RI K RESILIENCE. Annual Report. P14000 Printed in USA 2014 FM Global All rights reserved.

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1 Annual Report 2013 RI K RESILIENCE P14000 Printed in USA 2014 FM Global All rights reserved. In the United Kingdom FM Insurance Company Limited 1 Windsor Dials, Windsor, Berkshire, SL4 1RS Authorized by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority

2 Executive Message was a very successful year, from both insurance and investment points of 2013 view. We experienced good client retention and moderate new business success, and provided our policyholder-owners with their sixth membership credit since At the same time, we accomplished all our objectives to improve our products and services, and we continued to focus on becoming a more efficient organization. Our in-force premium grew a modest 2.7 percent with a combined ratio of 77.7 percent and our surplus grew 22.9 percent to US$9.7 billion. These outstanding results reinforce the unique strengths of our mutual business model, our balance sheet, and the trusted partnerships we have formed with our clients to ensure the resiliency of their businesses. Review of 2013 In April 2013, the FM Global board of directors approved a membership credit of approximately US$435 million our highest total dollar amount to date to eligible policyholders renewing between June 30, 2013 and June 29, This membership credit marks the sixth time we have been able to make a tangible policy renewal or anniversary credit to our policyholders. At the conclusion of the credit period, we will have applied nearly US$2.1 billion in total membership credit to our mutual owners since The membership credit process reaffirms the strength and benefit of our mutual structure; namely, when our clients invest in making their facilities less prone to business interruption, it results in fewer and less severe losses than expected, leading to the conditions for a credit. Given the volatility of the business, we have consistently established the practice whenever conditions make it possible. We continued our multiyear focus on improving the quality and efficiency of our worldwide services, expanding our product and underwriting capacities, and strengthening the capabilities of our workforce. A key to our long-term success is the commitment we share with our clients to make their facilities and their businesses more resilient. Physical risk improvement and the reduction of human element risk are important drivers of resiliency, and our clients made significant gains in both areas. For instance, in 2013 they installed sprinklers in 47 million square feet (4.4 million square meters) of existing facilities worldwide. On a longer-term basis, we continue to improve our abilities and outcomes with large machinery and equipment, data centers and related exposures. fm global annual report

3 Flood is a leading cause of natural hazard loss throughout the world, which is why we are making considerable progress in expanding our flood-mapping capabilities outside of North America. Additionally, we have increased the number of FM Approved products available worldwide to help mitigate the impact of flood events on our clients facilities. We continue to improve our performance in the delivery of our insurance products. Despite the complexity of our property insurance policies, 76 percent of policies were delivered on or before the effective date of the contract, and 97 percent were delivered within 40 days. Lastly, the combination of our site-specific knowledge and research expertise with current technologies, models and analytics is starting to make our services more effective and efficient. This will strengthen our business model and further differentiate us from traditional insurance products and services. The quality and value of our products and services continue to be recognized by industry ratings agencies, analysts and media channels. FM Global was named the best commercial property insurer overall and best for service and expertise in Business Insurance magazine s 2013 Buyers Choice Awards. Similarly, we were rated the top choice in nine categories in Property Casualty 360 National Underwriter magazine s 2013 Risk Manager Choice Awards Premium Trends The lack of insured natural disasters, combined with new and abundant forms of alternative reinsurance capacity and strong balance sheets, created a very competitive marketplace in our industry. In this environment, our consolidated in-force premium (excluding new business and net of lost business) shrank by 1.3 percent. Affiliated FM experienced an even greater decline, reflecting the more competitive nature of our middle-market business. From a geographical standpoint, Australia and Europe were significantly more competitive than North America. TOTAL GROSS PREMIUM IN FORCE IN US$ MILLIONS NON-NORTH AMERICA GROSS PREMIUM IN FORCE IN US$ MILLIONS 5, , , , , , , , , , fm global annual report 2013

