<PAGE>
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
/x/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 1999
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From_______To_______
Commission File Number 1-8278
RELIANCE GROUP HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
Delaware 13-3082071
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
Park Avenue Plaza
55 East 52nd Street
New York, New York 10055
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 909-1100
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes /x/ No / /
As of November 1, 1999, 114,835,000 shares of common stock of Reliance Group
Holdings, Inc. were outstanding.
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
I N D E X
Page
No.
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statement of Operations for the Quarters and Nine-
Month Periods Ended September 30, 1999 and 1998 (Unaudited). 2
Consolidated Balance Sheet at September 30, 1999 (Unaudited)
and December 31, 1998....................................... 3
Consolidated Statement of Changes in Shareholders' Equity for
the Nine-Month Period Ended September 30, 1999 (Unaudited).. 4
Consolidated Statement of Comprehensive Income (Loss)
for the Quarters and Nine-Month Periods Ended
September 30, 1999 and 1998 (Unaudited)..................... 5
Consolidated Condensed Statement of Cash Flows for the Nine-
Month Periods Ended September 30, 1999 and 1998 (Unaudited). 6
Notes to Consolidated Financial Statements (Unaudited)......... 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations..................... 18
PART II. OTHER INFORMATION, AS APPLICABLE............................... 29
SIGNATURES ............................................................. 30
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS (UNAUDITED)
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
- -----------------------------------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Revenues:
Premiums earned ................................................ $ 719,293 $ 588,341 $ 1,894,053 $ 1,808,588
Net investment income .......................................... 72,107 74,908 216,565 224,608
Gain on sales of investments ................................... 3,193 1,483 9,608 107,421
Gain on sales of subsidiaries .................................. -- -- -- 197,258
Other .......................................................... 72,093 83,339 232,495 235,927
----------- ----------- ----------- -----------
866,686 748,071 2,352,721 2,573,802
----------- ----------- ----------- -----------
Claims and expenses:
Policy claims and settlement expenses .......................... 548,684 376,471 1,645,200 1,092,056
Policy acquisition costs and other insurance expenses .......... 248,283 226,240 714,756 733,218
Restructuring charge ........................................... -- -- 24,000 --
Interest ....................................................... 15,246 18,906 46,338 61,675
Reversal of interest expense related to income tax ............. -- -- (31,500) --
Other operating expenses ....................................... 77,823 93,858 252,265 269,581
----------- ----------- ----------- -----------
890,036 715,475 2,651,059 2,156,530
----------- ----------- ----------- -----------
Income (loss) before income taxes and equity
in investee companies ...................................... (23,350) 32,596 (298,338) 417,272
Income tax (provision) benefit ................................. 7,000 (9,000) 139,100 (131,100)
Equity in investee companies ................................... 1,287 6,410 29,585 17,017
----------- ----------- ----------- -----------
Income (loss) before extraordinary item and
cumulative effect of accounting change .................... (15,063) 30,006 (129,653) 303,189
Extraordinary item - early extinguishment of debt .............. -- -- -- (7,504)
Cumulative effect of change in accounting
for insurance assessments ................................. -- -- (57,850) --
----------- ----------- ----------- -----------
Net income (loss) ............................................. $ (15,063) $ 30,006 $ (187,503) $ 295,685
=========== =========== =========== ===========
Basic per share information:
Income (loss) before extraordinary item and
cumulative effect of accounting change .................... $ (.13) $ .26 $ (1.13) $ 2.62
=========== =========== =========== ===========
Net income (loss) .............................................. $ (.13) $ .26 $ (1.64) $ 2.56
=========== =========== =========== ===========
Diluted per share information:
Income (loss) before extraordinary item and
cumulative effect of accounting change .................... $ (.13) $ .25 $ (1.13) $ 2.52
=========== =========== =========== ===========
Net income (loss) .............................................. $ (.13) $ .25 $ (1.64) $ 2.46
=========== =========== =========== ===========
</TABLE>
See notes to consolidated financial statements
-2-
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
September 30 December 31
1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands, except per share amount)
<S> <C> <C>
ASSETS
Marketable securities:
Fixed maturities held for investment - at amortized cost
(quoted market $509,669 and $578,179) ....................................... $ 504,516 $ 539,848
Fixed maturities available for sale - at quoted market
(amortized cost $2,775,449 and $2,687,009) .................................. 2,693,173 2,738,864
Equity securities - at quoted market (cost $319,379
and $262,986) ............................................................... 783,561 754,543
Short-term investments ......................................................... 236,253 383,658
Cash ................................................................................ 82,505 81,612
Premiums and other receivables ...................................................... 1,886,189 1,708,761
Reinsurance recoverables ............................................................ 6,495,172 4,958,504
Federal and foreign income taxes, including deferred taxes .......................... 113,401 --
Investment in investee company ...................................................... 422,394 415,654
Deferred policy acquisition costs ................................................... 310,477 295,939
Excess of cost over fair value of net assets acquired, less
accumulated amortization ...................................................... 212,684 219,854
Other assets ........................................................................ 746,561 678,102
