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 Re grew premiums by offering reinsurance for crop losses.
Despite a high level of Catastrophic losses in 1998 in this line, Reliance Re was able to lock in profit by offering reinsurance to other companies, actually reinsure the reinsurer. Reliance Surety Business grew over 20% in 1998 due in large part to the formation of Reliance Specialty division. In 1997 two competitors merged, when St.Paul purchased United States Fidelity and Guarantee USF). The management of USF was chosen to lead the combined surety operations. Reliance Surety hired 7 people in the senior management ranks of the former St.
Paul surety operation and formed the Specialty division. These individuals were able to capitalize on their existing relationships and bring a substantial amount of profitable surety business over to Reliance. Viewed as one of Reliance Group’s first specialization success stories. Increased profits as well through he use of technology in the high volume/low premium sector. Relaince Surety was quoted in the Wall Street Journal as being the crown jewel of Reliance Group Holdings (footnote) Personal Auto This is a new venture and grew very fast in 1998. There was a launch of Reliance Direct, an e-commerce venture to offer personal auto insurance over the Internet.
This unit had revenue of $201m, with no mention of profit and loss. Two separate efforts in personal auto were included in these numbers and these efforts were subsequently merged. RGC Information Technologies This is a non-insurance related entity, offering computer software services. Started in response to Y2K concerns and revenue growth in 1998 was 29% to close to $250m. Strong Financial Position The company had more capital and less leverage than at anytime in their history.
They reduced debt to 35% of equity from 40% of equity, achieved primarily through the sale of their stake in Commonwealth title. Duffs and Phelps and Standard and Poor raised Reliance Group’s senior debt ratings. (These ratings were short lived as they were downgraded in the third quarter of 1999). – Insider information. The management of Reliance Group was hoping that A.M. Best, a key insurance industry rating agency, would raise Reliance’s rating from A- (excellent) to A (superior) in response to the 1998 results.
This did not happen much to the disappointment of senior management. This rating increase has been a goal of Reliance Group for several years. Outlook Property and Casualty market will continue to be challenging but the management notes some signs of a hardening in the market. Reliance plans to continue to differentiate themselves through disciplined, selected, and sophisticated underwriting and offering outstanding service. Travelers Property Casualty Corp. 1998 Annual Report Letter to the Shareholders by Jay Fishman, President and Chief Executive Officer Revenues and earnings in 1998 achieved all time highs with operating earnings increasing 11% on revenue increase of 5%.
This is before an adjustment for FAS 115 (I need to find out what this was). Strategy is to build Travelers as an efficient low cost provider. Commercial lines had an 11% increase in operating profits. Personal lines had sufficient price increases to invest in the capital necessary to grow aggressively. Strategies Applied – Create a culture that recognizes the importance of efficient, low cost provider of high quality products and services. Reduced operating expenses $300m sin …