4 On a consolidated basis, FM Global (large commercial property) and Affiliated FM (middle-market property) represent 97 percent of our overall in-force premium, with Mutual Boiler Re and FM Global Cargo representing the balance. Consolidated net premium earned increased 3.4 percent to US$3.7 billion, excluding the impact of six months of the membership credit. Loss Trends Our consolidated loss ratio was 51.4 percent, which includes an increase of US$185 million to our discontinued lines loss reserves. Our discontinued lines consist of legacy company contracts representing third-party liability insurance and reinsurance business prior to With this increase, we continue to be very conservatively reserved. LOSS RATIO 100% 95.9% 43.4% 54.2% 60.6% 51.4% Includes additional reserves for discontinued lines of business The 2013 loss ratio of our ongoing business, excluding membership credit, was 43.8 percent, the lowest since 2009, and reflects the reduced number of insured natural disaster losses worldwide. The loss ratio from natural disasters and aggregation was 10.4 percent, the lowest since 2007, and sharply lower than our average of 20 percent a year. Our 2013 risk loss ratio of 29.6 percent was slightly higher than the 2012 risk loss ratio of 27.7 percent, and slightly lower than the longer-term average of 31 percent. Risk losses result predominantly from fires and explosions and occur disproportionately at unsprinklered locations. fm global annual report

5 Expense Trends Our 2013 expense ratio of 26.3 percent is slightly above our 2012 result. However, adjusting for the membership credit, the expense ratio is slightly below last year s. EXPENSE RATIO 50% 26.2% 28.6% 25.1% 25.1% 26.3% As a provider of knowledge-based services in a commodity marketplace, we make it a priority to deliver high-quality services worldwide while carefully managing our expense ratio and the cost of delivering these services. A designated business process improvement team leads our ongoing initiative to efficiently manage our business processes and operating costs. The team has a companywide mandate and has completed its second full year of activities with all related stakeholders. Our process improvement efforts are directly tied to boosting our productivity and improving our client service activities, and the results of these efforts are now becoming more visible. Employee Trends Over the last three years, our workforce has grown by about 3 percent, significantly below the growth in insured values, a broad measure of workload. As our clients continue to grow more rapidly in serviced locations 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. Our strength as a knowledge-based company is tied to a stable and well-trained workforce. Our employee workforce reflects a stable, average tenure of 14 years. Our annual employee turnover rate was 6.7 percent in 2013 versus 6 percent in In 2013, employees completed 9,500 days of classroom training at an average cost of US$2,200 per employee. In addition, employees completed more than 20,000 hours of online training. Investments and Surplus Our investment portfolio performed well with a total return on assets of 12.8 percent versus a benchmark of 12.3 percent. Our relative performance was adversely affected by the strength of the U.S. dollar. Our asset allocation with a bias toward equities helped our overall relative performance. 6 fm global annual report 2013

6 The investment performance and the 77.7 percent combined ratio helped increase surplus by 22.9 percent to US$9.7 billion. Both A.M. Best and Fitch reaffirmed our ratings at A+ and AA, respectively. Governance Our board of directors, eight advisory boards and five risk management executive councils are the heart of our governance as a mutual company. We are thankful for their loyal support and oversight. Robert O Toole, retired chairman and chief executive officer of A.O. Smith Corporation, retired from our board in April Bob was part of a small group of directors who enabled our merger in 1998 and helped oversee the process of becoming a successful single company. He served as chairman of the finance and audit committees during his tenure. We thank him for his contributions, and we will miss his guidance and insight. Looking Ahead 2013 will be remembered as one of the insurance industry s best years, both for strong underwriting and investment results. In addition, large amounts of alternative reinsurance capital have entered via offshore markets. These developments will make for a more competitive market in Moreover, because we have reported significantly stronger underwriting results than our competitors have over the long term, others are trying to mimic our business model, specifically, our property loss prevention engineering approach. In this more competitive market, we will continue to focus on developing and delivering proven, cost-effective solutions to make our policyholders businesses more resilient to business interruption anywhere in the world, while providing stable risk-transfer solutions that are compliant with local regulatory requirements. We will fully leverage our strength as a mutual company for the benefit of our policyholder-owners. We attribute our long-term success to our dedicated, knowledgeable employees and to our clients, who share our philosophy and commitment to loss prevention. Thanks to their combined efforts, our unique business model has successfully endured for 179 years. We are deeply grateful for their contributions to our shared success. Shivan S. Subramaniam Chairman and Chief Executive Officer fm global annual report

