UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


 

FORM 10-Q

 


 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2007

or

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             


Commission file number 001-10898


The Travelers Companies, Inc.

(Exact name of registrant as specified in its charter)

Minnesota

 

41-0518860

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

385 Washington Street,
St. Paul, MN 55102
(Address of principal executive offices) (Zip Code)

(651) 310-7911
(Registrant’s telephone number, including area code)


 

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 o

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

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o    No x

The number of shares of the Registrant’s Common Stock, without par value, outstanding at April 25, 2007 was 663,999,243.

 




The Travelers Companies, Inc.

Quarterly Report on Form 10-Q

For Quarterly Period Ended March 31, 2007

TABLE OF CONTENTS

 

 

 

Page

 

 

Part I – Financial Information

 

 

 

 

 

 

 

Item 1.

 

Financial Statements:

 

 

 

 

 

 

 

 

 

Consolidated Statement of Income (Unaudited) – Three Months EndedMarch 31, 2007 and 2006

 

3

 

 

 

 

 

 

 

Consolidated Balance Sheet – March 31, 2007 (Unaudited) and December 31, 2006

 

4

 

 

 

 

 

 

 

Consolidated Statement of Changes in Shareholders’ Equity (Unaudited) – Three Months Ended March 31, 2007 and 2006

 

5

 

 

 

 

 

 

 

Consolidated Statement of Cash Flows (Unaudited) – Three Months Ended March 31, 2007 and 2006

 

6

 

 

 

 

 

 

 

Notes to Consolidated Financial Statements (Unaudited)

 

7

 

 

 

 

 

Item 2.

 

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

 

35

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosure About Market Risk

 

66

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

67

 

 

 

 

 

 

 

Part II – Other Information

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

67

 

 

 

 

 

Item 1A.

 

Risk Factors

 

73

 

 

 

 

 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

73

 

 

 

 

 

Item 3.

 

Defaults Upon Senior Securities

 

73

 

 

 

 

 

Item 4.

 

Submission of Matters to a Vote of Security Holders

 

73

 

 

 

 

 

Item 5.

 

Other Information

 

74

 

 

 

 

 

Item 6.

 

Exhibits

 

74

 

 

 

 

 

 

 

SIGNATURES

 

74

 

 

 

 

 

 

 

EXHIBIT INDEX

 

75

 

2




Item 1.  FINANCIAL STATEMENTS

THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF INCOME (Unaudited)
(in millions, except per share data)

For the three months ended March 31,

 

2007

 

2006

 

Revenues

 

 

 

 

 

Premiums

 

$

5,295

 

$

4,991

 

Net investment income

 

960

 

875

 

Fee income

 

120

 

150

 

Net realized investment gains (losses)

 

14

 

(6

)

Other revenues

 

38

 

40

 

Total revenues

 

6,427

 

6,050

 

 

 

 

 

 

 

Claims and expenses

 

 

 

 

 

Claims and claim adjustment expenses

 

3,189

 

3,042

 

Amortization of deferred acquisition costs

 

869

 

800

 

General and administrative expenses

 

833

 

794

 

Interest expense

 

76

 

76

 

Total claims and expenses

 

4,967

 

4,712

 

Income before income taxes

 

1,460

 

1,338

 

Income tax expense

 

374

 

332

 

Net income

 

$

1,086

 

$

1,006

 

Net income per share

 

 

 

 

 

Basic

 

$

1.62

 

$

1.45

 

Diluted

 

$

1.56

 

$

1.41

 

Weighted average number of common shares outstanding:

 

 

 

 

 

Basic

 

669.9

 

692.2

 

Diluted

 

701.2

 

720.8

 

 

See notes to consolidated financial statements (unaudited).

3




 

THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(in millions)

 

 

March 31,
2007

 

December 31,
2006

 

 

 

(Unaudited)

 

 

 

Assets

 

 

 

 

 

Fixed maturities, available for sale at fair value (including $1,582 and $1,674 subject to securities lending) (amortized cost $62,716 and $62,244)

 

$

63,133

 

$

62,666

 

Equity securities, at fair value (cost $442 and $436)

 

481

 

473

 

Real estate

 

810

 

793

 

Short-term securities

 

4,886

 

4,938

 

Other investments

 

3,380

 

3,398

 

Total investments

 

72,690

 

72,268

 

Cash

 

378

 

459

 

Investment income accrued

 

795

 

827

 

Premiums receivable

 

6,156

 

6,181

 

Reinsurance recoverables

 

17,265

 

17,820

 

Ceded unearned premiums

 

1,479

 

1,243

 

Deferred acquisition costs

 

1,696

 

1,615

 

Deferred tax asset

 

1,713

 

1,536

 

Contractholder receivables

 

5,079

 

5,023

 

Goodwill

 

3,437

 

3,438

 

Intangible assets

 

920

 

764

 

Other assets

 

2,513

 

2,587

 

Total assets

 

$

114,121

 

$

113,761

 

Liabilities

 

 

 

 

 

Claims and claim adjustment expense reserves

 

$

58,821

 

$

59,288

 

Unearned premium reserves

 

11,240

 

11,228

 

Contractholder payables

 

5,079

 

5,023

 

Payables for reinsurance premiums

 

915

 

685

 

Debt

 

6,123

 

5,760

 

Other liabilities

 

6,586

 

6,642

 

Total liabilities

 

88,764

 

88,626

 

Shareholders’ equity

 

 

 

 

 

Preferred Stock Savings Plan–convertible preferred stock (0.4 shares issued and outstanding at both dates)

 

124

 

129

 

Common stock (1,750.0 shares authorized; 665.3 and 678.3 shares issued and outstanding)

 

18,634

 

18,530

 

Retained earnings

 

8,167

 

7,253

 

Accumulated other changes in equity from nonowner sources

 

417

 

452

 

Treasury stock, at cost (39.7 and 25.2 shares)

 

(1,985

)

(1,229

)

Total shareholders’ equity

 

25,357

 

25,135

 

Total liabilities and shareholders’ equity

 

$

114,121

 

$

113,761

 

 

See notes to consolidated financial statements (unaudited).

4




 

THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY (Unaudited)
(in millions)

For the three months ended March 31,

 

2007

 

2006

 

Convertible preferred stock–savings plan

 

 

 

 

 

Balance, beginning of year

 

$

129

 

$

153

 

Redemptions during period

 

(5

)

(7

)

Total preferred shareholders’ equity

 

124

 

146

 

 

 

 

 

 

 

Common stock

 

 

 

 

 

Balance, beginning of year

 

18,530

 

18,096

 

Net shares issued under employee share-based compensation plans

 

58

 

42

 

Compensation amortization under share-based plans and other

 

46

 

54

 

Balance, end of period

 

18,634

 

18,192

 

 

 

 

 

 

 

Retained earnings

 

 

 

 

 

Balance, beginning of year

 

7,253

 

3,750

 

Net income

 

1,086

 

1,006

 

Dividends

 

(175

)

(161

)

Minority interest and other

 

3

 

(1

)

Balance, end of period

 

8,167

 

4,594

 

 

 

 

 

 

 

Accumulated other changes in equity from nonowner sources, net of tax

 

 

 

 

 

Balance, beginning of year

 

452

 

351

 

Change in net unrealized gain on investment securities

 

(13

)

(388

)

Net change in unrealized foreign currency translation and other changes

 

(22

)

12

 

Balance, end of period

 

417

 

(25

)

 

 

 

 

 

 

Treasury stock (at cost)

 

 

 

 

 

Balance, beginning of year

 

(1,229

)

(47

)

Shares acquired – share repurchase program

 

(725

)

 

Net shares reacquired related to employee share-based compensation plans

 

(31

)

(23

)

Balance, end of period

 

(1,985

)

(70

)

Total common shareholders’ equity

 

25,233

 

22,691

 

Total shareholders’ equity

 

$

25,357

 

$

22,837

 

 

 

 

 

 

 

Common shares outstanding

 

 

 

 

 

Balance, beginning of year

 

678.3

 

693.4

 

Shares acquired – share repurchase program

 

(13.9

)

 

Net shares issued under employee share-based compensation plans

 

0.9

 

2.8

 

Balance, end of period

 

665.3

 

696.2

 

 

 

 

 

 

 

Summary of changes in equity from nonowner sources

 

 

 

 

 

Net income

 

$

1,086

 

$

1,006

 

Other changes in equity from nonowner sources, net of tax

 

(35

)

(376

)

Total changes in equity from nonowner sources

 

$

1,051

 

$

630

 

 

See notes to consolidated financial statements (unaudited).

