Travelers 2005 Annual Report Download - page 200

THE ST. PAUL TRAVELERS COMPANIES, INC.AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
188
13. INCENTIVE PLANS (Continued)
Stock Option Fair Value Information
The fair value effect of stock options is derived by application of a variation of the Black-Scholes
option pricing model.
The significant assumptions used in estimating the fair value on the date of the grant for original
options and reload options granted in 2005, 2004 and 2003 and for the awards assumed on April 1, 2004
from SPC at the merger were as follows:
2005 2004 2003
Expected lifeof stock options. .................. 6 years 3 years 3 years
Expected volatility of the Company’sstock(1).... 32.0%32.1% 29.4%
Risk-free interest rate ......................... 3.96% 2.50% 2.04%
Expected annual dividend pershare ............. $ 0.89 $ 0.88 $ 0.60
Expected annual forfeiture rate ................. 5% 5% 5%
(1) The expected volatility is based on the average volatility of an industry peer group of entities because
the Company only became publicly traded in March 2002.
In connection with SPC options assumed in the merger, the estimated fair value of all the outstanding
SPC stock options at April 1, 2004 was $186 million and was included in the determination of the purchase
price based upon the announcement date market price per share of SPC common stock, using an option-
pricing model. The unvested stock option awards require the holder to render service during the vesting
period and are therefore considered unearned compensation. At April 1, 2004, the estimated fair values of
the unvested awards were $35 million and havebeen included in unearned compensation as a separate
component of equity. The unearned compensation expense is being recognized as a charge to income over
the remaining vesting period.
In addition, Commercial Insurance Resources, Inc. (CIRI) had equity-based compensation plans in
which awards were granted in CIRI’s privately held commonstock. In connection with The Travelers
Indemnity Company’s purchase of the minority interest of CIRI in 2004, the Company converted CIRI’s
outstanding equity-based awards into awards in the Company’s common stock. The converted awards
retained the same terms and conditions that were applicable prior to the conversion. The conversion of
CIRI outstanding nonvested options into options to purchase the Company’s common stock was
considered a modification and therefore the modification guidance of FAS 123 was applied to the
converted awards. For these converted options, the excess of the fair value of the modified options issued
over the fair value of the original options at the date of exchange was added to the remaining unrecognized
compensation cost of the original option and recognized over the remaining vesting period.
Under FAS 123, reload options are treated as separate grants from the original grants and as a result
are separately valued when granted. Reload options are exercisable for the remaining term of the related
original option and therefore would generally have a shorter estimated life. Shares received through option
exercises under the reload program are subject to restriction on sale. Discounts (as measured by the
estimated cost of protection) have been applied to the fair value of reload options granted to reflect these
sales restrictions.