------------ ------------
$ 14,486,886 $ 12,775,339
============ ============
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
Unearned premiums ................................................................... $ 2,200,996 $ 1,980,481
Unpaid claims and related expenses .................................................. 8,680,986 7,173,886
Accounts payable and accrued expenses ............................................... 1,074,397 847,452
Reinsurance ceded premiums payable .................................................. 831,927 570,252
Federal and foreign income taxes, including deferred taxes .......................... -- 167,505
Term loans and short-term debt ...................................................... 261,113 256,763
Debentures and notes ................................................................ 455,980 463,480
------------ ------------
13,505,399 11,459,819
------------ ------------
Contingencies and commitments
Shareholders' equity:
Common stock, par value $.10 per share, 225,000
shares authorized, 116,166 and 116,076 shares
issued and outstanding ....................................................... 11,617 11,608
Additional paid-in capital ..................................................... 550,937 548,674
Retained earnings .............................................................. 217,206 432,096
Accumulated other comprehensive income ......................................... 212,699 323,142
------------ ------------
992,459 1,315,520
Treasury stock, 1,331 shares ........................................................ (10,972) --
------------ ------------
981,487 1,315,520
------------ ------------
$ 14,486,886 $ 12,775,339
============ ============
</TABLE>
See notes to consolidated financial statements
-3-
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (UNAUDITED)
<TABLE>
<CAPTION>
Accumulated Other
Comprehensive Income
--------------------
Net
Unrealized
Net Loss on
Additional Unrealized Foreign
Common Paid-In Retained Gain on Currency Treasury Shareholders'
Stock Capital Earnings Investments Translation Stock Equity
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands, except per share amount)
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1999 .... $ 11,608 $ 548,674 $ 432,096 $ 355,759 $ (32,617) $ -- $ 1,315,520
Issuance of common stock .... 9 405 414
Transactions of investee
companies ........... 1,858 (5,457) (3,599)
Net loss .................... (187,503) (187,503)
Dividends ($.24 per share) .. (27,387) (27,387)
Depreciation after deferred
income taxes ........ (104,841) (104,841)
Foreign currency translation (145) (145)
Purchase of treasury stock .. (10,972) (10,972)
--------- ----------- ----------- ----------- ----------- ----------- -----------
Balance, September 30, 1999 . $ 11,617 $ 550,937 $ 217,206 $ 245,461 $ (32,762) $ (10,972) $ 981,487
========= =========== =========== =========== =========== =========== ===========
</TABLE>
See notes to consolidated financial statements
-4-
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)
<TABLE>
<CAPTION>
Quarter Ended September 30
------------------------------------------------------------------------------
1999 1998
------------------------------------ -------------------------------------
Income tax Income tax
Pretax effect After-tax Pretax effect After-tax
--------- ---------- --------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net income (loss) $ (15,063) $ 30,006
--------- ---------
Other comprehensive income (loss):
Unrealized holding gains (losses) $ (67,421) $ 23,598 (43,823) $ 26,619 $ (9,316) 17,303
Less: reclassification adjustment for
gains realized in net income (loss) (2,965) 1,038 (1,927) (1,142) 399 (743)
--------- --------- --------- --------- --------- ---------
Net unrealized gains (losses) recognized
in other comprehensive income (loss) (70,386) 24,636 (45,750) 25,477 (8,917) 16,560
Foreign currency translation (400) 140 (260) (1,436) 503 (933)
--------- --------- --------- --------- --------- ---------
Total other comprehensive income (loss) $ (70,786) $ 24,776 (46,010) $ 24,041 $ (8,414) 15,627
--------- --------- --------- --------- --------- ---------
Total comprehensive income (loss) $ (61,073) $ 45,633
========= =========
<CAPTION>
Nine Months Ended September 30
------------------------------------------------------------------------------
1999 1998
------------------------------------ -------------------------------------
Income tax Income tax
Pretax effect After-tax Pretax effect After-tax
--------- ---------- --------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Net income (loss) $(187,503) $ 295,685
--------- ---------
Other comprehensive income (loss):
Unrealized holding gains (losses) $(142,585) $ 49,907 (92,678) $ 82,756 $ (28,964) 53,792
Less: reclassification adjustment for
gains realized in net income (loss) (27,472) 9,852 (17,620) (94,885) 33,209 (61,676)
--------- --------- --------- --------- --------- ---------
Net unrealized losses recognized
in other comprehensive income (loss) (170,057) 59,759 (110,298) (12,129) 4,245 (7,884)
Foreign currency translation (223) 78 (145) (5,711) 1,999 (3,712)
--------- --------- --------- --------- --------- ---------
Total other comprehensive loss $(170,280) $ 59,837 (110,443) $ (17,840) $ 6,244 (11,596)
--------- --------- --------- --------- --------- ---------
Total comprehensive income (loss) $(297,946) $ 284,089
========= =========
</TABLE>
See notes to consolidated financial statements
-5-
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF CASH FLOWS (UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended September 30 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C>
CASH FLOWS FROM (USED BY) OPERATING ACTIVITIES ................................... $ 8,875 $ (44,086)
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of:
Fixed maturities available for sale .......................................... 427,730 376,715
Equity securities ............................................................ 107,325 362,617
Maturities and redemptions of:
Fixed maturities available for sale .......................................... 115,280 301,641
Fixed maturities held for investment ......................................... 48,693 76,115
Purchases of:
Fixed maturities available for sale .......................................... (591,896) (917,922)
Fixed maturities held for investment ......................................... (12,280) (26,807)
Equity securities ............................................................ (133,502) (114,306)
