 94,444 88,895 63,617 Salaries, administrative and other operating expenses 187,049 168,965 144,552 Property and casualty loss and loss adjustment expenses 261,828 243,725 203,108 Cost of mineral and filtration sales 130,555 128,681 113,149 Interest expense 32,111 26,573 22,526 Corporate administration 25,437 20,253 21,239 --------- -------- ------- Total costs and expenses 731,424 677,092 568,191 --------- -------- ------- Earnings from continuing operations, before income taxes 65,230 57,390 84,253 Income taxes 13,830 16,920 23,887 --------- -------- ------- Earnings from continuing operations 51,400 40,470 60,366 DISCONTINUED OPERATIONS Earnings from discontinued operations, net of tax 54,267 46,578 24,934 --------- -------- ------- Net earnings $ 105,667 $ 87,048 $85,300 ========= ======== ======= BASIC EARNINGS PER SHARE OF COMMON STOCK:* Continuing operations $ 7.05 $ 5.50 $ 8.21 Discontinued operations 7.45 6.32 3.39 --------- -------- ------- Basic net earnings per share $ 14.50 $ 11.82 $ 11.60 ========= ======== ======= DILUTED EARNINGS PER SHARE OF COMMON STOCK:* Continuing operations $ 6.98 $ 5.49 $ 8.20 Discontinued operations 7.37 6.32 3.38 --------- -------- ------- Diluted earnings per share common stock $ 14.35 $ 11.81 $ 11.58 ========= ======== =======
*Adjusted to reflect subsequent common stock dividends and the adoption of Statement of Financial Accounting Standards No. 128 "Earnings Per Share." See accompanying Notes to Consolidated Financial Statements. 23 22 CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCKHOLDERS' EQUITY Alleghany Corporation and Subsidiaries
Three Years Ended December 31, 1997 UNREALIZED APPRECIATION COMMON CONTRIBUTED (DEPRECIATION) TREASURY (IN THOUSANDS, EXCEPT SHARE AMOUNTS) STOCK CAPITAL OF SECURITIES STOCK ----------- ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1994 $ 6,980 $ 456,582 $ 11,706 $ (10,402) (7,407,534 shares of common stock issued; 78,533 in treasury)* ADD (DEDUCT): Net earnings -- -- -- -- Common stock dividend 100 16,400 -- 5,318 Cumulative translation loss -- -- -- -- Change in unrealized appreciation of investments, net -- -- 217,128 -- Other, net 79 4,690 -- (5,090) ----------- ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1995 7,159 477,672 228,834 (10,174) (7,448,490 shares of common stock issued; 66,180 in treasury)* ADD (DEDUCT): Net earnings -- -- -- -- Common stock dividend 75 15,756 -- 11,792 Cumulative translation loss -- -- -- -- Change in unrealized appreciation of investments, net -- -- 28,003 -- Other, net 69 1,508 -- (12,511) ----------- ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1996 7,303 494,936 256,837 (10,893) (7,449,126 shares of common stock issued; 62,794 in treasury)* ADD (DEDUCT): Net earnings -- -- -- -- Common stock dividend -- 1,181 -- 28,486 Cumulative translation loss -- -- -- -- Change in unrealized appreciation of investments, net -- -- 56,900 -- Other, net 110 15,032 -- (26,720) =========== =========== =========== =========== BALANCE AT DECEMBER 31, 1997 $ 7,413 $ 511,149 $ 313,737 $ (9,127)
(7,413,140 shares of common stock issued; 45,589 in treasury)
(CONTINUED) Three Years Ended December 31, 1997 CUMULATIVE CUMULATIVE TOTAL RETAINED TRANSLATION STOCKHOLDERS' (IN THOUSANDS, EXCEPT SHARE AMOUNTS) EARNINGS GAIN (LOSS) EQUITY ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1994 $ 564,009 $ (7,682) $ 1,021,193 (7,407,534 shares of common stock issued; 78,533 in treasury)* ADD (DEDUCT): Net earnings 85,300 -- 85,300 Common stock dividend (21,939) -- (121) Cumulative translation loss -- (2,536) (2,536) Change in unrealized appreciation of investments, net -- -- 217,128 Other, net -- -- (321) ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1995 627,370 (10,218) 1,320,643 (7,448,490 shares of common stock issued; 66,180 in treasury)* ADD (DEDUCT): Net earnings 87,048 -- 87,048 Common stock dividend (27,766) -- (143) Cumulative translation loss -- (1,357) (1,357) Change in unrealized appreciation of investments, net -- -- 28,003 Other, net -- -- (10,934) ----------- ----------- ----------- BALANCE AT DECEMBER 31, 1996 686,652 (11,575) 1,423,260 (7,449,126 shares of common stock issued; 62,794 in treasury)* ADD (DEDUCT): Net earnings 105,667 -- 105,667 Common stock dividend (29,815) -- (148) Cumulative translation loss -- (3,166) (3,166) Change in unrealized appreciation of investments, net -- -- 56,900 Other, net -- -- (11,578) =========== =========== =========== BALANCE AT DECEMBER 31, 1997 $ 762,504 $ (14,741) $ 1,570,935
(7,413,140 shares of common stock issued; 45,589 in treasury) *Adjusted to reflect subsequent common stock dividends. See accompanying Notes to Consolidated Financial Statements. 24 23 CONSOLIDATED STATEMENTS OF CASH FLOWS Alleghany Corporation and Subsidiaries
Years Ended December 31, (in thousands) 1997 1996 1995 --------- -------- ------- CASH FLOWS FROM CONTINUING OPERATING ACTIVITIES Earnings from continuing operations $ 51,400 $ 40,470 $60,366 Adjustments to reconcile earnings from continuing operations to cash provided by (used in) continuing operations: Depreciation and amortization 24,178 24,015 20,541 Net loss (gain) on investment transactions 10,347 (4,307) (32,365) Other charges to continuing operations, net (300) (683) 1,829 (Increase) decrease in funds held, accounts and other receivables (31,088) 18,072 (83,603) Decrease in reinsurance receivable 4,601 7,573 22,900 Increase in property and casualty loss and loss adjustment expenses 49,050 96,020 73,473 (Decrease) increase in other assets (3,175) (45,231) 89,511 Increase in other liabilities 63,395 30,849 1,011 Decrease (increase) in cash pledged to secure trust and escrow deposits 17,338 (3,041) (15,633) (Decrease) increase in trust and escrow deposits (17,599) 26,493 (2,677) --------- -------- ------- Net adjustments 116,747 149,760 74,987 --------- -------- ------- Cash provided by continuing operations 168,147 190,230 135,353 --------- -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES Purchase of investments (591,358) (494,421) (366,687) Maturities of investments 210,154 55,257 45,727 Sales of investments 224,717 124,273 268,202 Purchases of property and equipment (16,580) (23,728) (32,248) Purchase of mining operations and other acquisitions -- -- (82,043) Other, net 20,960 8,807 (14,624) --------- -------- ------- Net cash used in investing activities (152,107) (329,812) (181,673) --------- -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES Principal payments on long-term debt (112,000) (159,000) (149,824) Proceeds of long-term debt 97,639 296,082 158,625 Cash provided by discontinued operations 18,805 30,000 25,313 Other, net (11,594) (19,161) (9,048) --------- -------- ------- Net cash (used in) provided by financing activities (7,150) 147,921 25,066 --------- -------- ------- Net increase in cash 8,890 8,339 (21,254) Cash at beginning of year 36,882 28,543 49,797 --------- -------- ------- Cash at end of year $ 45,772 $ 36,882 $28,543 ========= ======== ======= SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION Cash paid during the year for: Interest $ 32,140 $ 26,464 $20,526 Income taxes $ 44,410 $ 63,646 $18,461 ========= ======== =======
See accompanying Notes to Consolidated Financial Statements. 25 24 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries 1. SUMMARY OF SIGNIFICANT ACCOUNTING PRINCIPLES a. PRINCIPLES OF FINANCIAL STATEMENT PRESENTATION. Alleghany Corporation, a Delaware corporation ("Alleghany", or together with its subsidiaries, the "Company"), owns Chicago Title and Trust Company ("CT&T") whose principal subsidiaries are Chicago Title Insurance Company ("CTI"), Security Union Title Insurance Company ("Security Union"), Ticor Title Insurance Company ("Ticor Title"), and Alleghany Asset Management, Inc.; Alleghany Funding Corporation ("AFC"); World Minerals Inc. ("World Minerals"); Underwriters Re Group, Inc., formerly known as URC Holdings Corp. ("Underwriters Re Group"), whose principal subsidiaries are Underwriters Reinsurance Company ("Underwriters Reinsurance"), Commercial Underwriters Insurance Company ("CUIC") and Underwriters Insurance Company ("UIC"); and Alleghany Properties Inc. ("API"). The Company announced in 1997 its intention to spin-off to Alleghany stockholders shares of a newly-formed holding company for Chicago Title and Trust Company, and accordingly its operations are shown as discontinued operations for all periods presented. See Note 2. The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles and include the accounts of the Company. All significant intercompany items have been eliminated in consolidation. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Such estimates and assumptions include those associated with estimating title insurance loss reserves which involve interpretations of varying real estate laws and inherent uncertainties primarily due to the long-term nature of the business. Estimates and assumptions associated with property and casualty loss reserves include inherent uncertainties primarily due to the long-term nature of most reinsurance business, the diversity of development patterns among different lines of business and types of reinsurance, and the necessary reliance on the ceding company for information regarding claims. Actual results could differ from those estimates. b. INVESTMENTS. Marketable investment securities at December 31, 1997 and 1996 consist of U.S. Treasury securities, obligations of U.S. government agencies, municipal obligations, mortgage-backed securities, corporate debt securities, certificates of deposit, and equity securities. The Company classifies its debt and marketable equity securities into one of three categories: trading, available for sale, or held to maturity. Trading securities are bought and held principally for the purpose of selling them in the near term. Held to maturity securities are those fixed maturity securities which the Company has the ability and intent to hold until maturity. Securities held for indefinite periods of time which may not be held to maturity are classified as available for sale. At December 31, 1997 and 1996, securities are classified as available for sale securities and recorded at fair value. Unrealized holding gains and losses, net of the related tax effect, on available for sale securities are excluded from earnings and are reported as a separate component of stockholders' equity until realized. A decline in the fair value of an available for sale security below its cost that is deemed other than temporary is charged to earnings. Realized gains and losses on investments are determined on the specific identification method. c. PROPERTY AND EQUIPMENT. Depreciation of buildings and equipment and amortization of leasehold improvements are principally calculated using the straight-line method over the estimated useful life of the respective assets or the life of the lease, whichever is less. d. PROPERTY AND CASUALTY LOSSES AND LOSS ADJUSTMENT EXPENSES. The liability for outstanding losses and loss adjustment expenses includes estimated provisions for all reported and unreported claims incurred and is reduced by allowances for salvage and subrogation. In management's opinion, reserves for property and casualty losses and loss adjustment expenses are adequate. e. REVENUE RECOGNITION. Title insurance premiums are recognized as revenues principally at the time of the real estate closing. Escrow and trust fees are recognized principally when billed. Property and casualty reinsurance premiums are reflected in income generally on a daily pro rata basis for facultative business and as reported by the ceding company for treaty business. F. DERIVATIVE FINANCIAL INSTRUMENTS. The Company has only limited involvement with derivative financial instruments and does not use them for trading purposes. The 26 25 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries Company enters into interest rate swaps for purposes of converting variable interest rate exposure to a fixed rate and to match interest expense with interest income. Interest rate swaps are accounted for as a hedge of the obligation. Interest expense is recorded using the revised interest rate. g. INCOME TAXES. The Company files a consolidated federal income tax return with its domestic subsidiaries. Deferred tax assets and liabilities are recognized for the future tax consequence attributable to differences between the financial statement carrying amount of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. h. FUNDS HELD, ACCOUNTS AND OTHER RECEIVABLES. Funds held, accounts, and other receivables consists of funds held under reinsurance contracts and accounts and other receivables, net of allowances. i. ACQUISITION COSTS. Acquisition costs related to unearned property and casualty premiums are deferred by major underwriting lines and amortized over the period in which the premiums are earned. The method followed in computing the deferred acquisition costs consists of deferring only those variable acquisition costs, such as commissions and brokerage fees, which relate directly to the production of business, and limiting the amount of those costs deferred to their net realizable value after allowing for anticipated investment income. j. REINSURANCE. Reinsurance receivables (including amounts related to claims incurred but not reported) and prepaid reinsurance premiums are reported as assets. Reinsurance contracts that do not result in a reasonable possibility that the reinsurer may realize a significant loss from the insurance risk assumed and that do not provide for the transfer of significant insurance risk generally do not meet the conditions for reinsurance accounting and are accounted for as deposits. k. CASH. For purposes of the consolidated statements of cash flows, cash includes only funds on deposit which are available for immediate withdrawal. l. NET EARNINGS PER SHARE OF COMMON STOCK. Earnings per share of common stock are based on the average number of shares of Alleghany common stock outstanding during the years ended December 31, 1997, 1996, and 1995, respectively, as adjusted for stock dividends. The average number of shares of common stock outstanding, as adjusted for stock dividends, was 7,287,459 in 1997, 7,360,584 in 1996, and 7,354,822 in 1995. m. IMPAIRMENT OF LONG-LIVED ASSETS. Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 121 (SFAS 121) "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of." SFAS 121 provides guidance for recognition and measurement of impairment of long-lived assets, certain identifiable intangibles and goodwill related both to assets to be held and used and assets to be disposed of. The adoption of SFAS 121 did not have a material impact on the Company's financial position or results of operations. n. STOCK OPTION PLANS. Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123 (SFAS 123) "Accounting for Stock-Based Compensation." SFAS 123 establishes accounting and reporting standards for stock-based employee compensation plans. This statement allows companies to choose between the "fair value based method of accounting" as defined in this statement and the "intrinsic value based method of accounting" as prescribed by Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees." The Company has elected to continue to follow the accounting guidance provided by APB 25, as permitted. o. RECENT ACCOUNTING PRONOUNCEMENTS. In June 1997, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 128 (SFAS 128) "Earnings per Share" which the Company implemented in 1997. SFAS 128 supersedes Opinion 15 and related accounting interpretations. SFAS 128 replaces the presentation of primary and fully diluted earnings per share with "basic earnings per share" and "diluted earnings per share," respectively. All prior periods presented have been restated to reflect the new requirement. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 130 (SFAS 130) "Reporting Comprehensive Income." SFAS 130 establishes standards for the reporting and display of comprehensive income and its components in a full set of general- 27 26 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries purpose financial statements. All items that are required to be recognized under accounting standards as components of comprehensive income are to be reported in a financial statement that is displayed with the same prominence as other financial statements. The Company will implement this statement in 1998. This statement relates to presentation of information and will have no impact on the consolidated statement of earnings or consolidated balance sheets. In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 (SFAS 131) "Disclosures about Segments of an Enterprise and Related Information." SFAS 131 establishes standards for the way that public enterprises report information about operating segments in annual financial statements and requires that selected information about those operating segments be reported in interim financial statements. The Company will implement this statement in 1998. The Company's reportable operating segments are not expected to change as a result of the adoption of SFAS 131. p. RECLASSIFICATION. Certain prior year amounts have been reclassified to conform to the 1997 presentation. 2. SPIN-OFF OF CHICAGO TITLE AND TRUST COMPANY As a result of the proposed spin-off, the Company has classified the operation to be spun-off as a "discontinued operation" in its financial statements. Historical financial information relating to the discontinued operations is as follows (in thousands):