7 resilience The ever-changing global economy, competitive markets and a volatile political environment worldwide have spurred companies to consistently reinforce their strengths and address any weaknesses. By identifying major challenges and implementing proven, research-based solutions, organizations not only can recover quickly from any missteps, but also renew themselves for ongoing success. Whether the aim is to boost production, address the challenges of consolidation or expand into new markets, savvy companies are embedding greater resilience in their business planning processes. In the following pages, senior leaders from three prestigious corporations discuss how resilience the ability to adjust to the consequence of a disruptive event via adaptive, proactive and reactive strategies is the linchpin of success at their organizations. We thank them and their companies for their participation. 8 fm global annual report 2013

8 EMC Corporation delivers information technology services to a wide range of public and private consumers, providing storage, management, protection and analysis of its customers information. The publicly traded global leader integrates cloud computing and big data to service both small and large companies, including financial services firms, manufacturers, health care and life science organizations, Internet service and telecommunications providers, airlines and transportation companies, educational institutions, and public-sector agencies. Headquartered in Hopkinton, Mass., USA, and 60,000 employees strong, EMC operates in 86 countries and 400 sales offices, with additional manufacturing facilities and research and development centers worldwide. Cobham plc is headquartered in Wimborne, Dorset, England. The company is publicly traded and serves customers in the commercial, defense and security markets. With 80 years of experience and 11,000 employees worldwide, it specializes in air-to-air refueling; aviation services; audio, visual and data communications, including satellite communications; defense electronics; life support and mission equipment. Cobham operates in three divisions: Aerospace and Security, Defense and Mission Systems, which provide equipment, technology and security solutions for land, sea and air applications. Its products and services reach clients and partners in more than 100 countries. Established in 1933 in Modesto, Calif., USA, E. & J. Gallo Winery has become the world's largest family-owned winery and the foremost winery in the art of grape growing, winemaking, distribution and marketing of wines and spirits. With nine wineries and access to grapes from vineyards strategically located in all of the premier grapegrowing areas in California and Washington, Gallo produces wines in every category to suit every taste. Gallo imports wines from eight of the major wine-growing countries in the world, and is also the largest exporter of California wines. Some of the brands in Gallo s wine portfolio include Gallo Family Vineyards, Barefoot Cellars, Apothic, Louis M. Martini, Mirassou Vineyards, Frei Brothers Reserve, William Hill Estate, Edna Valley Vineyard, Columbia Winery, Martín Códax, Ecco Domani and LaMarca. The winery is also expanding its portfolio with distilled spirits and has recently added New Amsterdam Gin and Vodka, Familia Camarena Tequila and Shellback Rum. Gallo employs more than 5,000 employees worldwide. fm global annual report

9 Resilience in New Industries EMC Corporation Scott Ross Senior Director, Treasury Equity Finance and Risk Management Ann Barry Director, Risk Management Anja Rittling Principal Financial Analyst, Risk Management Location, landscape and landlords: Those are the key challenges EMC must effectively address with our risk management program when operating outside of the United States, says Ann Barry, director, risk management. We have a strong global presence, and every country has different building standards. We must negotiate with local landlords to ensure our facilities are of the caliber we need to run our business; and that was certainly the case with our operations facility in Bangalore, India. We wanted to centralize our operation in a new multistory building, bringing workers from various locations under one roof. To do so, we planned to construct a building that adhered to the protection standards we feel strongly about. This project would take place in a developing market. In general, landlords in the region are used to dealing with traditional building designs and local building codes that do not meet our expectations for a business operating in the technology industry. The Value of Risk Improvement FIRE LOSSES WEAK PRACTICES US$3,400,000 US$724,000 STRONG PRACTICES NATURAL CATASTROPHE LOSSES WEAK PRACTICES US$3,200,000 US$478,000 STRONG PRACTICES It has been proven that average gross losses are substantially lower in facilities where loss prevention practices are implemented. Identifying critical areas: Our local facilities team collaborated with the landlord and FM Global in the early stages of the project and stressed the importance of building above local standards, recalls Scott Ross, senior director. After the specs were provided, FM Global worked with the facilities and employee health and safety departments to put together a master list of recommendations. Unfortunately, the owners of the property initially couldn t meet many of the recommendations; but our team worked closely with them and FM Global field engineers to identify critical areas. We determined pretty quickly that reducing the fire hazard was essential. That meant addressing two key areas: installing an FM Approved water pump and adequately sized holding tank, as well as a sprinkler system that was appropriate for our operations. The landlord was able to meet us halfway, and most importantly, they agreed to incorporate all of our fire safety measures into the building s design and construction. Says Anja Rittling, principal financial analyst, We believe we have met some very high standards, particularly around fire safety; and as a result, we have a very well-protected building that offers our people a safe place to work. This was a big win for us, Barry points out, and we think we may not have gotten here without FM Global. 10 fm global annual report 2013

