MOMENTUM ANNUAL REPORT 2014

Transcription

1 MOMENTUM ANNUAL REPORT 2014

2 CONTENTS Executive Message....page 5 Client Profiles....page 10 Business Operations....page 22 FM Global Around the World....page 23 Financial Information...page 25 Corporate Governance...page 59 FM Global is a leading commercial property insurance company that forms long-term partnerships with its clients to support risk management objectives through a unique combination of engineering, underwriting and claims services. We work to ensure our clients business continuity by safeguarding their properties with seamless, worldwide coverage and property loss prevention engineering solutions. Industry Ratings Rating Agency Financial Strength Rating Outlook A.M. Best A+ (Superior) Stable Fitch AA (Very Strong) Stable Standard & Poor s A+ Stable For additional ratings information, view Industry Ratings at fmglobal.com. FM GLOBAL ANNUAL REPORT

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4 EXECUTIVE MESSAGE 2014 WAS A VERY SUCCESSFUL YEAR, from both an insurance and investment perspective. We maintained very high client retention, recorded modest new business success in a highly competitive environment, and provided our policyholder-owners with their seventh membership credit since Concurrently, we continued to focus on becoming a more efficient organization while achieving all of our objectives to improve our products and services. Our combined ratio of 79.4 percent was exemplary for the second straight year, and the combination of strong underwriting performance and investment results increased our surplus by 9.5 percent to US$10.6 billion. These outstanding results are indicators of the strength of our mutual business model, our balance sheet, the trusted partnerships we have formed with our clients to ensure business resilience, and the dedication of our employees around the world to deliver our products with a single-minded commitment to serve our policyholders. Review of 2014 In April 2014, our board of directors approved a membership credit of approximately US$465 million to eligible policyholders renewing between June 30, 2014, and June 29, This marks our seventh membership credit and highest total dollar amount to date. By the end of June 2015, we will have provided nearly US$2.5 billion in total membership credits to our mutual owners since The membership credit process epitomizes the core value of our mutual structure. It is our clients focus on increasing the resilience of their business that reduces the frequency and severity of losses, making it possible for us to share the benefits of positive results. Despite the inherent volatility of the business, we have consistently established the practice whenever conditions make it possible. We continued to improve our processes and capabilities in many areas, with the resolve to be more efficient and further distinguish our product in a highly competitive marketplace. A collaborative spirit and shared commitment to resilience sustains the risk management partnerships we have with our clients. In 2014 our clients did their part by improving physical risk and reducing human element risk at their locations, making significant gains in both areas. To cite one substantial measure, they installed sprinklers in 40 million square feet (3.7 million square meters) of facilities worldwide. For our part, we continued to improve our processes and capabilities in many areas, with the resolve to be more efficient and further distinguish our product in a highly competitive marketplace. Among these efforts, we continued to focus on the prominent and emerging risks for many of our clients, including risks associated with large machinery and equipment and flood. FM GLOBAL ANNUAL REPORT

5 With respect to flood, one of the world s most costly natural hazards, we increased our capabilities to help clients identify, manage and mitigate their flood risk; further expanded our global flood-mapping capabilities; and continued to use our research and approvals resources to provide more options to overcome this hazard including increasing the availability of FM Approved flood loss prevention products on a worldwide basis. Coupled with our unique understanding of risk, we continued to develop advanced analytics and predictive modeling capabilities, benefiting our policyholder-owners in the areas of risk assessment and risk improvement. Mid-year, we introduced the FM Global Resilience Index, the first data-driven tool and repository that ranks the business resilience of 130 countries. Using this index, decision-makers are able to generate insights about risk and opportunities in their supply chain to help guide their operating strategy. We continue to provide our clients market-leading timeliness in terms of delivering our insurance policies. Despite the innate complexity of our insurance products, 86 percent of policies were delivered on or before the effective date of the contract, and 96 percent were delivered within 30 days. The quality and value of our products and services continue to be recognized by industry ratings agencies, analysts and media channels. Global Finance magazine once again named FM Global World s Best Supply Chain Risk Insurance Provider. We were also honored with a BEST Award from the Association for Talent Development and recognized with an Innovation award from Business Insurance for our SimZone training facility Premium Trends For the second year in a row, the lack of insured natural disasters, combined with new and abundant forms of alternative reinsurance capacity and strong balance sheets, created a competitive marketplace. Despite the competitive environment, we retained more than 94 percent of our clients, which reinforces the value placed in the strengths that are inherent in our mutual partnership whether it be our in-house claims capabilities, global consistency or financial stability in all market conditions. TOTAL GROSS PREMIUM IN FORCE 5, , , , , IN US$ MILLIONS NON-NORTH AMERICA GROSS PREMIUM IN FORCE 1, , , , IN US$ MILLIONS 1, FM GLOBAL ANNUAL REPORT 2014

