Accounting Differences

.. ce the company’s inception in 1996. – Achieve earnings growth while maintaining balance sheet strength. – Reduction in exposure to areas with high catastrophic exposure. – Substantially resolve major portion of outstanding environmental Claims.

(These claims are related to Asbestos and other environmental claims on policies written 20 + years ago. Policies written in last 20 years include and Environmental exclusion. At the time these policies were written, no person realized the long-term detrimental effects of what were, at the time, not known to be hazardous materials. Almost all old-line property and casualty companies have had to recognize their exposure to these types of claims.) -Successfully develop new distribution channels for personal lines products. Key Upgrade In December of 1998, the A.M. Best Company upgrades Travelers to A+. A++ is the highest possible rating.

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As a result, Travelers is now well positioned to take advantage of what we see as significant changes taking place in today’s Property and Casualty industry. Capitalizing on Market trends Personal lines agents are generally attempting to consolidate their writings to one or two companies within each agency. Due to favorable pricing, Travelers was able to invest in book transfers where an agent moves their entire book of business from another carrier to travelers. This helped to provide a 13.5% increase in revenue for personal lines to $3.5 billion. Commercial lines revenue was flat despite 4-5% decreases in industry premium levels each year since 1996. Operating income increased 11% in 1998 due to lower catastrophic losses and improved operating expense ratios. Opportunities within Citigroup Citigroup owns travelers Insurance 84%.

Management feels f=this creates exciting opportunities for Travelers with Citigroup’s cross selling of complimentary products. Other Growth Opportunities Travelers formed and Alliance with Winterthur, a Swiss owned insurance company that allows Travelers to provide insurance in Europe, Asia and Latin America for their domestic commercial clients. Key Differences Travelers is positioning themselves as a low cost provider while Reliance is trying to improve operations through innovation and creating market niches. No mention of the cost structure in the Reliance letter to the shareholders. Both companies had successful 1998, in actuality; the entire property and casualty industry faired pretty well in 1998 due in part tot the relatively low level of catastrophic losses.

-Insider information. One of the problems that were identified by Reliance management in 1999 was an expense problem at Reliance National and $50m in annualized cost savings were identified and implemented in the second and third quarter of 1999 at Reliance. Both companies mentioned the challenging property and casualty environment. Third Quarter of 1999 results- Travelers Earnings were solid despite height level of catastrophic losses, achieved due to lower expenses and Increased personal lines agents. Travelers experienced a slight increase in Combined ration from 102.5 in 1998 to 103 through the first three quarters of 1999. Third Quarter Results – Reliance The good news is the company is showing a $15m loss through for the third quarter of 1999.

The bad news is that what is not included in that number is an adjustment to loss reserves in excess of $330m, on a pre tax basis that resulted in an after tax charge of close to $147.7m, taken in the second quarter of 1999. Further, during the third quarter A.M. Best placed Reliance Group Holdings under review with negative implications. (As previously mentioned, Reliance’s current Best rating is A-, any drop below that would have significant detrimental effects. A- is generally considered the minimum acceptable rating for insurance companies by most national insurance agencies and many commercial insurance buyers.) The pre tax reserve adjustment is a good showcase for the problems facing the auditors when auditing an insurance company. An insurance company collects premiums today to cover losses expected to happen at some point in the future.

This future date could be next year or twenty years from now. During that time, state laws can change and common law can actually change the exposure of the insurance company from when they actually wrote the policy. Estimated losses are based on the best guess of the actuaries and management. Some industry experts believe the entire property and Casualty industry is under reserved by as much as 15%. The results even without that loss adjustment were not positive for Reliance. Saul Steinberg states in the third quarter press release that these results do not reflect the profitability of the core business.

While the combined ratio in the third quarter was in excess of 110, without the run off business this would have been 102. Run off business is lines of business that Reliance has decided to get out of but it takes some time to eliminate the risks associated with this business. Another item clouding the financial condition of Reliance group is was the potential loss surrounding what is referred to as Unicover. Unicover was a program administered by Reliance National where Insurance policies were written on Reliance paper (issued by Reliance) and the risk was 100% reinsured. For this, Reliance National would receive substantial fees, without taking any risk. Workman’s compensation insurance has two basic components, the wage loss component and the health insurance benefits. The idea was to separate these two risks and sell them to separate re insurers.

The Health portion of the risks were sold to Life and Health companies and it soon became apparent that these risks would have combined ratios far exceeding any ratio in which these companies could make a profit. Despite having legally binding re-insurance contracts, these insurers claimed they were mislead when they agreed to reinsure the risks and sought to void the reinsurance contracts. If they were successful, Reliance would be responsible for an estimated $1.1 billion in future claims. While Reliance’s position is they have legally binding contracts with these re-insurers, they cannot afford the long legal battle that would subsequently erupt. Having this cloud over the financial condition of the company influenced A.M. Best’s review of the company.

In the first quarter of 2000, Reliance settled the Unicover claim for approximately $100m. -Inside information. According to sources we are not at liberty to disclose, in order to maintain the A- rating, Reliance Group has to raise enough capital to restore the balance sheet to the pre reserve adjustment strength. With Unicover and the poor results in the third quarter, that would mean they would have to raise about $400m. (Important to note here that Reliance has yet to suspend the quarterly dividend that costs approximately $35m per year and that the Steinberg family owns over 40% of the common stock). Reliance Group Holdings has delivered very poor.

The fall out has been substantial. The entire management of Reliance National has been fired. Robert Steinberg was forced out as president and Chief Operating Officer and an outside president was brought in to run the company. – More Inside Information. These results potentially cost Saul Steinberg the company he bought in a leveraged buyout when he was 28 years old.

Unfortunately for the shareholders, none of the 14 companies that review Reliance were apparently willing to take on the risk in Reliance National. In short, these potential suitors are not convinced that all the losses have been adequately reserved. As management significantly influences losses for reserves, if investors do not have faith in that management, they have no basis of support for the numbers produced by the accountants. Reliance Group announced on February 28, 2000 the sale of their one consistently profitable profit center, Reliance group holdings for $xxxxm. This sale will provide the company with the capital required to maintain the A- rating from the A.M.

Best Company. Bibliography Travelers Property and Casualty Annual Report 1998 Reliance Group Holdings Annual Report, 1998.