By year's end, The St. Paul incurred $419 million in pretax catastrophe losses. That's more than three times our 1997 catastrophe losses and our second-worst annual total. Those losses, coupled with a decline in realized investment gains and merger and restructuring charges, resulted in 1998 net income of $89 million, or $0.32 per share. That compares with $929 million, or $3.69 per share, for 1997.

The fourth quarter of 1998, by contrast, showed some improvement. Our operating earnings (excluding restructuring charges) improved significantly over the second and third quarters of 1998. We saw some price strengthening in specialty commercial business. We also started to see the benefits of expense reduction initiatives we took earlier in 1998 after our merger with USF&G.

And in the midst of overall disappointing results for 1998, a number of our underwriting operations -- notably, reinsurance, surety, technology and financial services -- performed very well.

Despite the extraordinary challenges of 1998, The St. Paul has retained its fundamental financial strength.

With the addition of USF&G's $2.5 billion in written premiums and $11 billion investment portfolio, The St. Paul ended 1998 with assets of $38.3 billion and shareholders' equity of $6.6 billion. Our balance sheet strength continues to distinguish us within the property-liability industry.

Indeed, it is our ongoing commitment to sound financial management that enables us to withstand a year like 1998, yet move forward with strength and confidence. The St. Paul possesses the essential elements of success in a turbulent marketplace -- a focused strategy, quality leadership, market presence, underwriting expertise, financial strength and shareholder value.

Positioned for the Future

These elements have never been more important in the dynamic and global property-liability industry, which likely will continue to evolve rapidly and remain intensely competitive.

The trend toward consolidation within the industry will not abate. Companies will continue to build global capabilities to take advantage of fewer international obstacles to growth. Customers are becoming increasingly sophisticated, requiring more complex insurance solutions and demanding better value at lower cost. Ultimately, the traditional lines separating insurance companies from other financial services companies may disappear altogether, presenting new opportunities for companies that are prepared. I believe we are prepared for this new world market.

Our merger with USF&G was the right transaction, at the right time, at the right price, with the right company. It made The St. Paul larger in an industry in which size brings economies of scale and increased market presence. It made us smarter, with the addition of talented new leaders and skilled employees -- some of whom you will learn about in other parts of this report.

The merger made us more competitive by adding business volume, new products and new expertise to many of our operations, such as reinsurance, surety and other niche operations. Finally, the merger brought two profitable new operations to our portfolio -- a life insurance company and a nonstandard auto insurance operation.

We have a successful and growing international operation, an essential capability for our company because of the growth opportunities that exist outside the United States. We have insurance underwriting offices in Canada and 11 countries in Europe, Africa and Latin America. And, in early 1999, we established a Global Marine business unit -- our first primary insurance business unit with truly worldwide reach.

We are a major corporate investor in Lloyd's of London -- one of the most important insurance markets in the world -- through our ownership of three managing agencies that oversee approximately 4 percent of Lloyd's total premiums.

We will continue to seek other opportunities to manage our products on a worldwide basis as we grow into a global company.

Our reinsurance operations continue to build on a strong and profitable market presence. The merger brought together two successful and complementary reinsurance organizations, St. Paul Re and F&G Re -- as well as Discover Re, which provides creative solutions to the increasingly complex problems that face our largest customers.

Finally, our investment in The John Nuveen Company continues to add profits to this corporation. Our 78 percent ownership stake in this asset management company yielded $104 million of pretax earnings in 1998, another record.

Outlook for 1999

With market conditions largely unchanged, I expect 1999 to be as challenging as 1998. Our focus for the year will be increasing profitability and reducing expenses. I am confident we will achieve our expense reduction and profitability goals, and I fully anticipate that our results for 1999 will be significantly improved over 1998.

Maintaining underwriting discipline is another priority. As I have said in the past, we will not sacrifice profitability for market share. We are prepared to significantly shrink our premium volume to meet our profitability goals. Our underwriting operations have taken the necessary steps to implement this directive and to correct profitability issues that exist in some lines of business.

Given market conditions, The St. Paul has continued to build shareholder value through its share repurchase program. I believe this is a prudent use of our capital when we determine that our stock is undervalued. In November 1998, our board authorized the repurchase of up to $500 million of our common stock. Through March 1, 1999, we had repurchased 8.9 million shares at a cost of $295 million.

The Elements of Success

I said at the beginning of this letter that 1998 was a year of extremes. I close it with a declaration that The St. Paul -- as never before -- is poised and fully prepared to succeed in this dynamic, global business.

Our strategy is sound, and we have the leadership in place to successfully execute it. We now have a bigger market presence than ever before in several key market segments. We possess the industry-specific expertise that is vital to long-term success. And importantly, we retain our financial strength, our sound financial management philosophy and our commitment to building shareholder value.

It goes without saying that people are the most important part of our business.

I am pleased to welcome an exceedingly strong and talented leader in Jim Gustafson, who was recently named president and chief operating officer of The St. Paul Companies and elected to our board of directors. With his many years of experience as an executive of General Re Corporation, Jim is familiar with The St. Paul and brings a high level of expertise and skill to his responsibilities.