6 However, competition for new business was significant, and we did not meet our goals for adding new clients. Despite our strong retention rate, the shortfall in new business acquisition, combined with the foreign exchange rate impact of a strengthening U.S. dollar, resulted in a 1.9 percent decline in gross in-force premium. From a geographical standpoint, Australia and Europe remained significantly more competitive than North America. Affiliated FM also experienced a decline in premium, reflecting the more competitive nature of our middle-market business. While we were again challenged in writing new business, we are optimistic that we can improve upon our results in On a consolidated basis, FM Global (large commercial property) and Affiliated FM (middle-market property) represent 96.2 percent of our overall in-force premium, with Mutual Boiler Re and FM Global Cargo representing the balance. Consolidated net premium earned increased by 8.2 percent to US$4.1 billion, excluding the impact of 12 months of the membership credit. Loss Trends Our consolidated loss ratio for 2014 was 52.3 percent. The loss ratio, excluding membership credit, was 46.7 percent. This reflects the reduced number of insured natural disaster losses worldwide, as the number of claims submitted for natural disasters approached historic lows. The resulting loss ratio of 11.8 percent from natural disasters was slightly higher than prior year but still well below our five-year average of 23.6 percent. Our 2014 risk loss ratio of 31.6 percent was a slight increase over our 2013 ratio of 29.6 percent, and very close to our five-year average of 30.7 percent. Risk losses stem predominantly from fire and explosion and occur disproportionately at unsprinklered locations. Expense Trends Our 2014 expense ratio of 27.1 percent was slightly above our 2013 result. However, excluding the effect of the membership credit, our 2014 expense ratio of 24.2 percent was slightly lower than our 2013 measure of 24.9 percent. As a mutual company that has made a value promise to its clients, we remain committed to the delivery of highquality services worldwide, combined with careful expense management. A designated business process improvement team continues to identify and implement solutions that create efficiencies in business processes. The team s work, widely embraced in the organization, is already making a difference in our expenses. We are continuing to leverage technology, including mobile solutions that will streamline the way we deliver our products and services and contribute to our efficiency. LOSS RATIO 100% 54.2% 2010 EXPENSE RATIO 50% 28.6% % 60.6% Includes additional reserves for discontinued lines of business 25.1% 25.1% 51.4% % 52.3% 27.1% FM GLOBAL ANNUAL REPORT

7 Employee Trends Over the last three years, our workforce has grown by 3.8 percent. As our clients continue to expand outside of North America, our employee growth follows the same pattern. However, we lack similar economies of scale in some of the newer geographical territories, leading to a disproportionate level of resource allocation. The stability and training of our workforce is the primary source of our strength as a knowledge-based company. The average employee tenure at FM Global is 13 years, and our employee turnover rate was 6.4 percent in 2014 versus 6.7 percent in Moreover, employees completed more than 9,100 days of classroom training at an average cost of US$2,200 per employee, and another 27,000 hours of online training. Investments and Surplus Our investment portfolio produced a total return on assets of 7.1 percent. Investment allocations in profitable equity markets and outperformance in the bond portfolios helped our overall relative performance. Our investment performance and combined ratio of 79.4 percent helped increase surplus by 9.5 percent to US$10.6 billion. Both A.M. Best and Fitch reaffirmed our ratings at A+ and AA, respectively, and we have an A+ interactive rating from Standard & Poor s. We will continue to leverage our surplus for the benefit of our policyholder-owners and continue with our efforts to drive down our cost of doing business. Governance After long and valued service of more than 40 years, Shivan S. Subramaniam retired as chief executive officer of the company on December 31, His leadership was instrumental in effecting the merger that created FM Global. He served with distinction as the company s first chief executive officer and remains chairman of the board of directors. He is succeeded as chief executive officer by Thomas A. Lawson, who retains his title as president. Our board of directors, eight advisory boards and five risk management executive councils are the heart of our governance as a mutual company. They ensure our clients will always be front and center in determining FM Global s long-term strategy. We are grateful for the support and oversight they provide. In 2014 we welcomed two new members to our board of directors. They are Colin Day, Essentra plc chief executive, and a longtime member of our Europe Advisory Board; and Stuart Parker, USAA chief executive officer. We look forward to working with them both. 8 FM GLOBAL ANNUAL REPORT 2014

8 Looking Ahead We will reflect on 2014 as one of the insurance industry s best years, setting the stage for a year ahead that should be just as competitive. Adding to this challenge, a growing number of our competitors are trying to emulate our business model (specifically our engineering and loss prevention approach) because our underwriting results continue to significantly outpace the rest of the industry over the long term. Our emphasis in 2015 is to focus on flawless execution of our business model and deliver value to our clients by providing them with scientifically based, cost-effective risk management and insurance solutions that assist them in making their businesses more resilient. We will continue to leverage our surplus for the benefit of our policyholderowners and continue with our efforts to drive down our cost of doing business. Once again, our financial results reinforce the core strength of mutuality and the solid relationships we have formed with clients. While the financial numbers speak volumes, it s our people who really make the difference. Our success would not be possible without a knowledgeable, caring and dedicated workforce solely focused on the needs of our clients. As an organization, we are committed to providing them with the skills and resources they need to grow and flourish. We thank our employees for all they do to make us successful. Thomas A. Lawson President and Chief Executive Officer Shivan S. Subramaniam Chairman of the Board FM GLOBAL ANNUAL REPORT