10 EMC and FM Global met right at the outset of the project and stressed the importance of building above local standards. Scott Ross Anja Rittling Ann Barry fm global annual report

11 Resilience in global Global markets Markets Cobham plc andrew bryson Andrew Bryson Group Insurance and risk group Risk manager Manager A t Cobham, we recognize that effective risk management processes and procedures are essential to underpin performance across our business. Protecting our reputation is critical. That s why we chose to partner with FM Global back in 2005 to help us build greater resilience into our key operations from a property risk perspective, ensure greater security of supply and take appropriate measures to avoid losses. Together, we ve worked hard to improve our property risk. When FM Global first insured Cobham, our highly protected risk (HPR) profile was near zero. Today, the majority of our principal locations responsible for 80 percent of our operating profit are HPR, as are many of our smaller facilities. the challenges of consolidation: As part of our Excellence in The Delivery (EiD) program, we have consolidated manufacturing into a smaller number of key locations. One consequence of this activity was that, by concentrating our manufacturing at fewer sites, we increased our potential vulnerability to damaging loss. Any significant production interruption could damage our reputation. To counter this threat, it was imperative that we minimize the risk of a major loss occurring and maximize our ability to recover quickly, should the worst happen. FM Global helped us develop a standard loss prevention framework across the company, with a special focus on those hazards specific to Cobham. To give an example, high flow rates of ignitable liquid form a unique challenge in our air-to-air refuelling test rigs. We managed to overcome this by working with FM Global to design a bespoke fire protection solution at the start of a greenfield project in the U.K., which was implemented during construction. This solution has been standardized in Cobham s Property Loss Prevention Code. Policy Delivery policy POLICY DELIVERY 76% 94% on or before inception date within 20 days of inception date 94 percent of FM Global master policies are delivered to clients within 20 days of the contract inception date. 12 fm global annual report 2013 partners of the year: We were delighted when Continuity Partners Insurance & Risk (CIR) announced our companies would jointly receive the magazine s Partnership of the Year Award. This external validation of the work we have done with FM Global to truly embed property risk management within Cobham is a gratifying honor. If you link what we ve done in terms of risk improvement to the broad all-risk policy coverage we have through the FM Global Advantage policy, it makes a package that is a very strong tool in my armory as a risk manager. Through our combined efforts, we are a more resilient company, and this has certainly helped us to earn the trust of our stakeholders and our global business partners.

12 FM Global helped us develop a property loss prevention framework across the company, with a special focus on hazards specific to Cobham. Andrew Bryson fm global annual report

