Notes to financial statements
Note 11: Stock Incentive Plans
We have made fixed stock option grants to certain U.S.-based company officers and outside directors. We also have made separate fixed option grants to certain employees of our non-U.S. operations. These plans are referred to as "fixed plans" because the measurement date for determining compensation costs is fixed on the date of grant. In 1997 and 1996, we also made variable stock option grants to certain company officers. These were considered "variable" grants because the measurement date is contingent upon future increases in the market price of our common stock. At the end of 1998, approximately 3,700,000 shares remained available for grant under our stock incentive plan. We follow the provisions of Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" and related interpretations in accounting for our stock option plans. In 1996, we implemented the disclosure provisions required by SFAS No. 123, "Accounting for Stock-Based Compensation" for our option plans. SFAS No. 123 requires pro forma net income and earnings per share information, which is calculated assuming we had accounted for our stock option plans under the "fair value" method described in that Statement. Since the exercise price of our fixed options equals the market price of our stock on the day the options are granted, there is no related compensation cost. We have recorded compensation costs associated with our variable options and restricted stock awards, and the former USF&G's Long-Term Incentive Program, of $10.4 million, $17.5 million and $14.9 million in 1998, 1997 and 1996, respectively. In connection with the USF&G merger, The St. Paul assumed USF&G's obligations under four stock option plans and its Long-Term Incentive Plan. Exercise prices were based on the fair market value of USF&G's common stock on the date of grant. As a result of the merger, all outstanding options under the stock option plans were vested and converted into options to acquire The St. Paul's common stock.
Fixed Option Grants
U.S.-based Plans - Our fixed option grants for certain U.S.-based company officers and outside directors give these individuals the right to buy our stock at the market price on the day the options were granted. Fixed stock options granted under the stock incentive plan adopted by our shareholders in May 1994 may be exercised between one and 10 years subsequent to the date of grant. Options granted under our option plan in effect prior to May 1994 may be exercised at any time up to 10 years after the grant date. Non-U.S. Plans - We also have separate stock option plans for certain employees of our non-U.S. operations. The options granted under these plans were priced at the market price of our common stock on the grant date. Generally, they can be exercised from three to 10 years after the grant date. Approximately 73,000 option shares remained available at year-end for future grants under our non-U.S. plans. The following table summarizes the activity for our fixed option plans for the last three years. All grants were made at fair value on the date of grant.
Weighted Average Exercise Price
Option Shares
10,419,127
$20.47
Outstanding Jan. 1, 1996
Granted
3,444,162
26.42
Exercised
(1,395,719)
18.21
(586,775)
23.62
Canceled
11,880,795
22.60
Outstanding Dec. 31, 1996
Granted
3,353,133
34.38
Exercised
(2,133,788)
20.07
Canceled
(557,329)
31.77
12,542,811
25.76
Outstanding Dec. 31, 1997
Granted
3,693,511
42.65
Exercised
(3,663,620)
23.04
(1,428,810)
37.23
Canceled
Outstanding Dec. 31, 1998
11,143,892
$30.78
The following table summarizes the options exercisable at the end of the last three years and the weighted average fair value of options granted during those years. The fair value of options is estimated on the date of grant using the Black-Scholes option-pricing model, with the following weighted-average assumptions used for grants in 1998, 1997 and 1996, respectively: dividend yield of 3.0%, 2.1% and 2.0%; expected volatility of 18.9%, 20.1% and 22.7%; risk-free interest rates of 5.6%, 6.5% and 6.2%; and an expected life of 5.9 years, 5.4 years and 6.2 years.
1998
1997
1996
Options exercisable at year-end
8,174,128
7,186,957
8,078,734
Weighted average fair value of options granted during the year
$8.88
$7.20
$8.91
The following tables summarize the status of fixed stock options outstanding and exercisable at Dec. 31, 1998:
Options Outstanding
Range of Exercise Prices
Number of Options
Weighted Average Remaining Contractual Life
Weighted Average Exercise Price
$11,08-20.03
3.3 years
$17.80
1,992,242
20.13-25.38
5.9 years
23.67
1,849,880
6.8 years
25.44-29.00
26.33
2,322,290
8.2 years
29.81-40.83
36.17
2,120,164
41.38-50.76
9.1 years
44.05
2,859,316
$11.08-50.76
6.9 years
$30.78
11,143,892
Options Exercisable
Range of Exercise Prices
Number of Options
Weighted Average Exercise Price
$11,08-20.03
$17.80
1,992,242
20.13-25.38
23.67
1,849,880
25.44-29.00
26.32
2,254,290
29.81-40.83
36.23
1,943,664
41.38-50.76
49.33
38,658
$11.08-50.76
$26.11
8,078,734
Variable Option Grants
In 1997 and 1996, we made variable option grants of 316,200 and 1,650,000 shares, respectively, from our 1994 stock incentive plan to certain of our key officers. One-half of the options will vest when the market price of our stock reaches a 20-consecutive-day average of $50 per share. The remaining options will vest when our stock price reaches a 20-consecutive-day average of $55 per share. The exercise price of each option is equal to the market price of our stock on the grant date. These options may be exercised during the twelve months preceding the Dec. 1, 2001, expiration date provided the stock price targets are achieved.
The following table summarizes the activity for our variable option grants for the last three years.
Weighted Average Exercise Price
Option Shares
Outstanding Jan. 1, 1996
$ -
-
Granted
29.38
1,650,600
Outstanding Jan. 1, 1997
29.38
1,650,600
Granted
33.56
316,200
Outstanding Jan. 1, 1998
30.05
1,966,800
Granted
29.38
(468,600)
Outstanding Dec. 31, 1998
1,498,200
$30.26
The weighted average fair value of options granted during 1997 and 1996 is $5.46 and $4.54 per option, respectively. The fair value of the variable options was estimated on the date of grant using a variable option-pricing model with the following weighted average assumptions in 1997 and 1996, respectively: dividend yield of 2.8% and 3.0%; expected volatility of 20% for both years; risk-free interest rate of 6.1% and 5.8%; and an expected life of 4.6 years and 5.0 years.
Restricted Stock and Deferred Stock Awards
Up to 20% of the 11.6 million shares available under our 1994 stock incentive plan may be granted as restricted stock awards. The stock is restricted because recipients receive the stock only upon completing a specified objective or period of employment, generally one to five years. The shares are considered issued when awarded, but the recipient does not own and cannot sell the shares during the restriction period. Up to 1,800,000 shares remain available for restricted stock awards at Dec. 31, 1998. We also have a Deferred Stock Award Plan for stock awards to non-U.S. employees. Deferred stock awards are the same as restricted stock awards, except that shares granted under the deferred plan are not issued until the vesting conditions specified in the award are fulfilled. Up to 21,000 shares remain available for deferred stock awards at Dec. 31, 1998.
Pro Forma Information
Had we calculated compensation expense on a combined basis for our stock option grants based on the "fair value" method described in SFAS No. 123, our net income and earnings per share would have been reduced to the pro forma amounts as indicated.
(In thousands)
Year ended December 31
1998
1997
1996
Net Income
As reported
$929,292
$732,702
$89,348
Pro forma
914,831
721,209
75,983
Basic Earnings per Share
As reported
3.97
3.01
0.33
Pro forma
3.91
2.96
0.27
Diluted Earnings per Share
As reported
3.69
2.84
0.32
Pro forma
3.63
2.79
0.27