5




 

THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
(in millions)

For the three months ended March 31,

 

2007

 

2006

 

Cash flows from operating activities

 

 

 

 

 

Net income

 

$

1,086

 

$

1,006

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Net realized investment (gains) losses

 

(14

)

6

 

Depreciation and amortization

 

205

 

197

 

Deferred federal income tax expense (benefit)

 

(188

)

159

 

Amortization of deferred policy acquisition costs

 

869

 

800

 

Premiums receivable

 

17

 

110

 

Reinsurance recoverables

 

548

 

636

 

Deferred acquisition costs

 

(967

)

(836

)

Claims and claim adjustment expense reserves

 

(350

)

(1,137

)

Unearned premium reserves

 

60

 

103

 

Trading account activities

 

(1

)

4

 

Excess tax benefits from share-based payment arrangements

 

(9

)

(5

)

Other

 

(389

)

(481

)

Net cash provided by operating activities

 

867

 

562

 

 

 

 

 

 

 

Cash flows from investing activities

 

 

 

 

 

Proceeds from maturities of fixed maturities

 

1,637

 

1,571

 

Proceeds from sales of investments:

 

 

 

 

 

Fixed maturities

 

729

 

1,320

 

Equity securities

 

25

 

94

 

Purchases of investments:

 

 

 

 

 

Fixed maturities

 

(3,006

)

(3,983

)

Equity securities

 

(29

)

(47

)

Real estate

 

(26

)

(8

)

Net sales (purchases) of short-term securities

 

(103

)

67

 

Net sales of other investments

 

186

 

154

 

Securities transactions in course of settlement

 

305

 

490

 

Other

 

(203

)

(38

)

Net cash used in investing activities

 

(485

)

(380

)

 

 

 

 

 

 

Cash flows from financing activities

 

 

 

 

 

Payment of debt

 

(611

)

(4

)

Issuance of debt

 

986

 

 

Dividends to shareholders

 

(175

)

(161

)

Issuance of common stock – employee share options

 

54

 

32

 

Treasury shares acquired – share repurchase program

 

(698

)

 

Treasury shares acquired – net employee share-based compensation

 

(26

)

(16

)

Excess tax benefits from share-based payment arrangements

 

9

 

5

 

Other

 

(1

)

(2

)

Net cash used in financing activities

 

(462

)

(146

)

Effect of exchange rate changes on cash

 

(1

)

 

Net increase (decrease) in cash

 

(81

)

36

 

Cash at beginning of period

 

459

 

337

 

Cash at end of period

 

$

378

 

$

373

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

Income taxes paid (received)

 

88

 

(5

)

Interest paid

 

75

 

85

 

 

See notes to consolidated financial statements (unaudited).

6




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

The interim consolidated financial statements include the accounts of The Travelers Companies, Inc. (together with its subsidiaries, the Company). These financial statements are prepared in conformity with U.S. generally accepted accounting principles (GAAP) and are unaudited.  In the opinion of the Company’s management, all adjustments necessary for a fair presentation have been reflected.  Certain financial information that is normally included in annual financial statements prepared in accordance with GAAP, but that is not required for interim reporting purposes, has been omitted.  Certain reclassifications have been made to the 2006 financial statements to conform to the 2007 presentation.  The accompanying interim consolidated financial statements and related notes should be read in conjunction with the Company’s consolidated financial statements and related notes included in the Company’s 2006 Annual Report on Form 10-K/A.

Effective February 26, 2007, The St. Paul Travelers Companies, Inc. amended its articles of incorporation to change its name to The Travelers Companies, Inc. and, effective the same day, amended its bylaws to reflect the name change.

Adoption of New Accounting Standards

Accounting for Uncertainty in Income Taxes

In July 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109 (FIN 48).  FIN 48 is intended to clarify the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes the recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.

Under FIN 48, evaluation of a tax position is a two-step process.  The first step is to determine whether it is more-likely-than-not that a tax position will be sustained upon examination, including the resolution of any related appeals or litigation based on the technical merits of that position.  The second step is to measure a tax position that meets the more-likely-than-not threshold to determine the amount of benefit to be recognized in the financial statements.  A tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.

Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent period in which the threshold is met.  Previously recognized tax positions that no longer meet the more-likely-than-not criteria should be de-recognized in the first subsequent financial reporting period in which the threshold is no longer met.

The adoption of FIN 48 at January 1, 2007 did not have a material effect on the Company’s financial position.

The total amount of unrecognized tax benefits as of January 1, 2007 was $339 million.  Included in that balance were $101 million of unrecognized tax benefits that, if recognized, would affect the annual effective tax rate and $175 million of tax positions for which the ultimate deductibility is certain, but for which there is uncertainty about the timing of deductibility.  The timing of such deductibility would not affect the annual effective tax rate.    The balance of unrecognized tax benefits at January 1, 2007 was comprised of $63 million of unrecognized tax benefits that, if recognized, would reduce goodwill.

The Company recognizes interest and penalties accrued related to unrecognized tax benefits in income taxes.  The Company had approximately $35 million for the payment of interest and penalties accrued at January 1, 2007.

As of January 1, 2007, the Internal Revenue Service (IRS) is conducting an examination of the Company’s U.S. income tax returns for the years 2002 through 2004.  During the first quarter 2007, the Company effectively settled the pre-merger Travelers Property Casualty, Corp. IRS examinations for the 2002 and 2003 years, resulting in an after-tax benefit of $28 million.

7




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES, Continued

The Company anticipates that the current IRS examination will be effectively settled within the next twelve months.  An estimate of the range of the reasonably possible change to the unrecognized tax benefits that may occur as a result of the anticipated settlement cannot be made.

Accounting for Certain Hybrid Financial Instruments

In February 2006, the FASB issued Statement of Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140 (FAS 155).  FAS 155 nullifies the guidance in the FASB’s Derivatives Implementation Group Issue D1 “Application of Statement 133 to Beneficial Interests in Securitized Assets”, which had deferred the bifurcation requirements of Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities (FAS 133), for certain beneficial interests in securitized financial assets.  FAS 155 requires that beneficial interests in securitized financial assets be analyzed to determine whether they are freestanding derivatives or hybrid instruments that contain an embedded derivative requiring bifurcation.

FAS 155 permits entities to fair value any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation.  This election is on a contract-by-contract basis and is irrevocable.  Additionally, FAS 155 narrows the exception afforded to interest-only strips and principal-only strips from derivative accounting.   In addition, FAS 155 clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a replacement of FASB Statement 125, to eliminate the restriction on the passive derivative instruments a Qualifying Special Purpose Entity can hold.

FAS 155 is effective for all financial instruments acquired, issued or subject to a remeasurement (new basis) event occurring after the beginning of an entity’s fiscal year that begins after September 15, 2006.  At adoption, for contracts where the fair value option has been elected, any difference between the total carrying amount of the individual components of the existing bifurcated hybrid financial instrument and the fair value of the combined hybrid financial instrument should be recognized as a cumulative-effect adjustment to beginning retained earnings.

In January 2007, the FASB released Statement 133 Implementation Issue No. B40, Embedded Derivatives: Application of Paragraph 13(b) to Securitized Interests in Prepayable Financial Assets (B40).  B40 provides a limited scope exception from paragraph 13(b) of FAS 133 for securitized interests that contain only an embedded derivative that is tied to the prepayment risk of the underlying prepayable financial assets and if both of the following criteria are met: (a)  the investor does not control the right to accelerate the settlement, and (b) the securitized interest does not contain an embedded derivative for which bifurcation would be required other than an embedded derivative that results from embedded call options in the underlying financial assets.  B40 is effective upon the adoption of FAS 155, except for criterion (b) which is not applicable to securitized interests issued before June 30, 2007, and that only include embedded derivatives that have an extremely remote possibility of having greater than a trivial fair value during the life of the securitized interest.

The Company adopted FAS 155 effective January 1, 2007 and it did not elect the fair value option.  There was no cumulative effect upon adoption of FAS 155.

Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts

In September 2005, the Accounting Standards Executive Committee (AcSEC) issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications or Exchanges of Insurance Contracts (SOP 05-1).  SOP 05-1 provides guidance on accounting by insurance enterprises for deferred acquisition costs on internal replacements of insurance and investment contracts other than those specifically described in Statement of Financial Accounting Standards No. 97, Accounting and Reporting by Insurance Enterprises for Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale of Investments.  SOP 05-1 defines an internal replacement as a modification in

8




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES, Continued

product benefits, features, rights, or coverages that occurs by the exchange of a contract for a new contract, or by amendment, endorsement, or rider to a contract, or by the election of a feature or coverage within a contract.  The adoption of SOP 05-1 effective January 1, 2007 did not have a material effect on the Company’s results of operations, financial condition or liquidity.

Endorsement Split-Dollar Life Insurance Arrangements

In September 2006, FASB issued Emerging Issues Task Force Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (EITF 06-4).  EITF 06-4 requires a company to recognize a liability and related compensation expense for endorsement split-dollar life insurance policies that provide a benefit to an employee that extends to postretirement periods.  EITF 06-4 is effective January 1, 2008, with earlier adoption permitted.  The early adoption of EITF 06-4 on January 1, 2007 did not have a material effect on the Company’s results of operations, financial condition or liquidity.

Accounting for Corporate-Owned Life Insurance

In September 2006, the FASB issued Emerging Issues Task Force Issue No. 06-5, Accounting for Purchase of Life Insurance – Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No 85-4 (EITF 06-5).  EITF 06-5 provides additional guidance on determining the amount that can be realized under a corporate-owned life insurance contract (that is, converted to cash) based upon how the contract is assumed to be hypothetically settled.  EITF 06-5 is effective for fiscal years beginning after December 15, 2006.  The adoption of EITF 06-5 did not have a material effect on the Company’s results of operations, financial condition or liquidity.

Accounting Standards Not Yet Adopted

Fair Value Measurements

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (FAS 157).  FAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosure about fair value measurements.  It applies to other pronouncements that require or permit fair value but does not require any new fair value measurements.  The statement defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”

FAS 157 establishes a fair value hierarchy to increase consistency and comparability in fair value measurements and disclosures.  The hierarchy is based on the inputs used in valuation and gives the highest priority to quoted prices in active markets.  The highest possible level should be used to measure fair value.

FAS 157 is effective for fiscal years beginning after November 15, 2007.  The Company does not expect the provisions of FAS 157 to have a material effect on its results of operations, financial condition or liquidity.

Fair Value Option for Financial Assets and Financial Liabilities

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (FAS 159).  FAS 159 permits an entity to irrevocably elect fair value on a contract-by-contract basis as the initial and subsequent measurement attribute for many financial assets and liabilities and certain other items including property and casualty insurance contracts.  Entities electing the fair value option would be required to recognize changes in fair value in earnings and to expense upfront costs and fees associated with the item for which the fair value option is elected.  Entities electing the fair value option are required to distinguish on the face of the statement of financial position, the fair value of assets and liabilities for which the fair value option has been elected and similar assets and liabilities measured using another measurement attribute.  An entity can accomplish this by either reporting the fair value and non-fair-value carrying amounts as separate line items or aggregate those amounts and disclose parenthetically the amount of fair value included in the aggregate amount.

9




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

1.                       BASIS OF PRESENTATION AND ACCOUNTING POLICIES, Continued

FAS 159 is effective for fiscal years beginning after November 15, 2007.  Upon adoption, an entity is permitted to elect the fair value option irrevocably for any existing asset or liability within the scope of the standard.  The adjustment to reflect the difference between the fair value and the carrying amount would be accounted for as a cumulative-effect adjustment to retained earnings as of the date of initial adoption.  Retrospective application would not be permitted.  The Company does not intend to elect the fair value option for assets and liabilities currently held, and therefore FAS 159 will not have an impact on the Company’s results of operations, financial condition or liquidity.

Collateral Assignment Split-Dollar Life Insurance Arrangements

In March 2007, the FASB issued Emerging Issues Task Force Issue No. 06-10, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Collateral Assignment Split-Dollar Life Insurance Arrangements (EITF 06-10).  EITF 06-10 provides guidance on the recognition and measurement of assets related to collateral assignment split-dollar life insurance arrangements.  EITF 06-10 is effective for fiscal years beginning after December 15, 2007.  The Company does not expect the provisions of EITF 06-10 to have a material effect on its results of operations, financial condition or liquidity.

Nature of Operations

The Company is organized into three reportable business segments: Business Insurance, Financial, Professional & International Insurance, and Personal Insurance.  These segments reflect the manner in which the Company’s businesses are managed and represent an aggregation of products and services based on type of customer, how the business is marketed, and the manner in which risks are underwritten.  The business segments are as follows:

Business Insurance

The Business Insurance segment offers a broad array of property and casualty insurance and insurance-related services to its clients primarily in the United States. Business Insurance is organized into the following six groups, which collectively comprise Business Insurance Core operations: Select Accounts, Commercial Accounts, National Accounts, Industry-Focused Underwriting, Target Risk Underwriting and Specialized Distribution.

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

Financial, Professional & International Insurance

The Financial, Professional & International Insurance segment includes surety and financial liability coverages, which require a primarily credit-based underwriting process, as well as property and casualty products that are primarily marketed on an international basis.  The segment includes the Bond & Financial Products group, as well as the International and Lloyd’s group.

In March 2007, the Company completed the sale of its Mexican surety subsidiary, Afianzadora Insurgentes, S.A. de C.V., which accounted for $79 million of net written premiums for the year ended December 31, 2006.  The impact of this transaction was not material to the Company’s results of operations or financial condition.

Personal Insurance

The Personal Insurance segment writes virtually all types of property and casualty insurance covering personal risks. The primary coverages in Personal Insurance are automobile and homeowners insurance sold to individuals.

In April 2007, the Company completed the sale of its subsidiary, Mendota Insurance Company and its wholly-owned subsidiaries, Mendakota Insurance Company and Mendota Insurance Agency, Inc.  These subsidiaries primarily offered nonstandard automobile coverage and accounted for approximately $187 million of net written premium volume for the year ended December 31, 2006.  The sale was not material to the Company’s results of operations or financial condition.

10




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

2.                       SEGMENT INFORMATION

(for the three months
 ended March 31,
 in millions)

 

Business
Insurance

 

Financial,
Professional &
International
Insurance

 

Personal
Insurance

 

Total
Reportable
Segments

 

2007 Revenues

 

 

 

 

 

 

 

 

 

Premiums

 

$

2,763

 

$

844

 

$

1,688

 

$

5,295

 

Net investment income

 

694

 

121

 

145

 

960

 

Fee income

 

120

 

 

 

120

 

Other revenues

 

4

 

5

 

24

 

33

 

Total operating revenues (1)

 

$

3,581

 

$

970

 

$

1,857

 

$

6,408

 

Operating income (1)

 

$

678

 

$

156

 

$

266

 

$

1,100

 

 

 

 

 

 

 

 

 

 

 

2006 Revenues

 

 

 

 

 

 

 

 

 

Premiums

 

$

2,643

 

$

788

 

$

1,560

 

$

4,991

 

Net investment income

 

636

 

103

 

134

 

873

 

Fee income

 

150

 

 

 

150

 

Other revenues

 

7

 

5

 

24

 

36

 

Total operating revenues (1)

 

$

3,436

 

$

896

 

$

1,718

 

$

6,050

 

Operating income (1)

 

$

651

 

$

141

 

$

240

 

$

1,032

 

 


(1)                   Operating revenues exclude net realized investment gains (losses). Operating income equals net income excluding the after-tax impact of net realized investment gains (losses).