13 Resilience through Research E. & J. Gallo Winery Jeff Wilson Director of Risk Management Troy Lute Senior Loss Control Specialist Our company is constantly evolving and growing to best meet the needs of consumers, says Jeff Wilson, director of risk management at E. &. J. Gallo. One area that epitomizes this expansion is our spirits business. A few years ago, Chief Executive Officer Joe Gallo announced the company s initiative to double spirits production and sales volume. We knew Gallo s existing storage capabilities likely would not meet the demands for this growth and we envisioned two main challenges: creating a space to store the new inventory, and protecting the product against loss or damage. Managing risk at every stage: Given the international scope of our business, we have to think broadly about risk at all stages of the production and distribution process. With both property protection and business continuity goals in mind, we invited FM Global to tour our facility and listen to our concerns. FM Global came here and worked as a team with us ultimately proposing options that included a recommendation to relocate the spirits inventory and upgrade sprinkler systems in several facilities. At that point, says Troy Lute, Gallo s senior loss control specialist, There was not enough full-scale fire test information available to provide the exact protection standards necessary for our finished goods spirits storage configuration. So, we and FM Global met with the local fire departments to determine the best course of action. Long-term Relationships ACCOUNT RETENTION 65% 10+ years The majority of FM Global clients have been our policyholders for more than 10 years, and nearly one-third of clients have insured with us for 20 years or more. Research proving ground: Ultimately, we conducted a series of large-scale burn tests at FM Global s Research Campus, Lute continues. This research helped us determine a protection scheme for our specific storage arrangement, which was lacking in the previously accepted industry standards. The results also led Gallo on a path of education and training that culminated in inventory relocation and upgrades to several of our protection systems. Wilson asserts that the most critical goal at Gallo is to consistently provide high quality and value to our customers. Given that many of our products are produced only once per year, it is vital for us to appropriately protect those products. What is most valuable to us regarding FM Global is their willingness to challenge us in a proactive manner, and their ability to provide assurance. When FM Global comes to us with an issue that might be an exposure for us, we work together to turn research results into reality. 14 fm global annual report 2013

14 We have to think broadly about risk at all stages of the production and distribution process. Troy Lute Jeff Wilson fm global annual report

15 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 FM GLOBAL Emergency Response Consultants Affiliated FM specializes in commercial property insurance for the middle market. The company 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, 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 Global Cargo provides cargo insurance coverage, automated certificate management and risk engineering services tailored to the international trade and transportation needs of global businesses. 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. 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. 16 fm global annual report 2013

16 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 Nambia 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

17 Financial Information Investment Report...page 20 Management s Statement on Internal Control over Financial Reporting...page 22 Report of Independent Auditors...page 23 Consolidated Balance Sheets...page 24 Consolidated Statements of Operations...page 25 Consolidated Statements of Comprehensive Income...page 26 Consolidated Statements of Changes in Policyholders Surplus...page 26 Consolidated Statements of Cash Flows...page 27 Notes to Consolidated Financial Statements...page 28

18 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. The most notable issue in the investment markets in 2013 was the strong return from stock markets of most developed countries. The U.S. stock market was a leader in this performance, with the benchmark S&P 500 return at 32.4 percent. The size of these returns is particularly remarkable given that global GDP progress has remained below historic recovery standards, and has been very uneven among geographies and economic sectors. Numerous factors have been cited for this stock strength, but fundamentally we would point to two primary issues. First, corporate profits have remained healthy in terms of return on capital and growth. This reflects productivity gains, importantly derived from the ever-increasing use of information technology, which has resulted in improved profit margins and strong corporate cash flows. Indeed, part of the decoupling of the uneven economic expansion and strong stock market is that productivity can negatively impact economic growth due to reduced hiring. Second, stocks were revalued to higher levels after several years of carrying below-historic valuations relative to the low level of interest rates. Most observers would argue that stock valuations have now recovered to a more normal level, given the balance of opportunity and risk issues in place currently. Therefore, longer-term prospects from stocks are regarded by many as being in the historic range of upper single-digit returns, though a shorterterm stock pullback would not be surprising after such a strong advance. FM Global s investment horizon focuses on the longer-term, and so we have our usual commitment to common stock at this time (45-50 percent). Consistent with the higher valuation investors applied to stocks in 2013, the premium for the relative safety of bonds, especially government bonds, declined moderately from historically high levels. As an example, the yield on the 10 year U.S. Treasury bond rose from 1.76 percent to 3.03 percent during the year, with an important catalyst being the beginning of the Federal Reserve tapering its stimulative purchase of longer-dated fixed income securities. Moderately rising interest rates, along with the low starting yield from bonds, resulted in the primary U.S. high grade taxable bond benchmark returning -1.6 percent for the year, as shown below. FM Global s return on total assets was percent compared to benchmark of percent. The total portfolio benefited from a) an overweight to equities, b) a beneficial mix toward municipal and high yield bonds, which outperformed high grade taxable securities, and, c) an upper single-digit return from the company s conservative hedge fund positions, which are structured as bond market alternatives. Not included in the financial market assets in the tables 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 4.6 million ft.² (430,000 m²) 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 2013, commercial properties produced $83.8 million in revenue and $24.4 million in cash flow. All financial figures in U.S. dollars. 20 FM Global Annual Report 2013