9 CLIENT PROFILES MOMENTUM 10 FM GLOBAL ANNUAL REPORT 2014

10 For 90 years, Caterpillar Inc. has been making sustainable progress possible and driving positive change on every continent. Customers turn to Caterpillar to help them develop infrastructure, energy and natural resource assets. With 2014 sales and revenues of US$ billion, Caterpillar is the world s leading manufacturer of construction and mining equipment, diesel and natural gas engines, industrial gas turbines and diesel-electric locomotives. The company principally operates through its three product segments Construction Industries, Resource Industries and Energy & Transportation and also provides financing and related services through its Financial Products segment. HSN, Inc. (Nasdaq: HSNI) is a US$3.6 billion interactive multichannel retailer with strong direct-to-consumer expertise among its two operating segments, HSN and Cornerstone. HSNi offers innovative, differentiated retail experiences on TV, online, via mobile devices, in catalogs, and in brick and mortar stores. HSN, a leading interactive multichannel retailer which offers a curated assortment of exclusive products combined with top brand names, now reaches 95 million homes (24 hours a day, seven days a week, live 364 days a year). HSN.com offers a differentiated digital experience by leveraging content, community and commerce. In addition to its existing media platforms, HSN is the industry leader in transactional innovation, including services such as HSN Shop by Remote, the only service of its kind in the U.S., the HSN Shopping App for mobile handheld devices and HSN on Demand. Cornerstone comprises leading home and apparel lifestyle brands including Ballard Designs, Chasing Fireflies, Frontgate, Garnet Hill, Grandin Road, Improvements and TravelSmith. Cornerstone distributes approximately 320 million catalogs annually, operates seven separate digital sales sites and operates 10 retail and outlet stores. FM GLOBAL ANNUAL REPORT

11 Whether it s the 24-hour-a-day pace of HSN or 90 years of building roads and bridges at Caterpillar, our clients businesses never stop moving. At FM Global, it s our job to ensure that our policyholders never lose that momentum. 12 FM GLOBAL ANNUAL REPORT 2014

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13 A MOMENT WITH FM Global has been a strategic partner for many years. Instances like Oxford make it easy to see why we ve worked together for so long and consider them to be an integrated business partner. Edward J. Scott, Corporate Treasurer, Caterpillar

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15 Rob DeCamp, Director of Risk Management, and Gail Meyer, Risk Manager We worked with FM Global to make it happen, and didn t miss an order. Rob DeCamp, director of risk management 16 FM GLOBAL ANNUAL REPORT 2014

16 CATERPILLAR INC. FOR NEARLY 90 YEARS, CATERPILLAR HAS BEEN MOVING MOUNTAINS. Roads, bridges, airports if it s being built, there is a good chance Cat equipment is on the job. Cat products are always in demand. On February 5, 2008, Caterpillar s ability to meet that demand was tested. An F-3 tornado ripped through Oxford, Mississippi, USA, crippling a major Caterpillar manufacturing plant. Advanced warning systems helped to keep employees safe, and a seismic gas shutoff valve, recommended by FM Global, helped to eliminate the threat of fire and explosion. But the tornado destroyed nearly two-thirds of the plant. The Oxford facility supplies high-pressure couplings to many of our plants worldwide, so it is a key facility for us, explains Gail Meyer, risk manager. If you don t have these couplings, the hydraulics don t work, so the machines don t work. For Meyer, that meant getting to Oxford as soon as possible. When I arrived the next morning, FM Global was already there, working with the local folks, and putting a plan in place to get the plant up and running. Following the tornado, Caterpillar needed to immediately shift production of more than one million couplings a month to other locations. Getting the supply back up quickly to ensure we continued serving our customers was a must, says Rob DeCamp, director of risk management. Before the tornado, these fittings started and finished within those four walls. To replicate it in other locations, we ended up extending the supply chain by more than 6,000 miles (9,656 kilometers). We worked with FM Global to make it happen, and didn t miss an order. At the same time, the Oxford site needed to be rebuilt. The original contractor was called in to speed reconstruction. A temporary roof was installed, allowing Caterpillar to regain 50 percent of its production capacity by May. By October, Meyer asserts, we were up to full speed, and a month later the claim was closed record time for a loss that big. The rebuild also was an opportunity to make improvements, says DeCamp. We added new roof insulation, installed energy-efficient light fixtures and improved indoor air quality. Also, facility management collaborated with FM Global engineers to redesign product flow, creating a more efficient operation. In Meyer s view, the handling of the loss reflected the relationship between two companies with a shared mindset to keep everything moving. And it s hardly a surprise. Caterpillar s been dealing with FM Global for 80 years. We re both engineering companies, so we think alike. FM GLOBAL ANNUAL REPORT

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18 A MOMENT WITH FM Global is the right partner for our business model at HSNi. They have provided invaluable advice and best practices for our risk management program. Judy Schmeling, Chief Operating Officer and, HSNi