ASSETS 1997 1996 ---------- ---------- Investments: Fixed $1,032,089 $ 827,577 Equities 34,490 23,209 ---------- ---------- 1,066,579 850,786 ---------- ---------- Cash 21,219 23,072 Cash pledged 100,207 99,392 Funds held, accounts receivable 69,519 50,609 Title records 150,546 152,291 Property and equipment, net 97,223 93,368 Net deferred tax asset 75,197 70,275 Other assets 102,821 127,492 ---------- ---------- $1,683,311 $1,467,285 ========== ========== LIABILITIES AND EQUITY Title losses and claims $ 564,453 $ 533,139 Other liabilities 233,411 190,333 Long-term debt 32,443 43,282 Trust and escrow deposits 467,553 355,711 ---------- ---------- 1,297,860 1,122,465 ---------- ---------- Stockholder's equity 385,451 344,820 ---------- ---------- $1,683,311 $1,467,285 ========== ==========
REVENUES 1997 1996 1995 ---------- ---------- ---------- Title premiums, escrow and trust fees $1,395,865 $1,265,461 $1,071,424 ---------- ---------- ---------- Interest, dividend and other income 67,897 60,787 57,245 Net gain on investment transactions 1,469 1,436 3,697 ---------- ---------- ---------- Total revenues 1,465,231 1,327,684 1,132,366 ========== ========== ========== COSTS AND EXPENSES Commissions and brokerage expenses 526,324 484,352 420,555 Salaries, administrative and other operating expenses 749,624 684,548 581,495 Provision for title losses and other claims 103,251 83,526 87,037 Interest expense 4,644 5,566 6,456 ---------- ---------- ---------- Total costs and expenses 1,383,843 1,257,992 1,095,543 ---------- ---------- ---------- Earnings before income taxes 81,388 69,692 36,823 Income Taxes 27,121 23,114 11,889 ---------- ---------- ---------- NET EARNINGS $ 54,267 $ 46,578 $ 24,934 ========== ========== ==========
The financial information excludes the effects of certain intercompany securities transactions that CT&T and the Company have entered into. In addition, the operations of Alleghany Asset Management will be shown as a discontinued operation in CT&T's stand alone financial statements to be included in CT&T's registration statement on Form 10. Alleghany Asset Management is included in the continuing operations of the Company. Accordingly, the financial information shown above will not agree to CT&T's financial statements prepared on a stand alone basis. 3. INVESTMENTS Available for sale securities at December 31, 1997 and 1996 are summarized as follows (in thousands):
1997 AMORTIZED GROSS GROSS COST UNREALIZED UNREALIZED FAIR CONSOLIDATED OR COST GAINS LOSSES VALUE ----------- ----------- ----------- ----------- Fixed maturities: U.S. Government, government agency and municipal obligations $ 687,377 $ 16,638 $ (1,169) $ 702,846 Certificates of deposit 2,500 -- -- 2,500 Commercial paper 46,507 -- -- 46,507 Bonds, notes and other 518,697 8,393 (1,377) 525,713 ----------- ----------- ----------- ----------- 1,255,081 25,031 (2,546) 1,277,566 Equity securities 339,888 443,545 -- 783,433 ----------- ----------- ----------- ----------- $ 1,594,969 $ 468,576 $ (2,546) $ 2,060,999 =========== =========== =========== ===========
28 27 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries
AMORTIZED GROSS GROSS COST UNREALIZED UNREALIZED FAIR INDUSTRY SEGMENT OR COST GAINS LOSSES VALUE ----------- ----------- ----------- ----------- Asset management $ 18,205 $ 150 $ (25) $ 18,330 Property and casualty reinsurance 1,328,273 186,426 (2,521) 1,512,178 Mining and filtration 1,022 -- -- 1,022 Corporate activities 247,469 282,000 -- 529,469 ----------- ----------- ----------- ----------- $ 1,594,969 $ 468,576 $ (2,546) $ 2,060,999 =========== =========== =========== ===========
1996 CONSOLIDATED Fixed maturities: U.S. Government, government agency and municipal obligations $ 642,749 $ 6,569 $ (5,105) $ 644,213 Certificates of deposit 3,963 -- -- 3,963 Commercial paper 74,866 -- -- 74,866 Bonds, notes and other 459,817 2,871 (3,919) 458,769 ----------- ----------- ----------- ----------- 1,181,395 9,440 (9,024) 1,181,811 Equity securities 295,532 387,312 (1,325) 681,519 ----------- ----------- ----------- ----------- $ 1,476,927 $ 396,752 $ (10,349) $ 1,863,330 =========== =========== =========== =========== INDUSTRY SEGMENT Asset management $ 15,823 $ 23 $ (50) $ 15,796 Property and casualty reinsurance 1,231,801 149,969 (8,995) 1,372,775 Mining and filtration 2,278 -- -- 2,278 Corporate activities 227,025 246,760 (1,304) 472,481 ----------- ----------- ----------- ----------- $ 1,476,927 $ 396,752 $ (10,349) $ 1,863,330 =========== =========== =========== ===========
The amortized cost and estimated fair value of fixed maturities at December 31, 1997, by contractual maturity, are shown below (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
AMORTIZED FAIR COST VALUE ---------- ---------- Fixed maturities: Due in one year or less $ 195,274 $ 196,114 Due after one year through five years 275,949 278,516 Due after five years through ten years 307,983 314,061 Due after ten years 147,218 151,634 Mortgage-backed securities 328,657 337,241 ---------- ---------- $1,255,081 $1,277,566 ========== ==========
The net unrealized appreciation as reported in the Consolidated Statement of Changes in Common Stockholders' Equity does not agree to the amounts shown above due to the exclusion of CT&T discontinued operations and the income tax effect. The proceeds from sales of available for sale securities were $225 million, $124 million, and $268 million, which included the proceeds from sales of fixed maturities of $137 million, $111 million, and $201 million in 1997, 1996, and 1995, respectively. Gross realized gains and gross realized losses of available for sale securities were $2.4 million and $1.6 million, $4.5 million and $0.2 million, and $38.6 million and $6.2 million, respectively, in 1997, 1996, and 1995. These amounts include gross realized gains and gross realized losses on sales of fixed maturities of $0.5 million and $1.3 million, $0.1 million and $0.2 million, and $0.6 million and $6.2 million, respectively, in 1997, 1996, and 1995. During 1997 and 1995, Alleghany had fixed maturity and equity investments that were trading below cost. The Company determined that these declines were other than temporary and, accordingly, recorded a loss provision of approximately $11.2 million and $2.3 million, for these investments. No amounts were recorded in 1996. At December 31, 1997 and 1996, investments, carried at fair value, totalling approximately $35 million and $30 million, respectively, were on deposit with various states or governmental departments to comply with property and casualty insurance laws. Assets pledged to secure trust and escrow deposits at December 31, 1997 and 1996, carried at fair value, were as follows (in thousands):
1997 1996 ------- ------- Cash $ 1,336 $18,674 U.S. Government and municipal obligations 4,794 3,202 Certificates of deposit 2,000 2,010 ------- ------- $ 8,130 $23,886 ======= =======
4. REINSURANCE In the ordinary course of business, Underwriters Reinsurance cedes reinsurance for purposes of risk diversification and limiting maximum loss exposure to catastrophic events. If such assuming reinsurers are unable to meet the obligations assumed under these agreements, Underwriters Reinsurance would remain liable. Reinsurance receivable at December 31, 1997 and 1996 consists of the following (in thousands):
1997 1996 -------- -------- Reinsurance recoverable on paid losses $ 12,808 $ 14,646 ======== ======== Ceded outstanding losses and loss adjustment expenses $374,801 $377,564 ======== ========
For the years ended December 31, 1997, 1996, and 1995, Underwriters Reinsurance ceded losses and loss adjustment expenses of $58.1 million, $86.5 million, and $49.5 million, respectively. 29 28 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries The following table indicates property and casualty premiums written and earned for the years ended December 31, 1997, 1996, and 1995 (in thousands):
1997 WRITTEN EARNED -------- -------- Premiums direct $139,761 $112,158 Premiums assumed $366,143 $352,930 Premiums ceded $ 91,713 $ 88,416 ======== ======== 1996 Premiums direct $105,053 $ 85,437 Premiums assumed $328,604 $327,308 Premiums ceded $ 73,352 $ 65,968 ======== ======== 1995 Premiums direct $ 54,038 $ 42,413 Premiums assumed $330,435 $320,328 Premiums ceded $ 92,478 $ 85,234 ======== ========
The reinsurance receivable balance as of December 31, 1997 and 1996 includes $87.8 million and $111 million, respectively, from Continental Reinsurance under reinsurance contracts entered into prior to 1993. As of December 31, 1997 and 1996, loss reserves ceded are secured by deposits in a trust fund totalling $0.1 million and $57.4 million, respectively, and letters of credit totalling $290.3 million and $104.3 million, respectively. 5. LIABILITY FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES Activity in the liability for unpaid claims and claim adjustment expenses is summarized as follows (in thousands):