(Increase) decrease in short-term investments - net .............................. 167,239 (32,700)
Proceeds from sales of subsidiaries .............................................. -- 271,852
Other - net ...................................................................... (95,237) (48,761)
--------- ---------
33,352 248,444
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Increase in term loans ........................................................... 99,380 135,000
Increase (decrease) in short-term debt - net ..................................... (2,000) 317
Repayments of term loans ......................................................... (93,269) (130,741)
Redemption of debentures and notes ............................................... (7,500) (188,711)
Issuance of common stock ......................................................... 414 5,405
Dividends ........................................................................ (27,387) (27,768)
Purchase of treasury stock ....................................................... (10,972) --
--------- ---------
(41,334) (206,498)
--------- ---------
Increase (decrease) in cash ...................................................... 893 (2,140)
Cash, beginning of period ........................................................ 81,612 53,661
--------- ---------
Cash, end of period .............................................................. $ 82,505 $ 51,521
========= =========
Supplemental disclosures of cash flow information:
Interest paid .................................................................... $ 66,500 $ 41,000
========= =========
Income taxes paid ................................................................ $ 200 $ 77,100
========= =========
</TABLE>
See notes to consolidated financial statements
-6-
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
================================================================================
1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
In the opinion of management, the accompanying unaudited consolidated financial
statements include all adjustments (consisting of normal recurring accruals
only) considered necessary to present fairly the financial position at September
30, 1999, and the results of operations, changes in shareholders' equity,
comprehensive income (loss) and cash flows for all periods presented. The
results of operations for the interim periods are not necessarily indicative of
the results that may be expected for any other interim period or for the entire
year.
For a summary of significant accounting policies (which have not changed from
December 31, 1998 with the exception of the adoption of Statement of Position
No. 97-3 - see note 5 to the unaudited consolidated financial statements) and
additional financial information, see the Company's Annual Report on Form 10-K
for the year ended December 31, 1998.
Certain reclassifications have been made to the Company's prior year
consolidated financial statements to conform with the current year's unaudited
consolidated financial statements.
2. INCREASE IN LOSS RESERVES
Net policy claims and settlement expenses for the nine month period ended
September 30, 1999, include a provision of $227.2 million to increase net loss
reserves related to policies issued in prior periods, resulting from updated
information and subsequent developments. In addition, the Company also incurred
an expense of $103.2 million representing the cost of ceding to reinsurers
$172.1 million of losses under various stop loss treaties. Accordingly, for the
first nine months of 1999, the net effect of the increase in net loss reserves
and the amounts ceded to reinsurers was a pretax charge of $330.4 million, of
which $171.0 million was incurred at Reliance National, $104.9 million at
Reliance Insurance, $49.4 million at Reliance Reinsurance and $4.1 million at
Reliance Surety.
Regularly scheduled actuarial loss reserve reviews in the second quarter of 1999
revealed significant deterioration in a number of lines and programs. As a
result of this updated information, the Company hired an independent actuarial
firm to assist in its loss reserve reviews. The results of these reviews led the
Company to conclude that an increase in loss reserves in the second quarter of
1999 was appropriate. The increase in loss reserves was due principally to
construction defect claims, higher than expected losses in property, marine and
aviation lines, deterioration in a program which wrote environmental coverages
and adverse development in the commercial automobile line. The increase in loss
reserves (before application of the stop loss treaties) was comprised of the
following:
7
<PAGE>
o $108.4 million for construction defect claims, arising mostly in California.
In the second quarter of 1999, the Company completed an actuarial study of these
claims, utilizing methodologies provided by the independent actuarial firm.
Actuarial analysis of these types of claims is particularly complex due to the
protracted claims settlement process, as well as a widening interpretation of
what constitutes insurance coverage that courts have applied to these cases. The
Company is now using an exclusion on construction policies that should mitigate
its exposure on recently issued policies.
o $106.7 million for property, marine and aviation lines. This is largely the
result of higher than expected losses reported to the Company during the second
quarter, on assumed excess of loss reinsurance treaties. The Company has decided
to non-renew the majority of these treaties.
o $70.1 million for business written by a program manager, which provided
commercial automobile coverage to hazardous waste haulers and general liability
coverage to entities with environmental exposures. The Company's second quarter
1999 actuarial study of this program revealed recent price deterioration and an
unusual amount of recent loss activity. With the completion of the actuarial
study, the Company eliminated this program.
o $114.1 million for adverse development in other lines of business, primarily
$77.2 million for commercial automobile where loss activity was higher than
expected.
3. TAX SETTLEMENT
In the second quarter of 1999, the Company reached settlement with the Internal
Revenue Service concerning various tax matters, including a 1980 asserted tax
deficiency with respect to investment tax credits. As a result of the
settlement, the Company recorded an after-tax benefit in the nine month period
ended September 30, 1999 of $55.5 million, including the reversal of $31.5
million of previously accrued interest expense.
