Travelers 2005 Annual Report Download - page 154

THE ST. PAUL TRAVELERS COMPANIES, INC.AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
142
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Cont inued)
The following table illustrates the effect on net income and earnings per share for each period
indicated as if the Company had applied the fair value recognition provisions of FAS 123 to all outstanding
and unvested stock-based employee awards.
(for the year ended December 31, in millions, except per share data) 2005 2004 2003
Net income as reported ............................................... $1,622
$955 $1,696
Add: Stock-based employee compensation expense included in reported net
income, net of related tax effects(1).................................. 64 49 18
Deduct: Stock-based employee compensation expense determined under fair
value based method, net of related tax effects(2) ....................... (76 )(75 ) (73)
Net income pro forma................................................. $1,610
$929 $1,641
Earnings per share
Basic—as reported ................................................. $2.39 $1.56 $3.91
Basic—pro forma.................................................. 2.37 1.52 3.79
Diluted—as reported ............................................... 2.33 1.53 3.80
Diluted—pro forma ................................................ 2.31 1.49 3.76
(1) Represents compensation expense on all restricted stock and stock option awards granted after
January 1, 2003.
(2) Includes the compensation expense added back in (1).
Derivative Financial Instruments
The Company may use derivative financial instruments,including interest rate swaps, equity swaps,
credit derivatives, options, forward contracts and financial futures, as a means of hedging exposure to
interest rate, equity price change and foreign currency risk. The Company’s insurance subsidiaries do not
hold or issue derivative instruments for trading purposes. The Company recognizes all derivatives,
including certain derivative instruments embedded in other contracts, as either assets or liabilities in the
consolidated balance sheet and measures those instruments at fair value. Where applicable, hedge
accounting is used to account for derivatives. To qualify for hedge accounting, the changes in value of the
derivative must be expected to substantially offset the changes in value of the hedged item. Hedges are
monitored to ensure that there is a high correlation between the change in the value of the derivative
instruments and the change in value of the hedged investment. Derivatives that do not qualify for hedge
accounting are carried at fair value with the changes in fair value reflected in the consolidated statement of
income in net realized investment gains (losses).
Interest rate swaps, equity swaps, credit derivatives, options and forward contracts were not significant
at December 31, 2005 and 2004.
Nature of Operations
The Company is organized into three reportable business segments: Commercial, Specialty and
Personal. These segments reflect the manner by which the Company manages its property and casualty
insurance products and insurance-related services and represent an aggregation of these products and