1997 1996 1995 ----------- ----------- ----------- PROPERTY AND CASUALTY LOSSES AND LOSS ADJUSTMENT EXPENSES Balance at January 1 $ 1,110,020 $ 1,014,000 $ 940,527 Less reinsurance recoverables 377,564 385,580 404,210 ----------- ----------- ----------- Net balance at January 1 732,456 628,420 536,317 Incurred related to: Current year 267,530 242,332 199,783 Prior years (5,702) 1,393 3,325 ----------- ----------- ----------- Total incurred 261,828 243,725 203,108 ----------- ----------- ----------- Paid related to: Current year 35,033 23,341 9,239 Prior years 174,982 116,348 101,766 ----------- ----------- ----------- Total paid 210,015 139,689 111,005 ----------- ----------- ----------- Net balance at December 31 784,269 732,456 628,420 Plus reinsurance recoverables 374,801 377,564 385,580 ----------- ----------- ----------- Balance at December 31 $ 1,159,070 $ 1,110,020 $ 1,014,000 =========== =========== ===========
Underwriters Reinsurance's reserve for unpaid losses and loss adjustment expenses includes $64.5 million, $87.6 million, and $96.9 million gross reserves and $45.1 million, $67.5 million, and $66.5 million net reserves at December 31, 1997, 1996, and 1995, respectively, for various liability coverages related to asbestos and environmental impairment claims that arose from general liability and certain commercial multiple-peril coverages. Restrictive asbestos and environmental impairment exclusions were introduced in late 1986 on both insurance and reinsurance contracts, significantly reducing these exposures for accidents occurring after 1986. Reserves for asbestos and environmental impairment claims cannot be estimated with traditional loss reserving techniques because of uncertainties that are greater than those associated with other types of claims. Factors contributing to those uncertainties include a lack of historical data, the significant periods of time that often elapse between the occurrence of an insured loss and the reporting of that loss to the ceding company and the reinsurer, uncertainty as to the number and identity of insureds with potential exposure to such risks, unresolved legal issues regarding policy coverage, and the extent and timing of any such contractual liability. Such uncertainties are not likely to be resolved in the near future and, therefore, management believes it is not possible at this time to determine the ultimate losses in this area or develop a meaningful range of such losses. For both asbestos and environmental excess of loss reinsurance claims, Underwriters Reinsurance establishes case reserves by applying reinsurance contract terms to losses reported by ceding companies, analyzing from the first dollar of loss incurred by the primary insurer. In establishing the liability for claims for asbestos related liability and for environmental impairment claims, management considers facts currently known and the current state of the law and coverage litigation. Additionally, ceding companies often report potential losses on a precautionary basis to protect their rights under the reinsurance arrangement, which generally calls for prompt notice to the reinsurer. Ceding companies, at the time they report such potential losses, advise Underwriters Reinsurance of the ceding companies' current estimate of the extent of such loss. Underwriters Reinsurance's claims department reviews each of the precautionary claims notices and, based upon current information, assesses the likelihood of loss to Underwriters Reinsurance. Such assessment is one of the factors used in determining the adequacy of the recorded asbestos and environmental reserves. 30 29 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries 6. LONG-TERM DEBT Long-term debt at December 31, 1997 and 1996 is summarized as follows (in thousands):
1997 1996 -------- -------- ALLEGHANY Revolving credit $ 16,000 $ 0 API Senior notes at 8.6%, due through 2000 30,000 40,000 AFC Notes payable at 6.2% to 6.7% due 2007 80,000 80,000 UNDERWRITERS RE GROUP Senior notes at 7.9%, due 2006 197,384 197,116 WORLD MINERALS Notes payable at 6.0% to 7.0%, due through 1999 64,000 86,000 Other loans at 7.4% to 11.2%, due 1998 2,257 618 Capital lease obligations 0 510 -------- -------- $389,641 $404,244 ======== ========
Under the terms of a revolving credit loan agreement dated June 14, 1995 with a bank, Alleghany may borrow up to $200 million until July 2000. At Alleghany's option, borrowings bear interest at a rate based on the purchase of negotiable certificates of deposit, prevailing rates for dollar deposits in the London interbank market or the greatest of the Federal funds rate, the bank's prime rate or a specified certificate of deposit rate. $16 million and $0 were outstanding under this agreement at December 31, 1997 and 1996, respectively. A commitment fee of 1/4 of 1% per annum of the unused commitment is charged. The revolving credit agreement, among other things, requires Alleghany to maintain tangible net worth not less than $750 million, limits the amount of certain other indebtedness and contains restrictions with respect to mortgaging or pledging any of Alleghany's assets and consolidation or merger with any other corporation. In February 1995, API issued $50 million of senior notes. Proceeds were used to repay short-term borrowings and to make a dividend to Alleghany. The senior notes are being repaid in five equal annual installments which began in 1996. AFC notes are primarily secured by a $91.5 million installment note receivable. AFC has entered into a related interest rate swap agreement with a notional amount of $86 million for the purpose of matching interest expense with interest income. This swap is pay variable, receive variable. Alleghany pays a variable rate equal to the one month commercial paper rate plus 0.0625% and receives a variable rate equal to the three month LIBOR rate plus 0.375%. The swap matures on January 22, 2007. AFC is exposed to credit risk in the unlikely event of nonperformance by the swap counter party. On June 25, 1996, Underwriters Re Group issued, without recourse to Alleghany, $200 million principal amount of 7.875% Senior Notes due 2006. Of the net proceeds of the offering, $120 million was contributed to the capital of Underwriters Reinsurance, $50 million was used to repay indebtedness under Underwriters Re Group's credit agreement and the remainder is being used for general corporate purposes. On December 20, 1991, World Minerals entered into a bank loan agreement, providing for borrowings of up to $70 million, pursuant to which it borrowed $50 million, without recourse to Alleghany. On March 10, 1995, the bank loan agreement was renegotiated to provide borrowing up to $117 million. During 1995, World Minerals borrowed an additional $31 million to fund a number of small acquisitions and joint ventures. In January 1992, World Minerals entered into two interest rate swap agreements each with a notional amount of $30 million. These swaps mature on January 15, 1997 and January 15, 1999. The January 15, 1997 swap was not renewed. These swaps were entered into for the purpose of converting variable interest rate exposure to a fixed rate. One such swap was entered into as a condition of a related variable rate loan agreement which required that hedging or interest rate protection agreements be maintained with respect to not less than 50% of the variable rate borrowing commitment. World Minerals is exposed to credit risk in the unlikely event of nonperformance by the swap counter party. In June and August 1996, World Minerals repurchased from the minority interest shareholders in its subsidiary, Harborlite, all of the redeemable preferred stock for a total of $7.8 million. Regarding the Company's interest rate swaps, there were no deferred gains or losses related to terminated interest rate swap contracts as of the end of each of the last three fiscal years. The impact of Alleghany's hedging activities has been to increase its weighted average borrowing rates by 0.31%, 0.55%, and 0.36% and to increase reported interest expense by $1.2 million, $1.9 million, and $1.0 million for the years ended 1997, 1996, and 1995, respectively. Scheduled aggregate annual maturities of long-term debt for each of the next five years and thereafter are as follows (in thousands): 1998 $ 33,257 1999 69,000 2000 10,000 2001 -- 2002 -- Thereafter 277,384 -------- $389,641 ========
31 30 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries 7. INCOME TAXES Income tax expense (benefit) from continuing operations consists of the following (in thousands):
FEDERAL STATE FOREIGN TOTAL -------- -------- -------- -------- 1997 Current $ 7,345 $ 4,184 $ 6,736 $ 18,265 Deferred (4,758) 11 312 (4,435) -------- -------- -------- -------- $ 2,587 $ 4,195 $ 7,048 $ 13,830 ======== ======== ======== ======== 1996 Current $ 8,823 $ 2,481 $ 6,415 $ 17,719 Deferred (440) (286) (73) (799) -------- -------- -------- -------- $ 8,383 $ 2,195 $ 6,342 $ 16,920 ======== ======== ======== ======== 1995 Current $ 20,609 $ 2,378 $ 4,938 $ 27,925 Deferred (4,817) 600 179 (4,038) -------- -------- -------- -------- $ 15,792 $ 2,978 $ 5,117 $ 23,887 ======== ======== ======== ========
Pre-tax earnings from continuing operations includes $15.4 million, $15.7 million, and $16.1 million from foreign operations in 1997, 1996, and 1995, respectively. The difference between the federal income tax rate and the effective income tax rate on continuing operations is as follows:
1997 1996 1995 ---- ---- ---- Federal income tax rate 35.0% 35.0% 35.0% Goodwill amortization 2.3 2.4 1.3 Income subject to dividends-received deduction (4.3) (4.3) (1.0) State taxes, net of federal tax benefit 2.7 3.6 2.1 Tax-exempt interest income (7.6) (7.0) (5.5) Other, net (6.9) (0.2) (3.6) ---- ---- ---- 21.2% 29.5% 28.3% ==== ==== ====
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 1997 and 1996 are as follows (in thousands):
1997 1996 -------- -------- DEFERRED TAX ASSETS Property and casualty loss reserves $ 55,610 $ 58,951 Reserves for impaired assets 21,253 17,366 Expenses deducted for tax purposes when paid 21,964 16,672 Unearned premium reserves 7,556 4,928 Other 9,668 2,515 -------- -------- 116,051 100,432 -------- -------- Valuation allowance 4,398 4,211 -------- -------- Total deferred tax assets $111,653 $ 96,221 ======== ========
1997 1996 --------- --------- DEFERRED TAX LIABILITIES Deferred revenues and gains $(196,810) $(171,263) Tax over book depreciation (31,382) (22,700) Other (16,702) (11,474) --------- --------- Total deferred tax liabilities (244,894) (205,437) --------- --------- Net deferred tax liability $(133,241) $(109,216) ========= =========
A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. At December 31, 1997 and 1996, the Company has established a valuation allowance of $4.4 million and $4.2 million, respectively, for certain deferred state tax assets which it believes may not be realized. The Internal Revenue Service has closed its examination of Alleghany's federal income tax returns for 1991 and 1992. The deficiencies were settled for an amount which was not material. The IRS is currently examining the tax returns for the years 1993 through 1995. 8. STOCKHOLDERS' EQUITY The total number of shares of all classes of capital stock which Alleghany has authority to issue is 30,000,000, of which 8,000,000 shares are preferred stock, par value of $1.00, and 22,000,000 shares are common stock, par value of $1.00. Stockholder's equity and surplus of CT&T, CTI, Security Union and Ticor Title are restricted by borrowing agreements and statutory limitations as to payment of dividends. At December 31, 1997 approximately $204 million was available from CT&T for dividends to Alleghany. CT&T's availability of funds for dividends, however, may be further restricted by limitations imposed by statutes to which its subsidiaries are subject. CT&T's combined statutory surplus at December 31, 1997 and 1996 was $222 million and $181 million, respectively, and statutory net income for the years ended December 31, 1997, 1996, and 1995 was $54 million, $49 million, and $45 million, respectively. Stockholder's equity and surplus of Underwriters Re Group is not restricted as relates to payment of dividends. However, Underwriters Re Group's availability of funds for dividends is restricted by limitations imposed by statutes to which its subsidiaries are subject. Underwriters Reinsurance statutory surplus at December 31, 1997 and 1996 was $659 million and $614 million, respectively, and statutory net income for the years ended December 31, 1997 and 1996 was $36 million and $29 million, respectively. Stockholders' equity of World Minerals is restricted by a borrowing agreement as to payment of dividends. At December 31, 1997, 32 31 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries substantially all of World Minerals stockholders' equity was restricted as to dividend payment to Alleghany. Additionally, payments of dividends (other than stock dividends) by Alleghany to its stockholders are limited by the terms of its revolving credit loan agreement which provides that Alleghany can pay dividends up to the sum of cumulative net earnings after 1994, proceeds from the issuance of stock after 1994 and $50 million, provided that Alleghany maintains certain financial ratios as defined in the agreement. At December 31, 1997 approximately $250 million of capital was available for dividends. Such limitation will be modified in connection with the spin-off. Alleghany provides, through its 1993 Long-Term Incentive Plan, for incentive compensation of the types commonly known as restricted stock, stock options, stock appreciation rights, performance shares, performance units, and phantom stock, as well as other types of incentive compensation. Awards may include, but are not limited to, cash and/or shares of Alleghany's common stock, rights to receive cash and/or shares of common stock and options to purchase shares of common stock including options intended to qualify as incentive stock options under the Internal Revenue Code and options not intended to qualify. The number of performance shares awarded under the incentive plan to employees of the Company were 13,603 in 1997, 38,570 in 1996, and 32,250 in 1995 (as adjusted for stock dividends). Under the incentive plan, participants are entitled, at the end of a four-year award period, to the fair value of the number of shares of Alleghany's common stock (adjusted for anti-dilution from date of award), equal to the number of performance shares issued to them based on market value on the payment date and normally payable half in cash and half in stock, provided defined levels of performance are achieved. As of December 31, 1997 (for all award periods through the award period 1997), approximately 115,000 performance shares were outstanding. The amounts charged to the Company's earnings with respect to the plan was $10.9 million in 1997, $6.9 million in 1996, and $6.2 million in 1995. Alleghany also provides, through its Directors' Stock Option Plan, for the automatic grant of non-qualified stock options to purchase 1,000 shares of common stock in each year after 1987 to each non-employee director. Options to purchase 7,000 shares at the then fair market value of $208.75 were granted in 1997. Options to purchase 7,000 shares at the then fair market value of $194.69 were granted in 1996. At December 31, 1997, 45,000 options were outstanding, of which 33,000 options were fully vested at an average option price of $139. In August 1997 options outstanding under the 1993 Stock Option Plan of the Underwriters Re Group, Inc. were converted into Alleghany options. The stock options are not exerciseable until one year from the date of grant when 25% are exercisable with an additional 25% becoming exercisable on each subsequent anniversary of the grant date. Options to purchase 7,000 shares at the then weighted average fair market value of $213 were granted in 1997. At December 31, 1997, 174,000 were outstanding, of which 146,000 were fully vested at an average option price of $134. The Board of Directors has authorized the purchase from time to time of additional shares of common stock for the treasury. During 1997, 1996, and 1995, Alleghany repurchased 157, 174 shares, 92,700 shares, and 44,523 shares of its common stock at a cost of $33.1 million, $17.9 million, and $7.6 million, respectively. 9. FIXED STOCK OPTION PLAN The company has two fixed option plans as described in Note 8. The fair value of each option grant, including the converted Underwriters Re Group options, is estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for grants in 1997, 1996, and 1995, respectively; no cash dividend yield for all years; expected volatility ranged from 16 to 17 percent for all years; risk-free interest rates ranged from 4.7 to 7.0 percent; and expected lives of six and seven years. A summary of the status of the Company's fixed option plan as of December 31, 1997, 1996, and 1995 and changes during the years ending on those dates is presented below:
1997 1996 1995 WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE SHARES GRANT SHARES GRANT SHARES GRANT (000) PRICE (000) PRICE (000) PRICE ----- ----- ----- ----- ----- ----- Fixed Options Outstanding, beginning 255 128 236 121 235 119 Granted 14 213 22 200 16 140 Exercised (37) 115 (3) 78 (3) 123 Forfeited (13) 138 0 0 (12) 124 ----- ----- ----- ----- ----- ----- Outstanding, ending 219 135 255 128 236 121 ===== ===== ===== ===== ===== ===== Options exercisable at year-end 179 168 117 Weighted-average fair value of options granted during the year $68.26 $65.34 $52.71 ===== ===== ===== ===== ===== =====
33 32 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries
OPTIONS OUTSTANDING ------------------- WEIGHTED AVERAGE WEIGHTED NUMBER REMAINING AVERAGE OUTSTANDING CONTRACTUAL EXERCISE AT 12/31/97 LIFE (YEARS) PRICE ----------- ------------ -------- Range of Exercise Prices $ 60 to 85 11,000 2.0 $74 $112 to 149 174,000 6.0 125 $191 to 220 34,000 8.7 205 ------- --- --- $60 to 220 219,000 6.2 135 ======= === ===
OPTIONS EXERCISABLE ------------------- WEIGHTED NUMBER AVERAGE EXERCISABLE EXERCISE AT 12/31/97 PRICE ----------- ----- Range of Exercise Prices $ 60 to 85 11,000 $ 74 $112 to 149 162,000 124 $191 to 220 6,000 200 ------- ------- $60 to 220 179,000 124 ======= =======