4. RESTRUCTURING CHARGE
During the first quarter of 1999, the Company recorded a $24 million
restructuring charge. This charge resulted from the consolidation of the
Company's non-standard automobile insurance operation, Reliant, formerly part of
Reliance National, with Reliance Direct, formerly a separate operating unit. The
new combined operating unit is named Reliance Personal.
8
<PAGE>
The restructuring charge includes the write-off of $18 million of deferred
policy acquisition costs at Reliance Direct, which resulted from the decision to
offer a new integrated product, change marketing focus and support, non-renew
certain policies, and the related reduction in the estimate of automobile policy
renewal rates. The charge also includes the write-off of $2.2 million of
previously capitalized information technology expenditures at Reliance Direct
which will not be utilized by Reliance Personal and which have no alternative
use. The charge also includes $2 million of severance costs, of which $600,000
has been paid through September 30, 1999, related to the termination of Reliance
Direct employees, and $1.8 million of costs, of which $1.4 million has been paid
through September 30, 1999, associated with the termination of certain of
Reliance Direct's third party service contracts. The Company estimates that the
remaining severance and terminated service contracts will be substantially paid
by the end of 2000.
In November 1999, the Company entered into an Asset Purchase Agreement pursuant
to which it will transfer substantially all of the assets and non-insurance
liabilities of Reliance Direct to a third party. The closing of the agreement is
anticipated to take place in the fourth quarter of 1999, subject to customary
closing conditions. In addition, through reinsurance and other arrangements
effective January 15, 2000, the Company will transfer all of Reliance Direct's
liabilities for unearned premium and related insured losses, as well as the
renewal rights to in-force policies. The gain from the transaction is not
expected to be significant.
5. INSURANCE-RELATED ASSESSMENTS
Effective January 1, 1999, the Company adopted the American Institute of
Certified Public Accountants' Statement of Position No. 97-3, "Accounting by
Insurance and Other Enterprises for Insurance-Related Assessments" ("SOP"). The
SOP provides guidance as to when to recognize a liability for loss-based and
other insurance-related assessments. Previously, and as was the practice of many
property and casualty insurance companies, the Company had accounted for these
assessments on a pay-as-you-go basis and, accordingly, had no recorded liability
related to these assessments. The effect of adopting the SOP was an increase in
the net loss in the first nine months of 1999 for the cumulative effect of the
change in accounting principle of $57.9 million ($.51 per diluted share), net of
a $31.1 million income tax benefit. Approximately $61 million of the $89 million
pretax charge relates to loss-based assessments for workers' compensation
insurance. The remaining $28 million charge relates primarily to premium-based
assessments and assessments by guaranty funds. The Company estimates that a
substantial majority of the liability for assessments will be paid over the next
ten years.
During the third quarter of 1999, new legislation by New York State changed the
assessment liability for workers' compensation insurance. As a result, the
Company reduced its assessment liability and decreased underwriting loss by
$11.0 million ($8.3 million for Reliance National and $2.7 million for Reliance
Insurance) in the third quarter and first nine months of 1999.
9
<PAGE>
6. EQUITY IN INVESTEE COMPANIES
On October 25, 1999, the Company completed the sale of its entire investment in
Zenith National Insurance Corp. ("Zenith") for cash proceeds of $184.1 million.
In anticipation of the sale, the Company wrote-down its investment in Zenith by
$9.3 million in the second quarter of 1999 and, effective July 1, 1999, no
longer accounted for Zenith under the equity method of accounting. The
write-down is included in gain on sales of investments in the accompanying
unaudited consolidated statement of operations, and the Company's investment in
Zenith has been reclassified from investment in investee company to other assets
in the accompanying unaudited consolidated balance sheet.
The Company's equity in investee companies is as follows:
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
- ---------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
LandAmerica Financial Group, Inc. (1).... $ 1,287 $ 4,837 $ 5,808 $ 11,159
Zenith (2)............................... -- 1,573 23,777 5,858
------- -------- ------- --------
$ 1,287 $ 6,410 $29,585 $ 17,017
======= ======== ======= ========
</TABLE>
(1) The equity in investee company for the nine months ended September 30,
1998 includes equity earnings for the seven month period ending September
30, 1998.
(2) The equity in investee company for the nine months ended September 30,
1999 includes $24.9 million representing the Company's portion of a gain
from the sale of CalFarm Insurance Company by Zenith.