19 HSN, INC. THE CLOCK IS ALWAYS TICKING AT HSN: 24 hours a day, seven days a week. Every day of the year except Christmas there is something for sale on HSN. And when the clock ticks to zero, another item is ready to take its place. Because we re connected to our customer at all times, business continuity is critical, says Art Singleton, vice president and treasurer, HSN, Inc. Other organizations might be able to afford being down for a short time, but we can t afford an outage for even a minute. There is never a lull here. Business disruption is simply not an option, says Jason Lynch, director of risk and insurance, HSN, Inc. We need to be ready for anything. We re constantly working to improve our operations and minimize risk. One of HSN s biggest exposures in Florida is weather. Our studios are the heartbeat of the organization, Lynch continues. We have eight active studios here seven of them are always live. We re exposed to windstorms, lightning and power outages. We can t afford to worry about that. We have to make sure what s on TV stays on TV. HSN largely alleviated the windstorm worry by strengthening the roofs throughout the campus. FM Global was a big part of that upgrade, says Lynch. They knew exactly what actions we could take to minimize our exposure. Another driver was reputation: for HSN, even a momentary lapse in activity could be damaging. Realizing that, said Singleton, it was easy on a practical level for us to commit to risk improvements. The campus is now certified as a storm-ready facility by the National Weather Service. Backup power, a 10-day supply of fuel, contingency plans, and the readiness of a backup studio all help ensure HSN is always there for its customers. When you enter into a business relationship that is more than transactional, the parties have to establish trust, says Lynch. Our client service team at FM Global has earned that, not only with what we ve accomplished here in Florida, but also at our fulfillment centers. At one location, they recommended we retrofit a sprinkler system, an important upgrade, at a fraction of the cost of a new system. As we design new facilities, we know we are benefiting from the latest thinking in fire protection. I can say we ve never had an insurer partner with us the way FM Global has. 20 FM GLOBAL ANNUAL REPORT 2014

20 Art Singleton, and Treasurer (left), and Jason Lynch, Director of Risk and Insurance FM Global knew exactly what actions we could take to minimize our exposure. Jason Lynch, director of risk and insurance

21 BUSINESS OPERATIONS In addition to its large-risk property insurance line of business, FM Global and its member companies comprise a number of other key business operations. Several of those are described in this section. FEE FOR SERVICES PRODUCT LINES Member of the FM Global Group SM Emergency Response Consultants Affiliated FM specializes in commercial property insurance for the middle market. Affiliated FM provides tailored underwriting expertise and property loss control engineering through a select international network of broker partners. The organization has office locations in Australia, Canada, France, Germany, Italy, the Netherlands, the United Kingdom and throughout the United States, and it offers coverage in more than 60 countries. Mutual Boiler Re provides boiler and machinery insurance in North America, specializing in mechanical, electrical and pressure systems breakdown treaty reinsurance and support services to the commercial property insurance marketplace. Today it works with more than 200 insurance companies, providing coverage to their policyholders. FM Approvals provides third-party certification of property loss prevention products and services. More than 500 categories are represented, including roofing and building material, cleanroom material and electrical and fire protection equipment. FM Approvals also offers complimentary online resources dedicated to property loss prevention. FM Global Cargo provides cargo insurance coverage, automated certificate management and risk engineering services tailored to the international trade and transportation needs of global businesses. Corporate Insurance Services (CIS) is FM Global s wholly owned brokerage operation, maintaining relationships with a variety of U.S. domestic insurers, Lloyd s of London, excess and surplus lines insurers and specialty companies. FM Global Emergency Response Consultants is an emergency services training organization providing comprehensive training for emergency response personnel and those responsible for organizing, managing and/or directing emergency response activities. 22 FM GLOBAL ANNUAL REPORT 2014

22 FM GLOBAL AROUND THE WORLD FM Global products and services are available around the world. The countries listed below represent those where we regularly serve our clients. North America South America Europe, Middle East and Africa Asia/Pacific Bahamas Canada Costa Rica Dominican Republic El Salvador Guatemala Honduras Jamaica Mexico Nicaragua Panama Trinidad and Tobago United States Argentina Bolivia Brazil Chile Colombia Ecuador Paraguay Peru Uruguay Venezuela Albania Algeria Angola Armenia Austria Azerbaijan Bahrain Belgium Bosnia and Herzegovina Botswana Bulgaria Burkina Faso Cameroon Croatia Cyprus Czech Republic Denmark Egypt Estonia Finland France Gabon Georgia Germany Ghana Greece Hungary Iceland Ireland Israel Italy Jordan Kazakhstan Kenya Kuwait Kyrgyzstan Latvia Lebanon Liechtenstein Lithuania Luxembourg Macedonia Madagascar Malta Montenegro Morocco Mozambique Namibia Netherlands Norway Oman Poland Portugal Qatar Romania Russia Saudi Arabia Senegal Serbia Slovakia Slovenia South Africa Spain Sweden Switzerland Tanzania Tunisia Turkey Ukraine United Arab Emirates United Kingdom Australia Bangladesh Brunei Cambodia China Hong Kong India Indonesia Japan Laos Macau Malaysia New Zealand Pakistan Philippines Singapore South Korea Sri Lanka Taiwan Thailand Vietnam FM GLOBAL ANNUAL REPORT

