Accounting differences

General Comments about the Insurance Industry

Insurance Companies generate revenues by selling insurance policies. These policies provide a known amount of revenue for an unknown amount of losses offsetting that revenue. This can make the matching principle difficult. Some of the potential losses can come years after the insurance policy was written and the premiums received. The liabilities for these future losses are estimated by actuaries and are subject to a certain amount of interpretation by management.

The accounting for the premium revenues is reflected in written vs. earned premium. Various statutory requirements are based on written premium, which is the amount of premium booked in a given accounting period. Earned premium is generally used for recognizing revenues for financial reporting. As insurance policies are written on an annual basis or longer, the premiums (revenues) are spread over the duration of the policy period even if the potential liability exceeds the policy period. The future liability is estimated and booked against the earned premiums. Some costs, however are not matched against this revenue, primarily commissions paid to the insurance agent that sold the policy. This expense is fully recognized at the time the premium is booked.

These effects can have both positive and negative implications. In an era of declining written premiums, revenue can actually increase and expenses should decrease because of the costs incurred at the time the policy was written.

Very few insurance companies in the United States actually make a profit by selling insurance. The profit is generally made from the investment income earned investing the premiums they receive now, but do not expect to pay out until some point in the future.

This paper examines the published financial information of Reliance Group Holdings and Travelers Property Casualty Corp for the fiscal year ending December 31, 1998 and the third quarter reports for the quarter ending September 30, 1999. The letters to the shareholders are examined as well as the financial statements and subsequent notes. An outline of the accounting principles employed by both companies is provided as well as some basic ratio analysis.

Reliance Group Holdings, Inc. 1998 Annual Report
Letter to Shareholders from Saul Steinberg, Chairmen and CEO and Robert Steinberg, President and Chief Operating Officer.

Operating income was up slightly over 1997. Net income was a record due to proceeds from sale of asset, Commonwealth Title.

Reliance grew Shareholders Equity by $1.32 billion, highest it has ever been in the history of the company. This may not be significant accomplishment if the company had sustained steady operating and earnings growth over the long run.

Reliance had 18% growth in property and casualty premiums, despite continued soft pricing environment and significant catastrophic losses as well as other weather related losses. Combined ratio for 1998 102.1. Combined ratio is a measure of premiums spent to cover losses and expenses. For every dollar in premium revenues, the company spent $1.02 in expenses and losses.

Employee and management "ownership" aligns interests of employees with that of shareholders.

The Steinberg\'s note a successful track record of putting innovative and specialized skills to work. In the third quarter of 1999 it will be noted that several of these "innovations" were not as profitable as they thought they were.

Note disciplined underwriting approach.

Reliance National

Reliance Group Holdings largest profit center offering specialized property and casualty insurance and risk management services. They "broke new ground" in overseas expansion and e-commerce opportunities. These e-commerce opportunities are Cybercomp, a program to offer workmen\'s compensation insurance over the Internet.

Reliance National\'s international sources generated 12% of the total premium in 1998, through offices in London, China and Argentina.

Reliance Insurance

This is considered a middle market company, writing insurance for small and mid size companies. The Steinbergs feel this is one of the few companies offering a full range of specialized products delivered locally. This means it is underwritten through local branch offices. Reliance National business is largely underwritten centrally, in their head office in New York.

Reliance Reinsurance

Reinsurance offers a method of limiting exposure for the generators of insurance policies. A reinsurer will take on a portion of a risk for a portion of the premium. Reliance Reinsurance got out of several less attractive lines of business and as they did not act soon enough as significant reserve adjustments will be made in the third quarter of 1999. Reliance