Summarized financial information for LandAmerica Financial Group, Inc. is as
follows:
<TABLE>
<CAPTION>
Nine Months Ended September 30 1999 1998
- ---------------------------------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C>
Revenues................................................. $ 1,547,846 $1,277,870
Income before income taxes............................... 64,904 99,979
Net income............................................... 41,214 64,122
Net income per diluted share............................. 2.08 3.61
</TABLE>
10
<PAGE>
7. REINSURANCE
The reconciliation of property and casualty insurance direct premiums to net
premiums is as follows (in thousands):
Nine Months Ended September 30
--------------------------------------------------------
1999 1998
--------------------------------------------------------
Premiums Premiums Premiums Premiums
Written Earned Written Earned
----------- ----------- ----------- -----------
Direct ..... $ 3,441,134 $ 3,247,043 $ 2,925,751 $ 2,777,039
Assumed .... 1,089,455 1,029,711 532,029 499,189
Ceded ...... (2,518,046) (2,382,701) (1,639,053) (1,606,772)
----------- ----------- ----------- -----------
Net Premiums $ 2,012,543 $ 1,894,053 $ 1,818,727 $ 1,669,456
=========== =========== =========== ===========
The reconciliation of property and casualty insurance gross policy claims and
settlement expenses to net policy claims and settlement expenses is as follows
(in thousands):
Nine Months Ended
September 30
--------------------------
1999 1998
----------- -----------
Gross ................................... $ 3,905,454 $ 2,129,625
Reinsurance recoveries .................. (2,260,254) (1,044,245)
----------- -----------
Net policy claims and settlement expenses $ 1,645,200 $ 1,085,380
=========== ===========
11
<PAGE>
8. EARNINGS PER SHARE
The basic and diluted per share reconciliations of income (loss) before
extraordinary item and cumulative effect of accounting change to net income
(loss) is as follows:
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Basic income (loss) per share:
Income (loss) before extraordinary item and
cumulative effect of accounting change ........ $(.13) $ .26 $(1.13) $2.62
Extraordinary item - early extinguishment of debt -- -- -- (.06)
Cumulative effect of change in accounting
for insurance assessments .................... -- -- (.51) --
----- ----- ------ -----
Net income (loss) ............................... $(.13) $ .26 $(1.64) $2.56
===== ===== ====== =====
Diluted income (loss) per share:
Income (loss) before extraordinary item and
cumulative effect of accounting change ........ $(.13) $ .25 $(1.13) $2.52
Extraordinary item - early extinguishment of debt -- -- -- (.06)
Cumulative effect of change in accounting
for insurance assessments ..................... -- -- (.51) --
----- ----- ------ -----
Net income (loss) ............................... $(.13) $ .25 $(1.64) $2.46
===== ===== ====== =====
</TABLE>
12
<PAGE>
The reconciliation of the basic to diluted per share information is as follows:
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
- --------------------------------------------------------------------------------------------------------
(In thousands, except per share amounts)
<S> <C> <C> <C> <C>
Income (loss) before extraordinary
item and cumulative effect of
accounting change ...................... $ (15,063) $ 30,006 $ (129,653) $303,189
========= ======== ========== ========
Weighted average number of basic
shares outstanding ..................... 113,639 116,015 114,278 115,539
Effect of dilutive securities - options (1) -- 4,376 -- 4,678
--------- -------- ---------- --------
Weighted average number of diluted
shares outstanding ..................... 113,639 120,391 114,278 120,217
========= ======== ========== ========
Basic per share income (loss) before
extraordinary item and cumulative
effect of accounting change ............ $ (.13) $ .26 $ (1.13) $ 2.62
========= ======== ========== ========
Diluted per share income (loss) before
extraordinary item and cumulative
effect of accounting change ............ $ (.13) $ .25 $ (1.13) $ 2.52
========= ======== ========== ========
</TABLE>
(1) For the quarter and nine months ended September 30, 1999, the effect of
options has been excluded since their inclusion would be anti-dilutive.
13
<PAGE>
9. BUSINESS SEGMENT INFORMATION
<TABLE>
<CAPTION>
Quarter Ended Nine Months Ended
September 30 September 30
1999 1998 1999 1998
- ------------------------------------------------------------------------------------------------------------
(In thousands)
<S> <C> <C> <C> <C>
Revenues:
Property and casualty insurance
Premiums earned:
Reliance National (1) $ 317,476 $ 235,944 $ 803,407 $ 715,953
Reliance Insurance 193,955 191,394 551,956 548,004
Reliance Reinsurance 77,144 67,033 178,231 155,894
Reliance Surety 52,212 51,294 153,603 144,964
Reliance Personal (1) 78,452 42,717 206,752 104,308
Other 54 (41) 104 333
----------- ----------- ----------- -----------
719,293 588,341 1,894,053 1,669,456
Net investment income 72,107 74,908 216,565 219,332
Gain on sales of investments 3,193 1,483 9,608 107,116
Gain on sales of subsidiaries -- -- -- 194,080
----------- ----------- ----------- -----------
794,593 664,732 2,120,226 2,189,984
----------- ----------- ----------- -----------
Title insurance
Premiums earned -- -- -- 139,132
Net investment income -- -- -- 5,276
Gain on sales of investments -- -- -- 305
----------- ----------- ----------- -----------
-- -- -- 144,713
----------- ----------- ----------- -----------
Information technology consulting 54,571 64,443 181,579 182,035
Other 17,522 18,896 50,916 57,070
----------- ----------- ----------- -----------
$ 866,686 $ 748,071 $ 2,352,721 $ 2,573,802
=========== =========== =========== ===========
Income (loss) before income taxes and
equity in investee companies:
Property and casualty insurance
Underwriting gain (loss):
Reliance National (1) $ (59,647) $ (9,851) $ (272,406) $ (18,615)
Reliance Insurance (18,442) (11,698) (142,162) (36,366)
Reliance Reinsurance (7,334) (2,949) (57,899) (3,995)
Reliance Surety 12,182 13,620 29,994 39,436
Reliance Personal (1) (7,302) (4,355) (52,394) (7,893)
Other 1,174 (1,107) 69 (869)
----------- ----------- ----------- -----------
(79,369) (16,340) (494,798) (28,302)
Net investment income 72,107 74,908 216,565 219,332
Gain on sales of investments 3,193 1,483 9,608 107,116
Gain on sales of subsidiaries -- -- -- 194,080
----------- ----------- ----------- -----------
(4,069) 60,051 (268,625) 492,226
Title insurance -- -- -- 11,286
Information technology consulting 2,040 5,342 11,596 14,575
Other (21,321) (32,797) (41,309) (100,815)
----------- ----------- ----------- -----------
$ (23,350) $ 32,596 $ (298,338) $ 417,272
=========== =========== =========== ===========
</TABLE>
(1) In the first quarter of 1999, the Company consolidated its non-standard
automobile operation, Reliant, formerly part of Reliance National, with
Reliance Direct into a new operating unit, Reliance Personal. Prior period
results of Reliance National have been restated to reflect the transfer of
Reliant. See note 4 to the unaudited consolidated financial statements.