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24 FINANCIAL INFORMATION Investment Report...page 26 Management s Statement on Internal Control over Financial Reporting...page 28 Report of Independent Auditors...page 29 Consolidated Balance Sheets...page 30 Consolidated Statements of Income...page 31 Consolidated Statements of Comprehensive Income...page 32 Consolidated Statements of Changes in Policyholders Surplus...page 32 Consolidated Statements of Cash Flows...page 33 Notes to Consolidated Financial Statements...page 34

25 INVESTMENT REPORT The tables below show key measures of FM Global s investment portfolios, including asset class weights, returns for both FM Global s portfolios and benchmarks, and contribution to surplus. As shown, investment returns were positive for both equities and fixed income in The benchmark U.S. stock market index (S&P 500) returned percent while FM Global s domestic bond index returned 5.14 percent. Bond returns were better than consensus expectations at the start of the year, as interest income was supplemented by rising bond prices as interest rates in general terms declined from the already low levels at the end of This further decline in interest rates, as indicated by the 10 year U.S. Treasury yield ending at 2.19 percent versus 2.97 percent at the start of the year, was unexpected given the moderately strengthening U.S. economy and reduced U.S. monetary policy accommodation. In hindsight, the interest rate reduction in both the U.S. (and globally) reflected below trend global GDP growth, low global inflation and deflation risks in some geographies, and increased monetary policy accommodation in many areas including the Eurozone. The continuation of very low global interest rates now five years after the 2008/2009 deep recession has been one of the more unusual elements of this economic cycle versus historic trends. U.S. stock returns reflected the favorable impact of low discount/interest rates combined with sound earnings growth, the latter aided significantly by continued productivity gains and accretive use of excess corporate cash generation. It should be noted that U.S. stock market returns, as measured by the large capitalization dominated S&P 500, exceeded both overseas market returns and smaller capitalization indices. Specifically on international stock returns, the MSCI excluding-u.s. index return in 2014 was 6.1 percent in local currency terms, and negative 3.9 percent in U.S. dollars, with U.S. dollar strength most pronounced late in the year. This international stock impact reduced FM Global s total stock benchmark return to percent, approximately two percentage points below the S&P 500 (note the total stock benchmark is weighted 89 percent S&P 500, 11 percent MSCI excluding-u.s.). FM Global s 2014 return on total assets was 7.09 percent compared to the benchmark of 7.93 percent. Relative returns benefited by an overweight to equities and outperformance in the bond portfolios. This was offset, however by an overweight in cash equivalents relative to bond weight, and stock returns of percent falling short of the percent benchmark return. The stock shortfall was due about equally to FM Global s large cap portfolio trailing the S&P 500 by 1/2 percentage point and the impact of outside managed small capitalization portfolios, which substantially underperformed following very strong results in prior years. As an overall characterization, investment returns were favorable in absolute terms, reflecting FM Global s typical relatively large commitment to equities, which is driven by the expectation that equities will provide significantly higher after tax return than fixed income over the intermediate to longer term horizon. Returns fell short of our benchmark weighted index (single point 48 percent stocks, 45 percent bonds, 7 percent cash) due to bond returns much higher than expected versus cash, and the relative stock performance noted above. Not included in the financial market assets in the table below are FM Global s real estate activities. In addition to providing functional support to FM Global s business operations, the real estate group manages 3.4 million square feet (314,000 square meters) of investment properties. These real property assets provide an additional element of portfolio diversification. They also provide a cost-effective approach in meeting FM Global s ongoing real estate needs, while enhancing the value of its properties. For 2014, commercial properties produced $92.2 million in revenue and $26.8 million in cash flow. All financial figures in U.S. dollars. 26 FM GLOBAL ANNUAL REPORT 2014

26 INVESTMENT REPORT Rates of Return Portfolio Benchmark Portfolio Benchmark Total portfolio 7.09% 7.93% % 12.29% 1 Debt securities Investment-grade taxable bonds 5.30% 5.14% % -1.59% 2 Municipal bonds* 7.47% 6.80% % 1.69% 3 High-yield bonds 3.04% 2.51% % 7.41% 4 Equity securities total 10.57% 11.64% % 30.51% 5 Internal portfolio 13.23% 13.69% % 32.39% 6 External portfolios** U.S. portfolios 3.12% 4.89% % 38.82% 7 International portfolios -4.67% -3.87% % 15.29% 8 1 Weighted S&P 500 Plus Global Stock Index (48%), Custom Barclays Index (45%), T Bill (7%) 2 Custom Barclays Index 3 Barclays Muni 2-12 Year 4 Merrill Lynch U.S. High-Yield Master II Constrained Index 5 S&P 500 Index (89%) plus MSCI All World ex. U.S. (11%) 6 S&P Russell 2000 Small Cap Index. 8 MSCI All World ex. U.S. * Taxable equivalent return. ** Primarily smaller sized companies. Pretax Contribution to Surplus (in millions) Investment income $ $ Realized gains Unrealized gains $ 1,085.4 $ 1,520.5 As of December Holdings (in millions) Total Percentage Total Percentage Equity securities $ 6, % $ 6, % Taxable debt securities 3, , Municipal debt securities 1, , Short-term funds 1, Alternative investments (private equity, hedge funds) Total $ 14, % $ 13, % All financial figures in U.S. dollars. FM GLOBAL ANNUAL REPORT