11




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

2.                       SEGMENT INFORMATION, Continued

Business Segment Reconciliations

 

Three Months Ended
March 31,

 

(in millions)

 

2007

 

2006

 

Revenue reconciliation

 

 

 

 

 

Earned premiums:

 

 

 

 

 

Business Insurance:

 

 

 

 

 

Commercial multi-peril

 

$

760

 

$

742

 

Workers’ compensation

 

533

 

502

 

Commercial automobile

 

507

 

478

 

Property

 

481

 

451

 

General liability

 

455

 

468

 

Other

 

27

 

2

 

Total Business Insurance

 

2,763

 

2,643

 

 

 

 

 

 

 

Financial, Professional & International Insurance:

 

 

 

 

 

Fidelity and surety

 

270

 

260

 

General liability

 

242

 

247

 

International

 

300

 

251

 

Other

 

32

 

30

 

Total Financial, Professional & International Insurance

 

844

 

788

 

 

 

 

 

 

 

Personal Insurance:

 

 

 

 

 

Automobile

 

939

 

872

 

Homeowners and other

 

749

 

688

 

Total Personal Insurance

 

1,688

 

1,560

 

Total earned premiums

 

5,295

 

4,991

 

Net investment income

 

960

 

873

 

Fee income

 

120

 

150

 

Other revenues

 

33

 

36

 

Total operating revenues for reportable segments

 

6,408

 

6,050

 

Interest Expense and Other

 

5

 

6

 

Net realized investment gains (losses)

 

14

 

(6

)

Total consolidated revenues

 

$

6,427

 

$

6,050

 

 

 

 

 

 

 

Income reconciliation, net of tax

 

 

 

 

 

Total operating income for reportable segments

 

$

1,100

 

$

1,032

 

Interest Expense and Other

 

(22

)

(21

)

Total operating income

 

1,078

 

1,011

 

Net realized investment gains (losses)

 

8

 

(5

)

Total consolidated net income

 

$

1,086

 

$

1,006

 

 

12




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

2.                       SEGMENT INFORMATION, Continued

(in millions)

 

March 31,
2007

 

December 31,
2006

 

Asset reconciliation:

 

 

 

 

 

Business Insurance

 

$

86,899

 

$

86,640

 

Financial, Professional & International Insurance

 

13,255

 

13,265

 

Personal Insurance

 

13,352

 

13,294

 

Total assets for reportable segments

 

113,506

 

113,199

 

Other assets (1)

 

615

 

562

 

Total consolidated assets

 

$

114,121

 

$

113,761

 

 


(1)                   The primary components of other assets in 2007 were intangible assets and accrued over-funded benefit plan assets.  The primary components of other assets in 2006 were accrued over-funded benefit plan assets and deferred taxes.

3.                       INVESTMENTS

Fixed Maturities

The amortized cost and fair value of investments in fixed maturities classified as available-for-sale were as follows:

 

 

Amortized

 

Gross Unrealized

 

Fair

 

(at March 31, 2007, in millions)

 

Cost

 

Gains

 

Losses

 

Value

 

Mortgage-backed securities, collateralized mortgage obligations and pass-through securities

 

$

7,521

 

$

62

 

$

106

 

$

7,477

 

U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities

 

2,336

 

16

 

24

 

2,328

 

Obligations of states, municipalities and political subdivisions

 

36,459

 

589

 

92

 

36,956

 

Debt securities issued by foreign governments

 

1,410

 

5

 

9

 

1,406

 

All other corporate bonds

 

14,887

 

173

 

211

 

14,849

 

Redeemable preferred stock

 

103

 

17

 

3

 

117

 

Total

 

$

62,716

 

$

862

 

$

445

 

$

63,133

 

 

 

 

Amortized

 

Gross Unrealized

 

Fair

 

(at December 31, 2006, in millions)

 

Cost

 

Gains

 

Losses

 

Value

 

Mortgage-backed securities, collateralized mortgage obligations and pass-through securities

 

$

7,665

 

$

52

 

$

128

 

$

7,589

 

U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities

 

2,736

 

13

 

31

 

2,718

 

Obligations of states, municipalities and political subdivisions

 

35,326

 

661

 

80

 

35,907

 

Debt securities issued by foreign governments

 

1,550

 

12

 

10

 

1,552

 

All other corporate bonds

 

14,866

 

165

 

247

 

14,784

 

Redeemable preferred stock

 

101

 

16

 

1

 

116

 

Total

 

$

62,244

 

$

919

 

$

497

 

$

62,666

 

 

Equity Securities

The cost and fair value of investments in equity securities were as follows:

 

 

 

 

Gross Unrealized

 

Fair

 

(at March 31, 2007, in millions)

 

Cost

 

Gains

 

Losses

 

Value

 

Common stock

 

$

106

 

$

29

 

$

 

$

135

 

Non-redeemable preferred stock

 

336

 

16

 

6

 

346

 

Total

 

$

442

 

$

45

 

$

6

 

$

481

 

 

13




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       INVESTMENTS, Continued

 

 

 

 

Gross Unrealized

 

Fair

 

(at December 31, 2006, in millions)

 

Cost

 

Gains

 

Losses

 

Value

 

Common stock

 

$

88

 

$

27

 

$

 

$

115

 

Non-redeemable preferred stock

 

348

 

15

 

5

 

358

 

Total

 

$

436

 

$

42

 

$

5

 

$

473

 

 

Other Investments

Venture Capital

The cost and fair value of investments in venture capital were as follows:

 

 

 

 

Gross Unrealized

 

Fair

 

(at March 31, 2007, in millions)

 

Cost

 

Gains

 

Losses

 

Value

 

Venture capital

 

$

372

 

$

103

 

$

 

$

475

 

 

 

 

 

 

Gross Unrealized

 

Fair

 

(at December 31, 2006, in millions)

 

Cost

 

Gains

 

Losses

 

Value

 

Venture capital

 

$

392

 

$

109

 

$

1

 

$

500

 

 

Variable Interest Entities (VIEs)

The following entities are consolidated:

·                  Municipal Trusts—The Company owns interests in various municipal trusts that were formed for the purpose of allowing more flexibility to generate investment income in a manner consistent with the Company’s investment objectives and tax position.  As of March 31, 2007 and December 31, 2006, there were 34 and 35 such trusts, respectively, which held a combined total of $379 million and $391 million, respectively, in municipal securities, of which $65 million and $76 million, respectively, were owned by outside investors. The net carrying value of the trusts owned by the Company at March 31, 2007 and December 31, 2006 was $314 million and $315 million, respectively.

The Company has significant interests in the following VIEs, which are not consolidated because the Company is not considered to be the primary beneficiary:

·                  The Company has a significant variable interest in two real estate entities.  These investments have total assets of approximately $286 million and $305 million as of March 31, 2007 and December 31, 2006, respectively. The carrying value of the Company’s share of these investments was approximately $20 million at March 31, 2007 and $33 million at December 31, 2006. The Company has an unfunded commitment of $12 million associated with one of these funds. The Company’s exposure to loss is limited to the investment carrying amounts reported in the consolidated balance sheet and the unfunded commitment amount. The purpose of the Company’s involvement in these entities is to generate investment returns.

14




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       INVESTMENTS, Continued

·                  The Company has a significant variable interest in Camperdown UK Limited, which The St. Paul Companies, Inc. (SPC) sold in December 2003. The Company’s variable interest resulted from an agreement to indemnify the purchaser in the event a specified reserve deficiency develops, a reserve-related foreign exchange impact occurs, or a foreign tax adjustment is imposed on a pre-sale reporting period. The maximum amount of this indemnification obligation is $184 million. The fair value of this obligation as of both March 31, 2007 and December 31, 2006 was $65 million.  See “Guarantees” section of note 11.

The Company has other significant interests in variable interest entities that are not material.

The following securities are not consolidated:

·                  Mandatorily redeemable preferred securities of trusts holding solely the subordinated debentures of the Company - These securities were issued by three separate trusts that were established for the sole purpose of issuing the securities to investors and are fully guaranteed by the Company.  The Company held beneficial interests in the trusts of $10 million and $13 million at March 31, 2007 and December 31, 2006, respectively.  The debt that the Company issued to these trusts is included in the “Debt” section of liabilities on the Company’s consolidated balance sheet. That debt had a carrying value of $311 million at March 31, 2007 and $399 million at December 31, 2006.  During the first quarter of 2007, the Company redeemed the $81 million, 8.47% subordinated debentures issued to USF&G Capital II, which in turn redeemed its preferred securities.

Unrealized Investment Losses

The following tables summarize, for all investment securities in an unrealized loss position at March 31, 2007 and December 31, 2006, the aggregate fair value and gross unrealized losses by length of time those investments have been continuously in an unrealized loss position.