19 Investment Report Rates of Return 2013 Portfolio Benchmark Total portfolio 12.80% 12.29% 1 Debt securities Investment-grade taxable bonds -1.60% -1.59% 2 Municipal bonds* 1.70% 1.69% 3 High-yield bonds 8.23% 7.41% 4 Equity securities total 30.33% 30.43% 5 Internal portfolio 30.77% 32.39% 6 External portfolios** U.S. portfolios 48.95% N/A International portfolios 17.10% 15.29% 7 1 Weighted S&P 500 Plus Global Stock Index, Barclays Index, T Bill 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 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 $ 1,520.5 $ 1,021.1 As of December Holdings (in millions) total Percentage total Percentage Equity securities $ 6, % $ 4, % Taxable debt securities 3, , Municipal debt securities 1, , Short-term funds Alternative investments (private equity, hedge funds) Total $ 13, % $ 11, % All financial figures in U.S. dollars. FM Global Annual Report

20 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 and disclosure controls 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, 2013 and December 31, Shivan S. Subramaniam Chairman and Chief Executive Officer Jeffrey A. Burchill Senior Finance 22 FM Global Annual Report 2013

21 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 (the Company), which comprise the consolidated balance sheets as of December 31, 2013 and 2012, and the related consolidated statements of operations, 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, 2013 and 2012, 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 21, 2014 FM Global Annual Report

22 Consolidated Balance Sheets (in thousands) December Assets Investments: Debt securities (including $278,000 and $300,300 of securities on loan under a securities lending program) $ 5,490,100 $ 5,375,300 Equity securities 6,436,900 4,989,900 Other securities 705, ,000 Real estate 429, ,400 Total Investments 13,061,400 11,397,600 Cash and cash equivalents 774, ,700 Recoverable from reinsurers 1,550,800 2,126,600 Premium receivable 612, ,800 Prepaid reinsurance premium 338, ,400 Premises and equipment 369, ,300 Other assets 1,085, ,700 Total Assets $ 17,792,200 $ 16,392,100 Liabilities Unpaid losses and loss adjustment expenses $ 3,939,500 $ 4,744,800 Reserve for unearned premium 2,467,900 2,371,200 Current and deferred income taxes 954, ,800 Other liabilities 714, ,500 Total Liabilities 8,076,000 8,485,300 Policyholders surplus Accumulated other comprehensive income 1,619, ,800 Retained earnings 8,096,300 7,075,000 Total Policyholders surplus 9,716,200 7,906,800 Total Liabilities and Policyholders surplus $ 17,792,200 $ 16,392,100 See accompanying notes. 24 FM Global Annual Report 2013

23 Consolidated Statements of Operations (in thousands) Year ended December Gross premium earned $ 5,561,700 $ 5,299,000 Ceded premium earned (1,816,200) (1,677,600) Net premium earned 3,745,500 3,621,400 Membership credit (200,700) Net premium earned after membership credit 3,544,800 3,621,400 Investment-related income 415, ,300 Fee-related income 55,800 53,000 Total revenue 4,016,000 4,061,700 Net losses and loss adjustment expenses 1,823,900 2,193,900 Insurance-related expenses 895, ,700 Investment-related expenses 159, ,700 Fee-related expenses 47,400 48,700 Total losses, loss adjustment and other expenses 2,926,500 3,265,000 Net income from operations 1,089, ,700 Net realized investment gains 394, ,600 Other than temporary impairment losses (700) (16,200) Net income before income taxes 1,483,000 1,131,100 Income tax expense 461, ,700 Net income $ 1,021,300 $ 774,400 See accompanying notes. FM Global Annual Report