27 MANAGEMENT S STATEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING The management of FM Global is responsible for establishing and maintaining adequate internal control over financial reporting and for the preparation and integrity of the accompanying financial statements and other related information in this report. The consolidated financial statements of the Company and its subsidiaries, including the footnotes, were prepared in accordance with accounting principles generally accepted in the United States of America and include judgments and estimates, which, in the opinion of management, are applied on an appropriately conservative basis. The Company maintains a system of internal control intended to provide reasonable assurance that assets are safeguarded from loss or material misuse, that transactions are authorized and recorded properly, and that the accounting records may be relied upon for the preparation of the financial statements. This system is tested and evaluated regularly for adherence and effectiveness by the Company s staff of internal auditors. The audit committee of the Board of Directors, which comprises directors who are not employees of the Company, meets regularly with management and the internal auditors to review the Company s financial policies and procedures, its internal control structure, the objectivity of its financial reporting and the independence of the Company s independent public accounting firm. The internal auditors have free and direct access to the audit committee, and they meet periodically, without management present, to discuss appropriate matters. Because of inherent limitations, a system of internal control over financial reporting may not prevent or detect misstatements and even when determined to be effective, can only provide reasonable assurance with respect to financial statement preparation and presentation. These consolidated financial statements are subject to an evaluation of internal control over financial reporting conducted under the supervision and with the participation of management, including the chief executive officer and chief financial officer. Based on that evaluation, conducted under the criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, management concluded that its internal control over financial reporting was effective as of December 31, 2014 and December 31, Thomas A. Lawson President and Chief Executive Officer Jeffrey A. Burchill Senior Finance 28 FM GLOBAL ANNUAL REPORT 2014

28 REPORT OF INDEPENDENT AUDITORS The Board of Directors and Policyholders of Factory Mutual Insurance Company and Subsidiaries We have audited the accompanying consolidated financial statements of Factory Mutual Insurance Company and Subsidiaries, which comprise the consolidated balance sheets as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in policyholders surplus, and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these financial statements in conformity with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free of material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Factory Mutual Insurance Company and Subsidiaries at December 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. Boston, Massachusetts February 24, 2015 FM GLOBAL ANNUAL REPORT

29 CONSOLIDATED BALANCE SHEETS (in thousands) December Assets Investments: Debt securities (including $288,800 and $278,000 of securities on loan under a securities lending program) $ 5,457,600 $ 5,214,300 Equity securities 7,082,100 6,436,900 Other securities 811, ,000 Real estate 545, ,400 Total Investments 13,896,400 12,785,600 Cash and cash equivalents 1,333,700 1,050,500 Recoverable from reinsurers 1,373,000 1,550,800 Premium receivable 670, ,900 Prepaid reinsurance premium 274, ,100 Premises and equipment 376, ,000 Other assets 886,700 1,085,300 Total Assets $ 18,811,400 $ 17,792,200 Liabilities Unpaid losses and loss adjustment expenses $ 3,872,200 $ 3,939,500 Reserve for unearned premium 2,476,600 2,467,900 Current and deferred income taxes 995, ,300 Other liabilities 829, ,300 Total Liabilities 8,174,000 8,076,000 Policyholders surplus Accumulated other comprehensive income 1,584,700 1,619,900 Retained earnings 9,052,700 8,096,300 Total Policyholders surplus 10,637,400 9,716,200 Total Liabilities and Policyholders surplus $ 18,811,400 $ 17,792,200 See accompanying notes. 30 FM GLOBAL ANNUAL REPORT 2014

30 CONSOLIDATED STATEMENTS OF INCOME (in thousands) Year ended December Gross premium earned $ 5,667,900 $ 5,561,700 Ceded premium earned (1,614,200) (1,816,200) Net premium earned 4,053,700 3,745,500 Membership credit (437,100) (200,700) Net premium earned after membership credit 3,616,600 3,544,800 Investment-related income 429, ,400 Fee-related income 62,500 55,800 Total revenue 4,108,100 4,016,000 Net losses and loss adjustment expenses 1,890,300 1,823,900 Insurance-related expenses 945, ,800 Investment-related expenses 164, ,400 Fee-related expenses 50,700 47,400 Total losses, loss adjustment and other expenses 3,050,900 2,926,500 Income from operations 1,057,200 1,089,500 Net realized investment gains 365, ,200 Other than temporary impairment losses (19,500) (700) Net income before income taxes 1,402,800 1,483,000 Income tax expense 446, ,700 Net income $ 956,400 $ 1,021,300 See accompanying notes. FM GLOBAL ANNUAL REPORT