 

 

Less than 12 months

 

12 months or
longer

 

Total

 

(at March 31, 2007, in millions)

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fixed maturities

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities, collateralized mortgage obligations and pass-through securities

 

$

712

 

$

4

 

$

4,221

 

$

102

 

$

4,933

 

$

106

 

U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities

 

188

 

 

1,091

 

24

 

1,279

 

24

 

Obligations of states, municipalities and political subdivisions

 

6,844

 

32

 

4,069

 

60

 

10,913

 

92

 

Debt securities issued by foreign governments

 

713

 

5

 

503

 

4

 

1,216

 

9

 

All other corporate bonds

 

2,855

 

25

 

6,740

 

186

 

9,595

 

211

 

Redeemable preferred stock

 

27

 

3

 

4

 

 

31

 

3

 

Total fixed maturities

 

11,339

 

69

 

16,628

 

376

 

27,967

 

445

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

 

 

 

 

 

 

Nonredeemable preferred stock

 

54

 

2

 

77

 

4

 

131

 

6

 

Total equity securities

 

54

 

2

 

77

 

4

 

131

 

6

 

Venture capital

 

 

 

 

 

 

 

Total

 

$

11,393

 

$

71

 

$

16,705

 

$

380

 

$

28,098

 

$

451

 

 

15




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

3.                       INVESTMENTS, Continued

 

 

Less than 12 months

 

12 months or
longer

 

Total

 

(at December 31, 2006, in millions)

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fair
Value

 

Gross
Unrealized
Losses

 

Fixed maturities

 

 

 

 

 

 

 

 

 

 

 

 

 

Mortgage-backed securities, collateralized mortgage obligations and pass-through securities

 

$

1,245

 

$

11

 

$

4,125

 

$

117

 

$

5,370

 

$

128

 

U.S. Treasury securities and obligations of U.S. Government and government agencies and authorities

 

1,014

 

2

 

964

 

29

 

1,978

 

31

 

Obligations of states, municipalities and political subdivisions

 

4,468

 

16

 

4,077

 

64

 

8,545

 

80

 

Debt securities issued by foreign governments

 

861

 

6

 

406

 

4

 

1,267

 

10

 

All other corporate bonds

 

3,690

 

36

 

6,325

 

211

 

10,015

 

247

 

Redeemable preferred stock

 

1

 

 

5

 

1

 

6

 

1

 

Total fixed maturities

 

11,279

 

71

 

15,902

 

426

 

27,181

 

497

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equity securities

 

 

 

 

 

 

 

 

 

 

 

 

 

Common stock

 

3

 

 

1

 

 

4

 

 

Nonredeemable preferred stock

 

50

 

1

 

53

 

4

 

103

 

5

 

Total equity securities

 

53

 

1

 

54

 

4

 

107

 

5

 

Venture capital

 

 

 

14

 

1

 

14

 

1

 

Total

 

$

11,332

 

$

72

 

$

15,970

 

$

431

 

$

27,302

 

$

503

 

 

Impairment charges included in net realized investment gains were as follows:

 

Three Months Ended
March 31,

 

 

 

2007

 

2006

 

 

 

 

 

 

 

Fixed maturities

 

$

1

 

$

 

Equity securities

 

1

 

1

 

Venture capital

 

7

 

5

 

Other investments (excluding venture capital)

 

 

4

 

Total

 

$

9

 

$

10

 

 

4.                       GOODWILL AND OTHER INTANGIBLE ASSETS

Goodwill

The following table presents the carrying amount of the Company’s goodwill by segment at March 31, 2007 and December 31, 2006:

(in millions)

 

March 31,
2007

 

December 31,
2006

 

Business Insurance

 

$

2,168

 

$

2,168

 

Financial, Professional & International Insurance

 

550

 

551

 

Personal Insurance

 

613

 

613

 

Other

 

106

 

106

 

Total

 

$

3,437

 

$

3,438

 

 

16




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

4.                       GOODWILL AND OTHER INTANGIBLE ASSETS, Continued

Other Intangible Assets

The following presents a summary of the Company’s intangible assets by major asset class as of March 31, 2007 and December 31, 2006:

(At March 31, 2007, in millions)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Intangibles subject to amortization

 

 

 

 

 

 

 

Customer-related

 

$

1,036

 

$

569

 

$

467

 

Fair value adjustment on claims and claim adjustment expense reserves and reinsurance recoverables (1)

 

191

 

(47

)

238

 

Total intangible assets subject to amortization

 

1,227

 

522

 

705

 

Intangible assets not subject to amortization (2)

 

215

 

 

215

 

Total intangible assets

 

$

1,442

 

$

522

 

$

920

 

 

(At December 31 2006, in millions)

 

Gross
Carrying
Amount

 

Accumulated
Amortization

 

Net

 

Intangibles subject to amortization

 

 

 

 

 

 

 

Customer-related

 

$

1,036

 

$

537

 

$

499

 

Fair value adjustment on claims and claim adjustment expense reserves and reinsurance recoverables (1)

 

191

 

(54

)

245

 

Total intangible assets subject to amortization

 

1,227

 

483

 

744

 

Intangible assets not subject to amortization

 

20

 

 

20

 

Total intangible assets

 

$

1,247

 

$

483

 

$

764

 

 


(1)

 

The time value of money and the risk margin (cost of capital) components of the intangible asset run off at different rates, and as such, the amount recognized in income may be a net benefit in some periods and a net expense in other periods.

 

 

 

(2)

 

During the first quarter of 2007, the Company acquired certain trademarks, service marks and logos.

17




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

4.                       GOODWILL AND OTHER INTANGIBLE ASSETS, Continued

The following presents a summary of the Company’s amortization expense for intangible assets by major asset class:

(for the three months ended March 31, in millions)

 

2007

 

2006

 

Customer-related

 

$

33

 

$

36

 

Marketing-related

 

 

3

 

Fair value adjustment on claims and claim adjustment expense reserves and reinsurance recoverables

 

6

 

3

 

Total amortization expense

 

$

39

 

$

42

 

 

Intangible asset amortization expense is estimated to be $107 million for the remainder of 2007, $126 million in 2008, $100 million in 2009, $86 million in 2010 and $69 million in 2011.

5.         DEBT

In March 2007, the Company issued $1 billion aggregate principal amount of 6.25% fixed-to-floating rate junior subordinated debentures due March 15, 2067 for net proceeds of $986 million (after original issue discount and expenses).  The debentures were issued at a discount, resulting in an effective interest rate of 6.447%.  The debentures bear interest at an annual rate of 6.25% from the date of issuance to March 15, 2017, payable semi-annually on March 15 and September 15.  From and including March 15, 2017, the debentures will bear interest at an annual rate equal to three-month LIBOR plus 2.215%, payable quarterly on March 15, June 15, September 15 and December 15 of each year.  The Company has the right, on one or more occasions, to defer the payment of interest on the debentures. The Company will not be required to settle deferred interest until it has deferred interest for five consecutive years or, if earlier, made a payment of current interest during a deferral period. The Company may defer interest for up to ten consecutive years without giving rise to an event of default.  Deferred interest will accumulate additional interest at an annual rate equal to the annual interest rate then applicable to the debentures.

The debentures carry a 60-year final maturity and a scheduled maturity date in year thirty.  During the 180-day period ending ten days prior to the scheduled maturity date, the Company is required to use commercially reasonable efforts to sell enough qualifying capital securities, or at its option, common stock, qualifying warrants, mandatorily convertible preferred stock, debt exchangeable for common equity or debt exchangeable for preferred equity to permit repayment of the debentures at the scheduled maturity date.  If any debentures remain outstanding after the scheduled maturity date, the unpaid amount will remain outstanding until the Company has raised sufficient proceeds from the sale of qualifying capital securities, or at its option, common stock, qualifying warrants, mandatorily convertible preferred stock, debt exchangeable for common equity or debt exchangeable for preferred equity to permit the repayment in full of the debentures.  If there are remaining debentures at the final maturity date, the Company is required to redeem the debentures using any source of funds.  Qualifying capital securities are securities (other than common stock, qualifying warrants, mandatorily convertible preferred stock, debt exchangeable for common equity, and debt exchangeable for preferred equity) which generally are treated by the ratings agencies as having similar equity content to the debentures.

The Company can redeem the debentures at its option, in whole or in part, at any time after March 15, 2017 at a redemption price of 100% of the principal amount being redeemed plus accrued but unpaid interest.  The Company can redeem the debentures at its option, in whole only, prior to March 15, 2017 in the event of certain tax or rating agency events relating to the debentures, at a redemption price of 100% of the principal amount being redeemed plus a make-whole premium.

In connection with the offering of the debentures, the Company entered into a “replacement capital covenant” for the benefit of holders of one or more designated series of the Company’s indebtedness (which will initially be the 6.750% Senior Notes due 2036). Under the terms of the replacement capital covenant, if the Company redeems the debentures at any time prior to March 15, 2047, it can only do so with the proceeds of securities that are treated by the rating agencies as having similar equity content to the debentures.