14
<PAGE>
10. SALE OF SUBSIDIARIES
In the first quarter of 1998, the Company sold its title insurance operations to
LandAmerica Financial Group, Inc. ("LandAmerica"). The transaction resulted in
an after-tax gain of $242.9 million of which $133.6 million ($1.11 per diluted
share) was recognized in the first quarter of 1998. The pretax deferred gain of
$158.8 million is included in "accounts payable and accrued expenses" in the
accompanying unaudited consolidated balance sheet. The Company accounts for its
investment in LandAmerica by the equity method of accounting for periods
subsequent to the sale date. See note 9 to the unaudited consolidated financial
statements for business segment information regarding the title insurance
operations in 1998.
In addition, in the first quarter of 1998, the Company sold a subsidiary which
resulted in an after-tax gain of $1.3 million, net of tax expense of $1.8
million.
11. WORKERS' COMPENSATION REINSURANCE FACILITY
In 1998, Reliance National entered into reinsurance fronting arrangements as
part of a workers' compensation insurance facility created and managed by
Unicover Managers, Inc. ("Unicover"), a third party manager of reinsurance
pools. Under these arrangements, Reliance National reinsures workers'
compensation policies, the occupational accident portion of which is then 100
percent reinsured by (also referred to as "retroceded to") a number of other
reinsurance companies ("retrocessional reinsurers"). In July 1999, the Company
received a copy of a letter from one of its retrocessional reinsurers, Sun Life
Assurance Company of Canada ("Sun Life"), purporting to demand arbitration
against Unicover and several Unicover pools and facilities. According to the
letter, in the arbitration, Sun Life will seek, among other things, rescission
of retrocessional reinsurance contracts with the Unicover pool and facilities,
including the Reliance facility, based on alleged but unspecified material
misrepresentations and nondisclosures by Unicover. In September 1999, Phoenix
Home Life Mutual Insurance Company ("Phoenix"), another of the Company's
retrocessionaires, likewise demanded arbitration seeking rescission. In October
1999, the Company served its own demand for arbitration, seeking money damages
and specific performance of the retrocessional contracts, and commenced an
action in United States District Court, Northern District of Illinois, seeking
an order that Sun Life and Phoenix arbitrate with the Company separately from
the other Unicover pools and facilities. The Company believes that the amount of
the ultimate losses which Sun Life and Phoenix seek to avoid are substantial and
would be material to the Company's financial condition if the Company's
reinsurance contracts with Sun Life and Phoenix were found to be unenforceable.
Based on its review and assessment of the information currently available to it
and after consultation with counsel, the Company believes that it has valid and
enforceable retrocessional reinsurance contracts with Sun Life and Phoenix and
its other reinsurers. Notwithstanding that belief, because litigation and
arbitration regarding this matter are unlikely to be resolved soon and because
of the risk to the Company's credit ratings and competitive position in the
market place that continued uncertainty would pose to the Company, the Company
has entered into settlement discussions and believes that there is a reasonable
likelihood that these discussions will result in contingent settlement
agreements, which if ultimately consummated, would result in an after-tax charge
to the Company which would not be expected to exceed 10% of consolidated
shareholders' equity.
15
<PAGE>
12. OTHER CONTINGENCIES
The Company is subject to the litigation set forth below:
(a) In February 1999, the Company received a decision in an initial phase of an
alternative dispute resolution trial of certain contested issues between an
asbestos producer and certain of its liability insurance carriers, including the
Company.
At issue in this proceeding, among other things, is the amount of remaining
insurance coverage, if any, under primary policies written by a predecessor of
the Company during the years 1942 to 1951, applicable to asbestos related bodily
injury claims against the producer. Those policies are treated as having
separate coverage limits for bodily injury claims resulting from the producer's
products and those resulting from its operations. Since 1970, the producer's
insurers, including the Company, have treated all such claims as coming within
the products coverage and on that basis the Company exhausted the coverage
limits of its policies in 1987.