31 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (in thousands) Year ended December Net income $ 956,400 $ 1,021,300 Other comprehensive (loss) income: Net unrealized appreciation on investments in debt and equity securities, net of income tax expense of $139,500 for 2014 and $276,900 for , ,700 Benefit plan assets and liabilities, net of income tax benefit of $116,800 for 2014 and income tax expense of $163,600 for (218,200) 306,400 Foreign currency translation adjustment, net of income tax benefit of $18,000 for 2014 and $9,300 for (89,600) (49,000) Other comprehensive (loss) income (35,200) 788,100 Comprehensive income $ 921,200 $ 1,809,400 CONSOLIDATED STATEMENTS OF CHANGES IN POLICYHOLDERS SURPLUS (in thousands) Year ended December Retained earnings at beginning of year $ 8,096,300 $ 7,075,000 Net income 956,400 1,021,300 Retained earnings at end of year 9,052,700 8,096,300 Accumulated other comprehensive income at beginning of year 1,619, ,800 Other comprehensive (loss) income (35,200) 788,100 Accumulated other comprehensive income at end of year 1,584,700 1,619,900 Policyholders surplus at end of year $ 10,637,400 $ 9,716,200 See accompanying notes. 32 FM GLOBAL ANNUAL REPORT 2014

32 CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands) Year ended December Operating activities Net income $ 956,400 $ 1,021,300 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 55,400 51,900 (Increase) decrease in premium receivable (57,300) 25,900 Increase in reserve for unearned premium 8,700 96,700 Decrease in unpaid losses and loss adjustment expenses (67,300) (805,300) Decrease in recoverable from reinsurers 177, ,800 Increase in current and deferred income taxes 44,500 30,700 Net realized investment gains (345,600) (393,500) Decrease (increase) in prepaid reinsurance premium 63,200 (22,700) Other (4,600) 600 Net cash provided by operating activities 831, ,400 Investing activities Net purchases of short-term investments (43,400) (8,400) Purchases of debt, equity and other securities (3,761,700) (4,021,700) Sales and maturities of debt, equity and other securities 3,410,000 3,520,500 Capital expenditures (165,700) (43,000) Other 12,800 (44,300) Net cash used in investing activities (548,000) (596,900) Increase (decrease) in cash and cash equivalents 283,200 (15,500) Cash and cash equivalents at beginning of year 1,050,500 1,066,000 Cash and cash equivalents at end of year $ 1,333,700 $ 1,050,500 See accompanying notes. FM GLOBAL ANNUAL REPORT

33 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2014 AND 2013 (in thousands) Note 1. Significant Accounting Policies Basis of Presentation The consolidated financial statements are stated in U.S. dollars and have been prepared on the basis of U.S. generally accepted accounting principles, which differ in some respects from statutory accounting practices prescribed or permitted by the State of Rhode Island and Providence Plantations, Department of Business Regulation, Insurance Division. On the basis of statutory accounting practices, consolidated policyholders surplus was $10,141,800 and $9,153,500 at December 31, 2014 and 2013, respectively; net income for the respective years then ended was $803,800 and $799,800. The process of preparing financial statements in conformity with U.S. generally accepted accounting principles requires the use of management s estimates and assumptions regarding certain types of assets, liabilities, revenues, and expenses. Such estimates primarily relate to unsettled transactions and events as of the date of the financial statements. Accordingly, upon settlement, actual results may differ from estimated amounts. The Company provides comprehensive lines of property coverage and supporting services for industrial and institutional properties throughout the world. Principles of Consolidation The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions were eliminated in consolidation. Reclassification Certain amounts reported in the 2013 financial statements and disclosures have been reclassified to conform to the 2014 presentation. Cash and Cash Equivalents Cash equivalents are short term, highly liquid investments that are both readily convertible into known amounts of cash and so near to maturity that they present insignificant risk of changes in value due to changing interest rates. The Company s cash equivalents include debt securities purchased with maturities of three months or less at acquisition and are carried at amortized cost, which approximates fair value. Investments Management determines the appropriate classification of debt securities at the time of purchase. All equity and debt securities are classified as available-for-sale and are stated at fair value. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage and asset-backed securities, over the estimated life of the security adjusted for anticipated prepayments. This amortization and accretion is included in investment-related income. For mortgage and assetbacked debt securities, the Company recognizes income using a constant effective yield based on anticipated prepayments over the economic life of the security. The mortgage and asset-backed debt securities are accounted for under the retrospective method and prepayment assumptions are based on market expectations. When actual prepayments differ significantly from anticipated prepayments, the effective yield is recalculated to reflect actual payments to date and anticipated future payments, and any resulting adjustment is included in investment-related income. 34 FM GLOBAL ANNUAL REPORT 2014