18




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

5.                                      DEBT, Continued

On January 18, 2007, the Company redeemed $81 million of 8.47% subordinated debentures originally issued in 1997 and due January 10, 2027.  The debentures were redeemable by the Company on or after January 10, 2007.  In January 1997, USF&G Capital II, a business trust, issued $100 million of capital securities, the proceeds of which, along with $3 million in capital provided by the Company, were used to purchase the subordinated debentures issued by USF&G Corporation and subsequently assumed by the Company after the merger of SPC and TPC.  During the period prior to redemption, the Company had repurchased and retired $22 million of the debentures in open market transactions.  Upon the Company’s redemption of the remaining $81 million of subordinated debentures in January 2007, USF&G Capital II in turn used the proceeds to redeem its remaining capital securities outstanding.  USF&G Capital II was then liquidated, and the Company received a $3 million distribution of capital.  The Company recorded a $3 million pretax gain on the redemption of the subordinated debentures, representing the remaining unamortized fair value adjustment recorded at the merger date, less the redemption premium paid.

On March 15, 2007, the Company’s $500 million, 5.75% senior notes matured and were fully paid.

On March 13, 2007, the Company called for redemption all of its outstanding $893 million, 4.50% convertible junior subordinated notes due in 2032 (the “notes”). The notes were originally issued by Travelers Property Casualty Corp. The Company assumed certain obligations relating to the notes pursuant to a Second Supplemental Indenture dated April 1, 2004. Each note had a principal amount of $25.00. The redemption date was April 18, 2007, and the redemption price for each note was $25.5625 plus $0.009375 of accrued and unpaid interest.  Any note called for redemption could be surrendered for conversion into common stock before the close of business on April 17, 2007. Each note was convertible into 0.4684 shares of common stock of The Travelers Companies, Inc.  As of April 17, 2007, holders of $36 million of the notes tendered their certificates in exchange for the issuance of 670,910 of the Company’s common shares.  The remaining $857 million of notes were redeemed for cash on April 18, 2007, along with accrued interest to the date of redemption.  The Company will record a $39 million pretax loss on redemption in the second quarter of 2007, due to the redemption premium paid and the write-off of remaining unamortized issuance costs.

6.                                      SHARE REPURCHASE PROGRAM

In January 2007, the Board of Directors authorized a $3 billion addition to the the Company’s $2 billion common share repurchase program originally authorized on May 2, 2006.  Under the program, repurchases may be made from time to time in the open market, pursuant to pre-set trading plans meeting the requirements of Rule 10b5-1 under the Securities Exchange Act of 1934, in private transactions or otherwise.  This program does not have a stated expiration date. The timing and actual number of shares to be repurchased in the future will depend on a variety of  factors, including corporate and regulatory requirements, price, catastrophe losses and other market conditions.  During the three months ended March 31, 2007, the Company repurchased 13.9 million shares under the program for a total cost of approximately $725 million.  The average cost per share repurchased was $52.20.

7.                       CHANGES IN EQUITY FROM NONOWNER SOURCES

The Company’s total changes in equity from nonowner sources were as follows:

 

Three Months Ended
March 31,

 

(in millions, after tax)

 

2007

 

2006

 

 

 

 

 

 

 

Net income

 

$

1,086

 

$

1,006

 

Change in net unrealized gain on investment securities

 

(13

)

(388

)

Other changes

 

(22

)

12

 

Total changes in equity from nonowner sources

 

$

1,051

 

$

630

 

 

19




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

8.                       EARNINGS PER SHARE

Basic earnings per share was computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period. The computation of diluted earnings per share reflected the effect of potentially dilutive securities.

The following is a reconciliation of the income and share data used in the basic and diluted earnings per share computations:

 

Three Months Ended
March 31,

 

(in millions, except per share amounts)

 

2007

 

2006

 

 

 

 

 

 

 

Basic

 

 

 

 

 

Net income, as reported

 

$

1,086

 

$

1,006

 

Preferred stock dividends, net of taxes

 

(1

)

(1

)

Net income available to common shareholders - basic

 

$

1,085

 

$

1,005

 

 

 

 

 

 

 

Diluted

 

 

 

 

 

Net income available to common shareholders

 

$

1,085

 

$

1,005

 

Effect of dilutive securities:

 

 

 

 

 

Convertible preferred stock

 

1

 

1

 

Zero coupon convertible notes

 

1

 

1

 

Convertible junior subordinated notes (1)

 

7

 

7

 

Net income available to common shareholders – diluted

 

$

1,094

 

$

1,014

 

 

 

 

 

 

 

Common shares

 

 

 

 

 

Basic

 

 

 

 

 

Weighted average shares outstanding

 

669.9

 

692.2

 

 

 

 

 

 

 

Diluted

 

 

 

 

 

Weighted average shares outstanding

 

669.9

 

692.2

 

Weighted average effects of dilutive securities:

 

 

 

 

 

Stock options and other incentive plans

 

9.1

 

5.9

 

Convertible preferred stock

 

3.1

 

3.6

 

Zero coupon convertible notes

 

2.4

 

2.4

 

Convertible junior subordinated notes (1)

 

16.7

 

16.7

 

Total

 

701.2

 

720.8

 

 

 

 

 

 

 

Net Income per Common Share

 

 

 

 

 

Basic

 

$

1.62

 

$

1.45

 

Diluted

 

$

1.56

 

$

1.41

 

 


(1)          Called in March 2007 and redeemed in April 2007. See note 5.

20




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

9.                           SHARE-BASED INCENTIVE COMPENSATION

The following presents stock option information for fully vested stock option awards at March 31, 2007:

Stock Options

 

Number

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Contractual
Life
Remaining

 

Aggregate
Intrinsic
Value
($ in millions)

 

Vested at end of period (1)

 

34,104,157

 

$

42.28

 

4.0 years

 

$

324

 

Exercisable at end of period

 

30,132,719

 

$

43.21

 

4.1 years

 

$

258

 

 


(1)

 

Represents awards for which the employees’ rights to receive or retain the awards are not contingent on satisfaction of a service condition and therefore the requisite service has been rendered, including those that are retirement eligible.

 

The total compensation cost recognized in earnings for all share-based incentive compensation awards was $35 million and $48 million for the periods ended March 31, 2007 and 2006, respectively.  The related tax benefit recognized in earnings was $11 million and $17 million for the periods ended March 31, 2007 and 2006, respectively.  The impact of the change in accounting policy upon adoption of FAS 123R, Share-Based Compensation, for employees that met the requisite service conditions before the awards vesting date, generally retirement eligible employees, was not material for the periods ended March 31, 2007 and 2006.

The total unrecognized compensation cost related to all nonvested share-based incentive compensation awards at March 31, 2007 was $184 million, which is expected to be recognized over a weighted-average period of 2.1 years. The total unrecognized compensation cost related to all nonvested share-based incentive compensation awards at December 31, 2006 was $125 million, which was expected to be recognized over a weighted-average period of 1.7 years.

10.                PENSION PLANS, RETIREMENT BENEFITS AND SAVINGS PLANS

The following tables summarize the components of net pension and postretirement benefit expense for the Company’s plans recognized in the consolidated statement of income.

 

Pension Plans

 

Postretirement Benefit Plans

 

(for the three months ended March 31, in millions)

 

2007

 

2006

 

2007

 

2006

 

 

 

 

 

 

 

 

 

 

 

Net Periodic Benefit Cost:

 

 

 

 

 

 

 

 

 

Service cost

 

$

17

 

$

16

 

$

 

$

 

 

Interest on benefit obligation

 

28

 

27

 

4

 

4

 

 

Expected return on plan assets

 

(38

)

(37

)

 

 

 

Amortization of unrecognized:

 

 

 

 

 

 

 

 

 

 

Prior service benefit

 

(1

)

(1

)

 

 

 

Net actuarial loss (gain)

 

1

 

2

 

(1

)

 

 

Net benefit expense

 

$

7

 

$

7

 

$

3

 

$

4

 

 

 

21




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

11.                CONTINGENCIES, COMMITMENTS AND GUARANTEES

Contingencies

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

Asbestos- and Environmental-Related Proceedings

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

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

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

An arbitration was commenced in January 2001 to determine whether and to what extent ACandS’ financial obligations for bodily injury asbestos claims are subject to insurance policy aggregate limits.  On July 31, 2003, the arbitration panel ruled in favor of TPC that asbestos bodily injury claims against ACandS are subject to the aggregate limits of the policies issued to ACandS, which have been exhausted.  In October 2003, ACandS commenced a lawsuit seeking to vacate the arbitration award as beyond the panel’s scope of authority (ACandS, Inc. v. Travelers Casualty and Surety Co., U.S.D.Ct. E.D. Pa.).  On September 16, 2004, the district court entered an order denying ACandS’ motion to vacate the arbitration award.   On January 19, 2006, the United States Court of Appeals for the Third Circuit reversed the district court’s decision and declared the arbitration award void on procedural grounds.  On May 22, 2006, the United States Supreme Court denied TPC’s petition for a writ of certiorari seeking review of the Third Circuit’s decision.  As a result, the matter has been remanded to the district court and TPC has asked the district court to remand the arbitration to the panel that initially ruled in favor of TPC for further proceedings consistent with the Third Circuit’s decision.  ACandS has opposed that request.