24 Consolidated Statements of Comprehensive Income (in thousands) Year ended December Net income $ 1,021,300 $ 774,400 Other comprehensive income: Net unrealized appreciation on investments in debt and equity securities, net of income tax expense of $276,900 for 2013 and $134,100 for , ,100 Benefit plan assets and liabilities, net of income tax expense of $163,600 for 2013 and income tax benefit of $11,800 for ,400 (27,600) Foreign currency translation adjustment, net of income tax benefit of $9,300 for 2013 and income tax expense of $4,400 for (49,000) 22,100 Other comprehensive income 788, ,600 Comprehensive income $ 1,809,400 $ 1,024,000 Consolidated Statements of Changes in Policyholders Surplus (in thousands) Year ended December Retained earnings at beginning of year $ 7,075,000 $ 6,300,600 Net income 1,021, ,400 Retained earnings at end of year 8,096,300 7,075,000 Accumulated other comprehensive income at beginning of year 831, ,200 Other comprehensive income 788, ,600 Accumulated other comprehensive income at end of year 1,619, ,800 Policyholders surplus at end of year $ 9,716,200 $ 7,906,800 See accompanying notes. 26 FM Global Annual Report 2013

25 Consolidated Statements of Cash Flows (in thousands) Year ended December Operating activities Net income $ 1,021,300 $ 774,400 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 51,900 49,300 Decrease in premium receivable 25,900 40,000 Increase in reserve for unearned premium 96, ,400 Decrease in unpaid losses and loss adjustment expenses (805,300) (431,700) Decrease/(increase) in recoverable from reinsurers 575,800 (115,200) Change in current and deferred income taxes 30, ,900 Net realized investment gains (393,500) (334,400) (Increase)/decrease in prepaid reinsurance premium (22,700) 10,500 Other ,600 Net cash provided by operating activities 581, ,800 Investing activities Net (purchases)/sales of short-term investments (49,900) 123,400 Purchases of debt, equity and other securities (4,021,700) (3,533,700) Sales and maturities of debt, equity and other securities 3,520,500 3,212,700 Capital expenditures (43,000) (98,800) Other (44,300) 52,100 Net cash used in investing activities (638,400) (244,300) (Decrease)/increase in cash and cash equivalents (57,000) 220,500 Cash and cash equivalents at beginning of year 831, ,200 Cash and cash equivalents at end of year $ 774,700 $ 831,700 See accompanying notes. FM Global Annual Report

26 Notes to Consolidated Financial Statements December 31, 2013 and 2012 (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 $9,153,500 and $7,525,100 at December 31, 2013 and 2012, respectively; net income for the respective years then ended was $799,800 and $712,300. 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 2012 financial statements and disclosures have been reclassified to conform to the 2013 presentation. Cash Equivalents Cash equivalents consist of various sweep accounts with a maturity of less than 90 days at acquisition. 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 asset-backed 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. 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 three-month lag. Changes in the Company s equity in the net assets of these investments are included in income as net realized investment gains. 28 FM Global Annual Report 2013

27 Notes to Consolidated Financial Statements December 31, 2013 and 2012 (in thousands) Note 1. Significant Accounting Policies (continued) 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 policyholders surplus. Impairments in equity securities deemed to be other than temporary are reported as a component of net 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 net 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. Income tax expense is based upon pretax income 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 and 2009 tax years and some issues remain unsettled. Additionally, the IRS is currently reviewing the Company s federal tax returns for the 2010 and 2011 tax years. 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

28 Notes to Consolidated Financial Statements December 31, 2013 and 2012 (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 pro-rata basis over the life of the policy. Recent Guidance on Existing Accounting Standards In May 2011, the FASB issued ASU No Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS (ASU No ). The amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the Board did not intend for the amendments in ASU No to result in a change in the application of the requirements in Topic 820. The required implementation date of ASU No for non-public entities was fiscal years beginning after December 15, The Company adopted ASU No in 2012, and has determined that it has no impact on its consolidated financial statements. In June 2011, the FASB issued ASU No Comprehensive Income (Topic 220): Presentation of Comprehensive Income (ASU No ), which prescribes that an entity has the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous Statement of Comprehensive Income or in two separate but consecutive statements. The required implementation date of ASU No for non-public entities was fiscal years ending after December 15, The Company adopted ASU No in 2012, and elected to present the total of comprehensive income (loss), the components of net income, and the components of other comprehensive income (loss) in two separate but consecutive statements. 30 FM Global Annual Report 2013