In 1996, pursuant to a 1985 settlement agreement between certain asbestos
producers and certain of their insurers, the producer instituted alternative
dispute resolution proceedings against various of its insurers, including the
Company. The proceedings sought to re-allocate a substantial percentage of
claims to operations coverage, which had not been previously exhausted. In the
decision, which the Company has appealed, the trial judge did not decide the
issue of the allocation of pending and future claims or direct the payment of
any amount by the Company to the producer. He did, however, reject the Company's
position as to re-allocation of past claims and ruled, based on statistical
data, that a substantial percentage of claims paid through September 1996 should
have been classified as operations claims.
Further trial phases have been scheduled to determine the financial implications
of the decision, the outcome of which may also be appealed. The Company is
unable to determine, at this time, the amount that it may be required to pay.
If not overturned on appeal, an effect of the decision would be to make
available for the payment of asbestos related bodily injury claims, up to an
additional $44 million in liability coverage, plus associated defense and loss
adjustment expenses, under the Company's policies.
The Company believes that the decision is incorrect and is based on flawed
statistical data. The Company does not believe that it is probable that its
liability, if any, in respect of this matter will have a material adverse effect
on the Company's financial position, although there is no assurance that the
disposition of this matter will not materially affect the Company's results of
operations for any period.
16
<PAGE>
(b) Employers who purportedly purchased workers' compensation insurance policies
on a retrospectively rated or other loss-sensitive basis have brought several
putative class actions against, among others, individual insurance companies
ranging in number from 6 to approximately 160, including Reliance Insurance
Company and several of its subsidiaries. The plaintiffs in the actions assert
that, from as early as January 1, 1985 through the present, they and the members
of the putative classes they purport to represent were overcharged for such
insurance covering workers' compensation risks in the states in which the
actions have been brought. The plaintiffs, on behalf of themselves and the
putative class members, seek unspecified monetary damages, with interest and
attorneys' fees, against all defendants jointly and severally, and injunctive
and other equitable relief.
Such actions in which the Company is a defendant have been brought in Georgia,
Tennessee, Florida, New Jersey, Pennsylvania, Illinois, Missouri, California,
Alabama, Michigan, New York, and Kentucky. In addition to these putative class
actions, approximately 85 employers, individually and not as a class, have
brought an action in Arizona asserting overcharge claims against approximately
65 defendants, including the Company.
The Company is also a defendant in a putative class action commenced in federal
court in Texas against approximately 150 individual insurance companies, in
which the plaintiffs claim that the defendants violated the federal RICO statute
by allegedly overcharging employers from 1988 to 1999 for retrospectively rated
workers' compensation insurance policies covering risks in 44 states and the
District of Columbia. The plaintiffs, on behalf of themselves and the putative
class of employers, seek unspecified monetary damages, with interest and
attorneys' fees, against all defendants jointly and severally.
The foregoing actions are in their early stages and there have been no rulings
on any motions by the plaintiffs for certification of the putative classes they
purport to represent. The Company has denied or intends to deny the material
allegations in each of the lawsuits and intends to contest each action
vigorously.
The Company does not believe that it is probable that its aggregate liability,
if any, in respect of these actions will have a material adverse effect on the
Company's financial position, although there is no assurance that the
disposition of the actions will not materially affect the Company's results of
operations for any period.
13. INITIAL PUBLIC OFFERING/SPIN OFF
On October 27, 1999, the Company filed a registration statement with the
Securities and Exchange Commission for an initial public offering of up to 20%
of the common stock of Reliance Surety Group, Inc., the insurance holding
company that was recently formed to operate the Company's surety and fidelity
business.
On October 13, 1999, the Company's Board of Directors approved a preliminary
plan to spin off to shareholders 10% of the common stock of a new e-commerce
company named Point, Click and Bind, Inc., that will consist of the business of
Cybercomp, the Company's Internet based underwriter of workers' compensation
insurance for small sized companies. The spin off is subject to certain
conditions and to final approval by the Company's Board of Directors and is
expected to be completed in the first quarter of 2000.
17
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
================================================================================
OVERVIEW
The Company incurred an operating loss of $17.1 million ($.15 per diluted
share) in the third quarter of 1999 compared to operating income of $29.0
million ($.24 per diluted share) in the third quarter of 1998. The decline
in operating results in 1999 resulted from an increase in the property and
casualty insurance underwriting loss due to higher catastrophe claims, and
losses from business which the Company had previously cancelled or intends
not to renew. For the nine months ended September 30, 1999, the operating
loss was $160.6 million ($1.40 per diluted share) compared to operating
income of $98.4 million ($.82 per diluted share) in the corresponding
prior year period. The 1999 nine month operating results include several
significant items: (i) an after-tax charge of $147.7 million ($1.29 per
diluted share) for increasing net loss reserves for policies issued in
prior periods, and an after-tax charge of $67.1 million ($.59 per diluted
share) representing the cost of ceding to reinsurers losses under various
stop loss treaties, (ii) an after-tax benefit of $55.5 million ($.49 per
diluted share) resulting from the settlement of various federal income tax
issues, (iii) an increase in catastrophe claims which were $35.4 million
after-tax ($.31 per diluted share) in the first nine months of 1999,
compared to $17.4 million after-tax ($.14 per diluted share) in the
corresponding 1998 period, and (iv) an after-tax restructuring charge of
$15.6 million ($.14 per diluted share). See notes 2, 3 and 4 for a
discussion of the increase in net loss reserves, settlement of tax issues
and restructuring charge, respectively.