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

22




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

11.                CONTINGENCIES, COMMITMENTS AND GUARANTEES, Continued

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

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

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

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

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

Four appeals were taken from the August 17, 2004 ruling. On March 29, 2006, the U.S. District Court for the Southern District of New York substantially affirmed the bankruptcy court’s orders while vacating that portion of the bankruptcy court’s orders that required all future direct actions against TPC to first be approved by the bankruptcy court before proceeding in state or federal court.  Judgment was entered on March 31, 2006.

Five appeals from the March 29, 2006 ruling were filed in the U.S. Court of Appeals for the Second Circuit and TPC filed a cross-appeal.  Two appellants voluntarily dismissed their appeals and a motion to dismiss the cross-appeal was filed.  Additionally, TPC appealed from a procedural order of the district court relating to the timeliness of the cross-appeal.  On January 17, 2007, the Second Circuit dismissed TPC’s cross-appeal and denied TPC’s appeal from the procedural order.  The three remaining principal appeals have been consolidated for disposition and remain pending.  It is not possible to predict how the appellate court will rule on the pending appeals.  The Company has no obligation to pay any of the settlement amounts unless and until the orders and relief become final and are not subject to any further appellate review.

23




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

11.                CONTINGENCIES, COMMITMENTS AND GUARANTEES, Continued

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

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

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

Shareholder Litigation and Related Proceedings

Three actions against the Company and certain of its current and former officers and directors are pending in the United States District Court for the District of Minnesota.  Two of these actions, which were originally captioned Kahn v. The St. Paul Travelers Companies, Inc., et al. (Nov. 2, 2004) and Michael A. Bernstein Profit Sharing Plan v. The St. Paul Travelers Companies, Inc., et al. (Nov. 10, 2004), are putative class actions brought by certain shareholders of the Company against the Company and certain of its current and former officers and directors.  These actions have been consolidated as In re St. Paul Travelers Securities Litigation II, and a lead plaintiff and lead counsel have been appointed.  On July 11, 2005, the lead plaintiff filed an amended consolidated complaint.  The amended consolidated complaint alleges violations of federal securities laws in connection with the Company’s alleged failure to make disclosure relating to the practice of paying brokers commissions on a contingent basis, the Company’s alleged involvement in a conspiracy to rig bids and the Company’s allegedly improper use of finite reinsurance products.  On September 26, 2005, the Company and the other defendants in In re St. Paul Travelers Securities Litigation II moved to dismiss the amended consolidated complaint for failure to state a claim.  Oral argument on the Company’s motion to dismiss was presented on June 15, 2006.  By order dated September 25, 2006, the Court denied the Company’s motion to dismiss.  Discovery has commenced. On November 3, 2006, the Company and the other defendants in In re St. Paul Travelers Securities Litigation II moved for partial judgment on the pleadings seeking dismissal of the allegations relating to the allegedly improper use of finite reinsurance products. That motion remains pending.  On March 15, 2007, the lead plaintiff in In re St. Paul Travelers Securities Litigation II moved for certification of a class of all purchasers of securities of the Company and St. Paul from January 27, 2000, through and including October 14, 2004.  That motion remains pending.  In the third action, an alleged beneficiary of the Company’s 401(k) savings plan commenced a putative class action against the Company and certain of its current and former officers and directors captioned

24




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

11.                CONTINGENCIES, COMMITMENTS AND GUARANTEES, Continued

Spiziri v. The St. Paul Travelers Companies, Inc., et al. (Dec. 28, 2004).  The complaint alleges violations of the Employee Retirement Income Security Act based on the theory that defendants were allegedly aware of issues concerning the value of SPC’s loss reserves yet failed to protect plan participants from continued investment in Company stock.  On June 1, 2005, the Company and the other defendants in Spiziri moved to dismiss the complaint.  On January 4, 2006, the parties in Spiziri entered into a stipulation of settlement. The settlement remains subject to court approval.

In addition, two derivative actions have been brought in the United States District Court for the District of Minnesota against all of the Company’s current directors and certain of the Company’s former Directors, naming the Company as a nominal defendant: Rowe v. Fishman, et al. (Oct. 22, 2004) and Clark v. Fishman, et al. (Nov. 18, 2004).  The derivative actions have been consolidated for pretrial proceedings as Rowe, et al. v. Fishman, et al. and a consolidated derivative complaint has been filed.  The consolidated derivative complaint asserts state law claims, including breach of fiduciary duty, based on allegations similar to those alleged in In re St. Paul Travelers Securities Litigation II and Spiziri described above.  On March 23, 2006, the Court dismissed the complaint without prejudice and, on March 30, 2006, entered judgment in favor of the Company and the other defendants. On June 5, 2006, plaintiffs in Rowe moved to alter or amend the judgment for leave to file an amended complaint. The Company and the other defendants opposed that motion.  On November 1, 2006, the parties in Rowe entered into a stipulation of settlement whereby plaintiffs released the Company and other defendants from liability in exchange for an agreement by defendants to adopt certain corporate governance measures for the benefit of the Company.  The Court approved the settlement on April 30, 2007.

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

Other Proceedings

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

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

On October 1, 2003, Gulf entered into a final settlement agreement with Employers, and all claims and counterclaims with respect to Employers have been dismissed.  On May 26, 2004, the Court denied Gulf’s motion to dismiss certain claims asserted by Transatlantic and denied a joint motion by Transatlantic, XL and Odyssey for summary judgment against Gulf.  On December 15, 2006, Gulf and XL entered into a final settlement agreement which resolves all claims between Gulf and XL under the reinsurance agreements at issue in the litigation.  On April 13, 2007, Gulf and Transatlantic entered into a final settlement agreement which resolves all claims between Gulf and Transatlantic under the reinsurance agreements at issue in the litigation.

25




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

11.                CONTINGENCIES, COMMITMENTS AND GUARANTEES, Continued

Fact and expert discovery are complete with respect to the remaining parties: Odyssey and Gerling.  Gulf and Gerling have filed motions for partial summary judgment.  The Court has not yet set a trial date.  Gulf denies the reinsurers’ allegations, believes that it has a strong legal basis to collect the amounts due under the reinsurance contracts and intends to vigorously pursue the actions.

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

The Company is a defendant in three consolidated lawsuits in the United States District Court for the Eastern District of Louisiana arising out of disputes with certain policyholders over whether insurance coverage is available for flood losses arising from Hurricane Katrina: Chehardy, et al. v. State Farm, et al., C.A. No. 06-1672, 06-1673 and 06-1674, Vanderbrook, et al. v. State Farm Fire & Cas. Co., et al. C.A. No. 05-6323; and Xavier University of Louisiana v. Travelers Property Ca. Co. of America, C.A. No. 06-516.  Chehardy and Vanderbrook are proposed class actions in which the Company is one of several insurer defendants.  Xavier is an individual suit involving a property insurance policy brought by one of the Company’s insureds.  All of these actions allege that the losses were caused by the failure of the New Orleans levees.

On November 27, 2006, the Court issued a ruling in the three consolidated cases denying the motions of the Company and certain other insurers for a summary disposition of the cases.  The Court’s ruling does not determine that any additional amounts are owed under any of the Company’s policies or otherwise reach the merits of the policyholders’ claims.  The Company disagrees with the ruling and, along with certain other insurers named in the consolidated lawsuits, filed a motion with the United States Court of Appeals for the Fifth Circuit, seeking to have the Court of Appeals accept an immediate appeal from the District Court’s ruling. On February 1, 2007, the Fifth Circuit accepted the appeal.

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

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

26




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

11.                CONTINGENCIES, COMMITMENTS AND GUARANTEES, Continued

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

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

The Company’s internal review with respect to finite reinsurance considered finite products the Company both purchased and sold.  The Company has completed its review with respect to the identified finite products purchased and sold, and has concluded that no adjustment to previously issued financial statements is required.