34 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2014 AND 2013 (in thousands) Note 1. Significant Accounting Policies (continued) Other securities consist primarily of partnerships and alternative investments, which are accounted for under the equity method. As a result of the timing of the receipt of valuation data from the investment managers, these investments are reported on up to a six-month lag. Changes in the Company s equity in the net assets of these investments are included in income as net realized investment gains. The cost of securities sold is based upon the specific identification method. Unrealized appreciation or depreciation of available-for-sale debt and equity securities, net of tax, is reported directly in other comprehensive income. Impairments in equity securities deemed to be other than temporary are reported as a component of income before income taxes. Impairments in debt securities deemed to be other than temporary are segregated into credit risk and non-credit risk impairments. Credit risk impairments are reported as a component of income before income taxes. Non-credit risk impairments are recognized in other comprehensive income. Securities are reviewed for both quantitative and qualitative considerations in the determination of impairments. Under a securities lending program with an agent, the Company has temporarily loaned certain debt securities. Borrowers of these securities must deposit with the agent an amount of cash and/or securities equal to 102 percent of the loaned securities fair value for U.S. currency-denominated securities or 105 percent of the loaned securities fair value for foreign-denominated securities. The portion of collateral received in securities is held in trust by the agent. The portion of collateral received in cash is invested by the agent in high-quality, short-term investments. The Company continues to receive the interest on the loaned debt securities as a beneficial owner, and the loaned debt securities are included in the investment portfolio of the Company. The cash collateral and the obligation to return that collateral are included in other assets and other liabilities, respectively, on the Consolidated Balance Sheets. Income Taxes The Company files consolidated U.S. and foreign income tax returns as required by law. The income tax expense is based on income before taxes reported in the consolidated financial statements. Deferred income taxes are provided, when appropriate, for the effects of temporary differences in reporting income and expenses for tax and financial reporting purposes. Deferred income taxes are also provided for unrealized appreciation or depreciation of investments, for pension and postretirement liabilities and for foreign currency translations. The Internal Revenue Service (IRS) has reviewed the Company s federal tax returns for the 2008 through 2011 tax years and is currently reviewing the Company s federal tax return for the 2012 tax year. Any adjustments that might result from the IRS examination of these income tax returns are not expected to have a material impact on the financial position, liquidity or results of operations of the Company. Deferred Costs Premium taxes and commissions, the principal business acquisition costs, are deferred to the extent recoverable and are amortized over the period during which the related premium is earned. Deferred costs are included in other assets. Certain pre-rental and other expenses incurred by the Company s real estate limited liability corporation subsidiaries are deferred and amortized over the lives of the various tenant leases. FM GLOBAL ANNUAL REPORT

35 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2014 AND 2013 (in thousands) Note 1. Significant Accounting Policies (continued) Real Estate and Premises and Equipment Premises and equipment are stated at cost, and depreciation is provided on a straight-line basis over the estimated useful lives of the respective assets. Upon retirement or sale, the cost of the asset disposed of and its related accumulated depreciation are removed from the accounts, and any resulting gain or loss is recognized in net realized investment gains. The net book value of the Company s investments in land and buildings is included in real estate, whereas the remaining net book value of the Company s occupied land and buildings, furniture, fixtures, and equipment is included in premises and equipment. Unpaid Losses and Loss Adjustment Expenses Liabilities for unpaid losses and loss adjustment expenses are based on case estimates or reports from ceding companies. Estimates of incurred-but-not-reported (IBNR) reserves are based on historical experience and management analysis. Although the above-described amounts are based on estimates, management believes recorded liabilities for unpaid losses and loss adjustment expenses are adequate to cover the ultimate settlement cost of losses incurred. These estimates are continually reviewed and adjustments to such estimates are reflected in current operations. Premiums The Company issues term premium policies. The term premium is earned on a prorata basis over the life of the policy. Translation of Foreign Currency The Company translates the financial statements of its foreign operations into U.S. dollars from the functional currency applicable for each foreign unit, which is the currency of the country representing the primary economic environment in which each operation conducts business. Foreign currency balances are re-measured to the respective functional currencies, and the resulting foreign exchange gains or losses are reflected in earnings. Functional currency assets and liabilities are then translated into U.S. dollars at the exchange rates in effect at the end of the period, while income and expenses are translated at average rates. Foreign currency translation adjustments are recorded as a separate component of the consolidated statements of comprehensive income, net of income taxes. Reinsurance In the normal course of business, the Company seeks to reduce losses that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk with other insurance enterprises. Reinsurance premium and losses and loss adjustment expenses ceded under these arrangements are accounted for on a basis consistent with those used in accounting for the original policies issued and the terms of the reinsurance contract. Retirement Income Plans and Postretirement Benefit Plans Other than Pensions Noncontributory retirement income plans cover the vast majority of employees. The Company s funding policy is generally to contribute the net periodic pension cost each year, as determined pursuant to the guidance in Compensation Employee Benefits (ASC 715). However, the contribution for any year will not be less than the minimum required contribution, nor greater than the maximum tax-deductible contribution. The Company provides certain health care and life insurance benefits for retired employees and their dependents. The plan is contributory, with retiree contributions adjusted annually, and contain other cost-sharing features, such as deductibles and coinsurance. Current service and interest costs of postretirement health care and life insurance benefits are expensed on an accrual basis. 36 FM GLOBAL ANNUAL REPORT 2014