The Company applies APB Opinion 25 and related interpretations in accounting for its plans. Accordingly, no compensation cost has been recognized for its fixed stock option plan. The compensation cost that has been charged against income for its performance-based plan was $10.9, $6.9 and $6.2 million in 1997, 1996 and 1995, respectively. Had compensation cost for the company's two stock-based compensation plans been determined based on the fair value at the grant date for awards under those plans consistent with the method of FASB Statement 123, the Company's net earnings and earnings per share would have been increased to the pro forma amounts indicated below:
1997 1996 1995 -------- ------- -------- Net earnings As reported $105,667 $87,048 $ 85,300 Pro forma $107,138 $87,721 $ 86,637 Basic earnings per share As reported $ 14.50 $ 11.82 $ 11.60 Pro forma $ 14.70 $ 11.92 $ 11.78 ======== ======= ========
10. EMPLOYEE BENEFIT PLANS The Company has several noncontributory defined benefit pension plans covering substantially all of its employees. The defined benefits are based on years of service and the employee's average compensation generally during the last five years of employment. The Company's funding policy is to contribute annually the amount necessary to satisfy the Internal Revenue Service's funding standards. Contributions are intended to provide not only for benefits attributed to service to date but also for those expected to be earned in the future. CT&T is a qualified trust company and, as such, serves as trustee for the assets of certain of the pension plans. The following tables set forth the defined benefit plans' funded status at December 31, 1997 and 1996 (in millions, except percentages):
1997 1996 --------- --------- ACTUARIAL PRESENT VALUE OF BENEFIT OBLIGATIONS Vested benefit obligation $ 34.3 $ 29.5 ========= ========= Accumulated benefit obligation $ 39.6 $ 35.2 ========= ========= Projected benefit obligation $ 45.1 $ 40.2 Plan assets at fair value 37.2 31.1 --------- --------- Projected benefit obligation, more than plan assets (7.9) (9.1) Unrecognized net loss (1.8) (1.8) Unrecognized prior service cost 6.7 8.1 Unrecognized net asset (1.5) (2.0) --------- --------- Pension asset recognized in the balance sheet $ (4.5) $ (4.8) ========= =========
1997 1996 1995 --------- --------- --------- NET PENSION COST INCLUDED THE FOLLOWING EXPENSE (INCOME) COMPONENTS Service cost -- benefits earned during the year $ 1.8 $ 1.8 $ 1.2 Interest cost on projected benefit obligation 2.8 3.0 2.9 Actual return on plan assets (4.9) (3.4) (5.2) Net amortization and deferral 4.2 2.4 4.0 ========= ========= ========= Net periodic pension cost included in costs and expenses $ 3.9 $ 3.8 $ 2.9 ========= ========= =========
1997 1996 -------- -------- ASSUMPTIONS USED IN COMPUTING THE FUNDED STATUS OF THE PLANS ARE AS FOLLOWS Range of rates for increases in compensation levels 4.5%-5.5% 4.5%-5.5% Range of weighted average discount rates 6.5%-7.5% 7.0%-8.0% Range of expected long-term rates of return 4.0%-9.0% 4.0%-9.0%
The Company provides supplemental retirement benefits through deferred compensation programs and profit sharing plans for certain of its officers and employees for which earnings were 34 33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries charged $6.2 million in 1997, $5.8 million in 1996, and $3.8 million in 1995. The Company also provides certain healthcare and life insurance benefits for retired employees. The cost of these benefits is accrued during the period that employees render service. The accrued postretirement benefit obligation was $1.7 and $1.8 million at December 31, 1997 and 1996 respectively. The postretirement healthcare and life insurance costs recognized were $.6 million, $.7 million, and $.7 million for 1997, 1996, and 1995, respectively. 11. EARNINGS PER SHARE Earnings per share has been computed in accordance with the provisions of SFAS 128. The following is a reconciliation of the income and share data used in the basic and diluted earnings per share computations for the years ended December 31 (in thousands, except per share amounts):
1997 1996 1995 ---------- ---------- ---------- Income from continuing operations $ 51,400 $ 40,470 $ 60,366 Discontinued operations 54,267 46,578 24,934 ---------- ---------- ---------- Income available to common stockholders for basic earnings per share 105,667 87,048 85,300 ========== ========== ========== Effect of dilutive securities 0 0 0 ---------- ---------- ---------- Income available to common stockholders for diluted earnings per share $ 105,667 $ 87,048 $ 85,300 ========== ========== ========== Weighted average common shares outstanding applicable to basic earnings per share 7,287,459 7,360,584 7,354,822 ========== ========== ========== Effect of dilutive securities Options 72,512 12,456 10,040 ---------- ---------- ---------- Adjusted weighted average common shares outstanding applicable to diluted earnings per share 7,359,971 7,373,040 7,364,862 ========== ========== ==========
Contingently issuable shares of 57,432, 59,888, and 44,841 were potentially available during 1997, 1996, and 1995, respectively, but were not included in the computation of diluted earnings per share because the impact was anti-dilutive to the earnings per share calculation. 12. COMMITMENTS AND CONTINGENCIES The Company leases certain facilities, furniture and equipment under long-term lease agreements. In addition, certain land, office space and equipment are leased under noncancelable operating leases which expire at various dates through 2012. Rent expense was $7.9 million, $6.5 million, and $6.3 million in 1997, 1996, and 1995, respectively. The aggregate minimum payments under operating leases with initial or remaining terms of more than one year are $7.5 million, $6.5 million, $5.5 million, $4.4 million, $3.3 million, and $8.7 million in 1998, 1999, 2000, 2001, 2002, and thereafter, respectively. The Company's subsidiaries and division are parties to pending litigation and claims in connection with the ordinary course of their businesses. Each such operating unit makes provisions for estimated losses to be incurred in such litigation and claims, including legal costs. In the opinion of management, based in part on advice of counsel, such provisions are adequate. 13. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair values of the Company's financial instruments are as follows (in thousands):
1997 1996 CALCULATED CALCULATED CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ---------- ---------- ---------- ---------- ASSETS Investments $2,060,999 $2,060,999 $1,863,330 $1,863,330 Notes receivable $ 91,536 $ 91,536 $ 91,536 $ 91,536 LIABILITIES Long-term debt $ 389,641 $ 391,898 $ 404,244 $ 404,961 ========== ========== ========== ==========
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate fair value: INVESTMENTS: The fair value of fixed maturities and equity securities are based upon quoted market prices. The fair value of short term investments approximates amortized cost. NOTES RECEIVABLE: The carrying amount approximates fair value because interest rates approximate market rates. LONG-TERM DEBT: The fair value of the Company's long-term debt is estimated based on the quoted market prices for the same or similar issues or on current rates offered to the Company for debt of the same remaining maturities. The fair value includes the effects of the interest rate swaps. 35 34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries 14. SEGMENTS OF BUSINESS Information concerning the Company's continuing operations by industry segment as of and for the years ended December 31, 1997, 1996, and 1995, respectively, is summarized as follows (in thousands):
1997 1996 1995 ---------- ---------- ---------- REVENUES Asset management $ 78,823 $ 53,280 $ 40,261 Property and casualty reinsurance 453,135 410,867 322,204 Mining and filtration 203,295 198,518 178,686 Corporate activities 61,401 71,817 111,293 ---------- ---------- ---------- Total $ 796,654 $ 734,482 $ 652,444 ========== ========== ========== EARNINGS FROM CONTINUING OPERATIONS, BEFORE INCOME TAXES Asset management $ 19,876 $ 9,726 $ 9,381 Property and casualty reinsurance 60,405 46,755 28,998 Mining and filtration 33,178 24,559 31,407 Corporate activities 9,319 23,176 58,232 ---------- ---------- ---------- 122,778 104,216 128,018 Interest expense 32,111 26,573 22,526 Corporate administration 25,437 20,253 21,239 ---------- ---------- ---------- Total $ 65,230 $ 57,390 $ 84,253 ========== ========== ========== IDENTIFIABLE ASSETS AT DECEMBER 31 Asset management $ 42,516 $ 50,757 $ 43,472 Property and casualty reinsurance 2,240,549 2,053,101 1,750,008 Mining and filtration 302,183 310,444 315,074 Corporate activities 729,677 689,301 655,215 ---------- ---------- ---------- Total $3,314,925 $3,103,603 $2,763,769 ========== ========== ========== CAPITAL EXPENDITURES Asset management $ 1,100 $ 1,190 $ 1,367 Property and casualty reinsurance 2,472 1,270 1,292 Mining and filtration 12,057 16,379 22,749 Corporate activities 951 338 383 ---------- ---------- ---------- Total $ 16,580 $ 19,177 $ 25,791 ========== ========== ========== DEPRECIATION AND AMORTIZATION Asset management $ 1,157 $ 910 $ 1,218 Property and casualty reinsurance 6,235 6,018 7,180 Mining and filtration 16,143 16,307 11,590 Corporate activities 643 780 553 ---------- ---------- ---------- Total $ 24,178 $ 24,015 $ 20,541 ========== ========== ==========
15. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) Selected quarterly financial data for 1997 and 1996 are presented below (in thousands, except per share amounts):
QUARTERS ENDED MAR. 31 JUN. 30 SEP. 30 DEC. 31 -------- -------- -------- -------- 1997 Revenues from continuing operations $194,346 $196,309 $204,974 $201,025 ======== ======== ======== ======== Earnings from continuing operations $ 6,980 $ 17,101 $ 13,973 $ 13,346 ======== ======== ======== ======== Earnings from discontinued operations 5,928 16,838 16,039 15,462 ======== ======== ======== ======== Net earnings $ 12,908 $ 33,939 $ 30,012 $ 28,808 ======== ======== ======== ======== Basic earnings per share of common stock: * Continuing operations $ .96 $ 2.36 $ 1.91 $ 1.82 ======== ======== ======== ======== Discontinued operations .81 2.33 2.19 2.11 ======== ======== ======== ======== Basic net earnings $ 1.77 $ 4.69 $ 4.10 $ 3.93 ======== ======== ======== ======== 1996 Revenues from continuing operations $173,038 $189,517 $194,128 $177,799 ======== ======== ======== ======== Earnings from continuing operations $ 8,433 $ 8,548 $ 9,855 $ 13,634 ======== ======== ======== ======== Earnings from discontinued operations 8,378 14,250 10,049 13,901 ======== ======== ======== ======== Net earnings $ 16,811 $ 22,798 $ 19,904 $ 27,535 ======== ======== ======== ======== Basic earnings per share of common stock: * Continuing operations $ 1.16 $ 1.16 $ 1.33 $ 1.84 ======== ======== ======== ======== Discontinued operations 1.16 1.94 1.36 1.88 ======== ======== ======== ======== Basic net earnings $ 2.32 $ 3.10 $ 2.69 $ 3.72 ======== ======== ======== ========
* Adjusted to reflect subsequent stock dividends and the adoption of Financial Accounting Standards No.128, "Earnings per Share." Earnings per share by quarter may not equal the amount for the year due to the timing of share transactions and rounding. 36 35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Alleghany Corporation and Subsidiaries 16. OTHER INFORMATION a. Other assets shown in the consolidated balance sheets at December 31, 1997 and 1996 include goodwill, net of accumulated amortization, are as follows (in thousands):
AMORTIZATION 1997 1996 PERIOD ------- ------- -------- Underwriters Re Group $43,565 $46,344 20 years World Minerals 29,790 28,991 40 years ------- ------- -------- $73,355 $75,335 ======= ======= ========
Goodwill is reviewed for impairment whenever events or circumstances provide evidence that suggests that the carrying amount of the asset may not be recoverable. In addition, other assets shown at December 31, 1997 and 1996 includes $29.6 million and $20.8 million, respectively, of deferred acquisition costs. Amortization of deferred acquisition costs included in the 1997, 1996, and 1995 statement of earnings were $94.4 million, $88.9 million, and $63.6 million, respectively. b. Other liabilities shown in the consolidated balance sheets include the following amounts at December 31, 1997 and 1996 (in millions):
1997 1996 --------- --------- Accounts payable $ 22.6 $ 21.0 Unearned premiums $ 136.3 $ 95.5 Reinsurance payable $ 30.9 $ 24.0 Funds held for reinsurers $ 99.3 $ 87.1 ========= =========
c. Property and equipment, net of accumulated depreciation and amortization at December 31, 1997 and 1996, are as follows (in thousands):
DEPRECIATION 1997 1996 PERIOD --------- --------- ----------- LAND $ 16,575 $ 16,911 -- Buildings and improvements 47,656 52,448 30-40 years Furniture and equipment 158,151 143,111 3-20 years Ore reserves 32,082 31,714 30 years Leasehold improvements 2,924 1,924 Various --------- --------- ----------- 257,388 246,108 Less: Accumulated depreciation and amortization (64,084) (52,299) --------- --------- ----------- $ 193,304 $ 193,809 ========= ========= ===========
37 36 INDEPENDENT AUDITORS' REPORT Alleghany Corporation and Subsidiaries [KPMG PEAT MARWICK LLP LOGO] Certified Public Accountants 757 Third Avenue New York, NY 10017 THE BOARD OF DIRECTORS AND STOCKHOLDERS ALLEGHANY CORPORATION: We have audited the accompanying consolidated balance sheets of Alleghany Corporation and subsidiaries as of December 31, 1997 and 1996, and the related consolidated statements of earnings, changes in common stockholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1997. These consolidated financial statements, appearing on pages 22 through 37, are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Alleghany Corporation and subsidiaries at December 31, 1997 and 1996, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 1997, in conformity with generally accepted accounting principles. /s/ KPMG PEAT MARWICK LLP KPMG PEAT MARWICK LLP February 20, 1998 38 37 APPENDIX Page Narrative Description of Graphic or Image Material 1 A table of year-end closing stock prices for the years 1988-97 appears in the electronic format version, replacing a bar graph that appears in the paper format version. 2 A table of stockholders' equity per share for the years 1988-97 appears in the electronic format version, replacing a bar graph that appears in the paper format version. 3 A photograph of John J. Burns, Jr., President and F.M. Kirby, Chairman, appears in the paper format version. 7 A table of CT&T's revenues and a table of CT&T's pre-tax earnings, each for the years 1993-1997 appear in the electronic format version, replacing bar graphs that appear in the paper format version. 8 A table of CT&T's stockholder's equity and a table of CT&T's claim reserves, each for the years 1993-1997 appear in the electronic format version, replacing bar graphs that appear in the paper format version. 9 A table of Alleghany Asset Management's assets under management for the years 1993-1997 appears in the paper format version replacing a bar graph that appears in the paper format version. 12 A table of Underwriters Re Group's revenues and a table of Underwriters Re Group's policy holders surplus, each for the years 1993-1997 appear in the electronic format version, replacing bar graphs in the paper format version. 14 Photographs of actual diatoms and the Research and Development group's product development appear in the paper format version. 15 A table of World Minerals' pre-tax earnings, revenues and cash flow for the years 1993-1997 appears in the electronic format version, replacing a line graph that appears in the paper format version. 16 A graphic depicting samples of steel fasteners appears in the paper format version. EX-21 5 LIST OF SUBSIDIARIES OF ALLEGHANY 1 Exhibit 21 SUBSIDIARIES OF ALLEGHANY Chicago Title and Trust Company (Illinois) Chicago Title Insurance Company (Missouri) Alexander Title Agency, Inc. (Virginia) CATCO, Inc. (Oklahoma - 50%) Chicago Title Company (California) Tri-Safe, Inc. (California - 25%) Chicago Title Company of Alameda County (California - 80%) Chicago Title Insurance Company of Puerto Rico (Puerto Rico - 99.2%) Chicago Title of Colorado, Inc. (Chicago) Creative Land Services, Inc. (Minnesota) Johnson County Title Company (Kansas) Liberty Title Company (Minnesota) McHenry County Title Company (Illinois) Meade Title Agency, Inc. (Ohio) Service Title of Virginia, Inc. (Virginia - 30%) Joint Title Plants and Associations CTP, Inc. (Florida - 16%) Dallas Seven Index, Inc. (Texas - 14%) SKLD, Inc. (Colorado - 12.91%) Title Data, Inc. (Texas - 6.25%) Diversified Information Services Corporation (Arizona) Standard Title Company of America, Inc. (Illinois - 25%) WesTitle Agency, Inc. (Arizona) Real Estate Index, Inc. (Illinois) Real Estate Index of Ohio, LLC (Ohio) McLean County Title Company (Illinois) LaSalle County Title LLC (Illinois - 60%) Spring Services Corporation (California) Spring Services Texas, Inc. (Texas) TPO, Inc. (Oklahoma) Title and Trust Company (Idaho) Baton Rouge Title Company, Inc. (Louisiana) The Title Company of Canada, Ltd. First Title and Abstract (Florida) Imaged Library Co., LLC (Washington - 50%) Yuma Title and Trust Company (Arizona) Consolidated Reconveyance Company (California) Lenders Posting and Publishing, Inc. (Delaware) Chicago Title and Trust Company Foundation (Illinois)(1) Title Accounting Services Corporation (Illinois) Iowa Land Services Corporation (Iowa) LC Investment Corporation (Indiana) The Lake County Trust Company (Indiana) RealInfo, LLC (Illinois - 50%) - -------- (1) A charitable foundation in which Chicago Title and Trust Company possesses no ownership interest.