Except as settled as previously disclosed, the industry-wide investigations described above are ongoing, as are the Company’s efforts to cooperate with the authorities, and the various authorities could ask that additional work be performed or reach conclusions different from the Company’s.  Accordingly, it would be premature to reach any conclusions as to the likely outcome of these matters.

Four putative class action lawsuits are pending against a number of insurance brokers and insurers, including the Company and/or certain of its affiliates, by plaintiffs who allegedly purchased insurance products through one or more of the defendant brokers.  Plaintiffs allege that various insurance brokers conspired with each other and with various insurers, including the Company and/or certain of its affiliates, to artificially inflate premiums, allocate brokerage customers and rig bids for insurance products offered to those customers.  The complaints are captioned: Redwood Oil Company v. Marsh & McLennan Companies, Inc., et al. (N.D. Ill. Jan. 21, 2005), Boros v. Marsh & McLennan Companies, Inc., et al. (N.D. Cal. Feb. 4, 2005), Mulcahy v. Arthur J. Gallagher & Co., et al. (D.N.J. Feb. 23, 2005) and Golden Gate Bridge, Highway, and Transportation District v. Marsh & McLennan Companies, Inc., et al. (D.N.J. Feb. 23, 2005).  To the extent they were not originally filed there, the federal class actions were transferred by the Judicial Panel on Multidistrict Litigation to the United States District Court for the District of New Jersey and have been consolidated with other class actions under the caption In re Insurance Brokerage Antitrust Litigation, a multidistrict litigation proceeding in that District. On August 1, 2005, various plaintiffs, including the four named plaintiffs in the above-referenced class actions, filed an amended consolidated class action complaint naming various brokers and insurers, including the Company and certain of its affiliates, on behalf of a putative nationwide class of policyholders.  The complaint includes causes of action under the Sherman Act, the Racketeer Influenced and Corrupt Organizations Act (“RICO”), state common law and the laws of the various states prohibiting antitrust violations.  Plaintiffs seek monetary damages, including punitive damages and trebled damages, permanent injunctive relief, restitution, including disgorgement of profits, interest and costs, including attorneys’ fees.  On November 29, 2005, all defendants moved to dismiss the complaint for failure to state a claim.  Oral arguments on the defendants’ motion to dismiss were heard on July 26, 2006.  On October 3, 2006, the court ruled that the complaint failed to plead actionable claims under the Sherman Act or RICO, provided plaintiffs an opportunity to replead those claims and reserved decision with respect to remaining state law claims.  On November 30, 2006, defendants renewed their motions to dismiss.  On April 5, 2007, the court dismissed the complaint. The court has provided plaintiffs with another opportunity to replead within 45 days and has stayed all discovery.  Additional individual actions have been brought in state and federal courts against the Company involving allegations similar to those in In re Insurance Brokerage Antitrust Litigation and further actions may be brought.  The Company believes that all of these lawsuits have no merit and intends to defend vigorously.

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

27




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

11.                CONTINGENCIES, COMMITMENTS AND GUARANTEES, Continued

On July 23, 2004, the Company announced that it was seeking guidance from the staff of the Division of Corporation Finance of the SEC with respect to the appropriate purchase accounting treatment for certain second quarter 2004 adjustments totaling $1.63 billion ($1.07 billion after-tax). The Company recorded these adjustments as charges in its consolidated statement of income in the second quarter of 2004. Through an informal comment process, the staff of the Division of Corporation Finance has subsequently asked for further information, which the Company has provided. Specifically, the staff has asked for information concerning the Company’s adjustments to certain of SPC’s insurance reserves and reserves for reinsurance recoverables and premiums due from policyholders, and how those adjustments may relate to SPC’s reserves for periods prior to the merger of SPC and TPC. After reviewing the staff’s questions and comments, the Company continues to believe that its accounting treatment for these adjustments is appropriate. If, however, the staff disagrees, some or all of the adjustments being discussed may not be recorded as charges in the Company’s consolidated statement of income, thereby increasing net income for the second quarter and full year 2004 and increasing shareholders’ equity at March 31, 2007 and December 31, 2006, 2005 and 2004, in each case by the approximate after-tax amount of the change. The effect on tangible shareholders’ equity (adjusted for the effects of deferred taxes associated with goodwill and intangible assets) at March 31, 2007 and December 31, 2006, 2005 and 2004 would not be material. Increases to goodwill and deferred tax liabilities would be reflected on the Company’s balance sheet as of April 1, 2004, either due to purchase accounting or adjustment of SPC’s reserves prior to the merger of SPC and TPC.  On May 3, 2006, the Company received a letter from the Division of Enforcement of the SEC (the “Division”) advising the Company that it is conducting an inquiry relating to the second quarter 2004 adjustments and the April 1, 2004 merger of SPC and TPC.  The Company is cooperating with the Division’s requests for information.

Other Commitments and Guarantees

Commitments

Investment Commitments—The Company has long-term commitments to fund venture capital investments through its subsidiary, St. Paul Venture Capital VI, LLC, through new and existing partnerships and certain other venture capital entities. The Company’s total future estimated obligations related to its venture capital investments were $84 million and $87 million at March 31, 2007 and December 31, 2006, respectively. The Company also has unfunded commitments to partnerships, joint ventures and certain private equity investments in which it invests. These additional commitments were $1.28 billion and $1.31 billion at March 31, 2007 and December 31, 2006, respectively.

Guarantees

The Company has certain contingent obligations for guarantees related to letters of credit, issuance of debt securities, third party loans related to venture capital investments and various indemnifications related to the sale of business entities.

During the first quarter of 2006, the Company entered into construction loan and performance guarantees relating to an investment in a real estate development joint venture.  The maximum obligation for the guarantees was $55 million.

In the ordinary course of selling business entities to third parties, the Company has agreed to indemnify purchasers for losses arising out of breaches of representations and warranties with respect to the business entities being sold, covenants and obligations of the Company and/or its subsidiaries following the close, and in certain cases obligations arising from undisclosed liabilities, adverse reserve development or certain named litigation.  Such indemnification provisions generally survive for periods ranging from 12 months following the applicable closing date to the expiration of the relevant statutes of limitations, or in some cases agreed upon term limitations.  As of March 31, 2007, the aggregate amount of the Company’s obligation for those indemnifications that are quantifiable related to sales of business entities was $1.84 billion.  Certain of these contingent obligations are subject to deductibles, which have to be incurred by the obligee before the Company is obligated to make payments.  Included in the indemnification obligations at March 31, 2007 was $184 million related to the Company’s variable interest in Camperdown UK Limited, which SPC sold in December 2003.  The Company’s variable interest results from an agreement to indemnify the purchaser in the event a specified reserve deficiency develops, a reserve-related foreign exchange impact occurs, or a foreign tax adjustment is imposed on a pre-sale reporting period.  The fair value of this obligation as of March 31, 2007 was $65 million, which was included in “Other Liabilities” on the Company’s consolidated balance sheet.

28




THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited), Continued

12.                               CONSOLIDATING FINANCIAL STATEMENTS OF THE TRAVELERS COMPANIES, INC. AND SUBSIDIARIES

The following consolidating financial statements of the Company have been prepared pursuant to Rule 3-10 of Regulation S-X. These consolidating financial statements have been prepared from the Company’s financial information on the same basis of accounting as the consolidated financial statements. The Travelers Companies, Inc. has fully and unconditionally guaranteed certain debt obligations of TPC, its wholly-owned subsidiary, which totaled $2.49 billion as of March 31, 2007.

Prior to the merger of SPC and TPC on April 1, 2004, TPC fully and unconditionally guaranteed the payment of all principal, premiums, if any, and interest on certain debt obligations of its wholly-owned subsidiary, Travelers Insurance Group Holdings, Inc. (TIGHI). The Travelers Companies, Inc. has fully and unconditionally guaranteed such guarantee obligations of TPC. TPC is deemed to have no assets or operations independent of TIGHI. Consolidating financial information for TIGHI has not been presented herein because such financial information would be substantially the same as the financial information provided for TPC.

CONSOLIDATING STATEMENT OF INCOME (Unaudited)

For the three months ended March 31, 2007

(in millions)

 

TPC

 

Other
Subsidiaries

 

Travelers (1)

 

Eliminations

 

Consolidated

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

Premiums

 

$

3,518

 

$

1,777

 

$

 

$

 

$

5,295

 

Net investment income

 

632

 

312

 

16

 

 

960

 

Fee income

 

116

 

4

 

 

 

120