2 Ticor Financial Company (California) Chicago Title Agency of Central Ohio (Ohio) Chicago Technology Services Corp. (Illinois) Washington Title Company (Washington) Heritage American Insurance Services (California) Decator Title Company (Illinois - 60%) Chicago Title Flood Services, Inc. (Delaware) Chicago Title Credit Services, Inc. (Delaware) Chicago Title Market Intelligence, Inc. (Massachusetts) Chicago Title Field Services, Inc. (Utah) TT Acquisition Corp. (Texas) Security Union Title Insurance Company (California) Land Title of Pierce County (Washington) Northwest Equities, Inc. (Texas) Guardian Title Company of Houston (Texas) RJW Development Company (New Jersey) Chicago Title Insurance Company of Oregon (Oregon) Real Estate Exchange, Inc. (Oregon) Title-Tax, Inc. (California) Ticor Title Insurance Company (California) Commonwealth Title Co. (Washington) Alleghany Asset Management, Inc. (Delaware) Montag & Caldwell Inc. (Georgia) Chicago Deferred Exchange Corporation (Illinois) The Chicago Trust Company (Illinois) Security Trust Company (California) Alleghany Properties, Inc. (Delaware) Sacramento Properties Holdings, Inc. (California) Alleghany Funding Corporation (Delaware) Alleghany Capital Corporation (Delaware) Mineral Holdings Inc. (Delaware - 93.4%) World Minerals Inc. (Delaware) World Minerals Acquisition Corp. (Pennsylvania) Advanced Minerals Corporation (Delaware) Fluxx France S.A. (France) LeVay & Houseman, Inc. (Nevada) World Minerals Italiana S.r.L. (Italy) World Minerals Espanola, S.A. (Spain) World Minerals (U.K.) Limited (United Kingdom) WM Canada Inc. (Canada) World Minerals do Brasil Ltda. (Brazil) World Minerals Europe, S.A. (France) World Minerals Island, h.f. (Iceland) World Minerals Japan K.K. (Japan) Celite Corporation (Delaware) Celite Europe Corporation (Delaware) Celite France, S.A. (France) Celite B.V. (Amsterdam, the Netherlands) Celite Hispanica, S.A. (Spain) Kisilidjan, h.f. (Iceland - 48.56%) Celite Mexico S.A. de C.V. (Mexico) Almeria, S.A. de C.V. (Mexico) Diatomita San Nicolas, S.A. de C.V. (Mexico) Celite Pacific Limited (Hong Kong)
-2- 3 Celite China Inc. (Delaware) Linjiang Celite Diatomite Company Ltd. (China - 72.65%) Celite Jilin, Inc. (Delaware) Changbai Celite Diatomite Company Ltd. (China - 70.11%) Celite Minerals China Corporation (Delaware) Linjiang Lin-Lin Celite Diatomite Company Limited (China - 71.89%) Celite Chile S.A. (Chile) Sociedad Minera Celite del Peru, S.A. (Peru) Celite Korea Ltd. (South Korea) Harborlite Corporation (Delaware) Perlite, Inc. (Delaware) Harborlite (U.K.) Limited (United Kingdom) Harborlite France (France) Harborlite Aegean Endustri Mineralleri-Sanayi, a.s. (Turkey) Substancias y Mineralas Navajas S.A. de C.V. (Mexico) Europerlite Acquisition Corp. (Delaware) Europerlite B.V. (Amsterdam, the Netherlands) Europerlita Espanola, S.A. (Spain) Europerlite Italiana, S.p.A. (Italy) Fluxx Corp. (Delaware) Bibb Steel and Supply Company (Delaware) MSL Property Holdings, Inc. (Delaware) MSL Capital Recovery Corp. (Delaware) J & E Corporation (Tennessee) Underwriters Re Group, Inc. (Delaware) Underwriters Reinsurance Company (New Hampshire) Commercial Underwriters Insurance Company (California) Underwriters Insurance Company (Nebraska) Texas Underwriters General Agency, Inc. (Texas) Newmarket Underwriters Insurance Company (New Hampshire) URC Risk Managers, Inc. (Delaware) The Center Insurance Services, Inc. (Delaware) The Center E&S Insurance Agency, Inc. (Georgia) The Center Special Risk Insurance Agency, Inc. (Georgia) The Center Marine Managers, Inc. (New York) The Center Financial Markets Insurance Agency, Inc. (Illinois) URC Representatives Ltd. (United Kingdom) URC International Inc. (Barbados) URC Management Inc. (Barbados) Heads and Threads (PA) LLC (Delaware)
-3- EX-23 6 CONSENT OF KPMG PEAT MARWICK LLP 1 EXHIBIT 23 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS The Board of Directors Alleghany Corporation: We consent to incorporation by reference in the Registration Statements Nos. 33-27598, 333-323, and 333-37237 on Forms S-8 and Nos. 33-55707, 33-62477, 333-9981 and 333-13971 on Forms S-3 of our reports dated February 20, 1998, relating to the financial statements and related schedules of Alleghany Corporation and subsidiaries, which appear in, or are incorporated by reference in this Annual Report on Form 10-K of Alleghany Corporation for the fiscal year ended December 31, 1997. We also consent to the reference to our Firm in Registration Statement Nos. 33-27598, 333-323, and 333-37237 and under the heading "Experts" in Registration Statement Nos. 33-55707, 33-62477, 333-9981 and 333-13971. /s/ KPMG Peat Marwick LLP New York, New York March 17, 1998 EX-27 7 FINANCIAL DATA SCHEDULE
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM ALLEGHANY CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEET AT 12/31/97 AND THE CONSOLIDATED STATEMENT OF EARNINGS FOR THE 12 MONTHS THEN ENDED 12/31/97 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 1000 12-MOS DEC-31-1997 JAN-01-1997 DEC-31-1997 1,277,566 0 0 783,433 0 0 2,060,999 47,108 387,609 0 3,700,376 1,159,070 0 0 0 389,641 0 0 0 1,570,935 3,700,376 376,672 149,724 (10,347) 203,264 261,828 0 0 65,230 13,830 51,400 54,267 0 0 105,667 14.50 14.35 0 0 0 0 0 0 0
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