The net loss in the third quarter of 1999 was $15.1 million ($.13 per
diluted share) compared to net income of $30.0 million ($.25 per diluted
share) in the third quarter of 1998. After-tax gains on sales of
investments were $2.1 million ($.02 per diluted share) and $964,000 ($.01
per diluted share) in the third quarter of 1999 and 1998, respectively.
The net loss for the first nine months of 1999 was $187.5 million ($1.64
per diluted share) which included (i) an after-tax charge of $57.9 million
($.51 per diluted share) representing the cumulative effect of adopting
the American Institute of Certified Public Accountants' Statement of
Position No. 97-3, "Accounting by Insurance and Other Enterprises for
Insurance-Related Assessments" ("SOP"), (ii) an after-tax gain of $24.9
million ($.22 per diluted share) representing the pro rata portion of a
gain realized by Zenith National Insurance Corp. ("Zenith") on the sale of
its CalFarm subsidiary, and (iii) an after-tax gain on sales of
investments of $6.0 million ($.05 per diluted share). Net income in the
first nine months of 1998 was $295.7 million ($2.46 per diluted share)
which included an after-tax gain on sales of investments of $69.8 million
($.58 per diluted share) and an after-tax extraordinary charge of $7.5
million ($.06 per diluted share), related to the early extinguishment of
debt. Net income in the first nine months of 1998 also included an
after-tax gain on sales of subsidiaries of $135.0 million ($1.12 per
diluted share) primarily resulting from the sale of the Company's title
insurance operations. See notes 5 and 10 to the unaudited consolidated
financial statements for a discussion of the adoption in 1999 of the SOP
and the sale of subsidiaries in 1998.
18
<PAGE>
PROPERTY AND CASUALTY INSURANCE OPERATIONS
The consolidated property and casualty insurance underwriting loss was
$79.4 million in the third quarter of 1999 compared to $16.3 million in
the corresponding 1998 period. The increase in underwriting loss in 1999
resulted from higher catastrophe claims which were $37.7 million in the
third quarter of 1999, primarily from international catastrophes, compared
to $18.2 million in 1998. The third quarter 1999 underwriting results were
also adversely affected by losses from business that the Company has
either previously cancelled or had decided not to renew. Partially
offsetting these declines was a third quarter benefit of $11.0 million
related to assessments. See note 5 to the unaudited consolidated financial
statements for a discussion of assessments.
The consolidated property and casualty insurance underwriting loss was
$494.8 million in the first nine months of 1999, which included a second
quarter pretax charge of $330.4 million to increase net loss reserves and
the cost of ceding to reinsurers losses under various stop loss treaties.
Regularly scheduled actuarial loss reserve reviews in the second quarter
of 1999 revealed significant deterioration in a number of lines and
programs. As a result of this updated information, the Company hired an
independent actuarial firm to assist in its loss reserve reviews. The
results of these reviews led the Company to conclude that an increase in
loss reserves in the second quarter of 1999 was appropriate. The increase
in loss reserves was due principally to construction defect claims, higher
than expected losses in property, marine and aviation lines, deterioration
in a program which wrote environmental coverages and adverse development
in the commercial automobile line. The increase in loss reserves (before
application of the stop loss treaties) was comprised of the following:
o $108.4 million for construction defect claims, arising mostly in
California. In the second quarter of 1999, the Company completed an
actuarial study of these claims, utilizing methodologies provided by the
independent actuarial firm. Actuarial analysis of these types of claims is
particularly complex due to the protracted claims settlement process, as
well as a widening interpretation of what constitutes insurance coverage
that courts have applied to these cases. The Company is now using an
exclusion on construction policies that should mitigate its exposure on
recently issued policies.
o $106.7 million for property, marine and aviation lines. This is largely
the result of higher than expected losses reported to the Company during
the second quarter on assumed excess of loss reinsurance treaties. The
Company has decided to non-renew the majority of these treaties.
o $70.1 million for business written by a program manager, which provided
commercial automobile coverage to hazardous waste haulers and general
liability coverage to entities with environmental exposures. The Company's
second quarter 1999 actuarial study of this program revealed recent price
deterioration and an unusual amount of recent loss activity. With the
completion of the actuarial study, the Company eliminated this program.
o $114.1 million for adverse development in other lines of business,
primarily $77.2 million for commercial automobile where loss activity was
higher than expected.
Excluding the $330.4 million pretax charge, the underwriting loss in the
first nine months of 1999 was $164.4 million compared to an underwriting
loss of $28.3 million in the
19
<PAGE>
corresponding 1998 period. The increased underwriting loss in the first
nine months of 1999, when compared to the corresponding period of 1998,
reflects losses from business that the Company has cancelled or intends
not to renew, an increase in catastrophe claims which were $54.5 million
in 1999 compared to $26.7 million in 1998, and the first quarter 1999 $24
million restructuring charge which resulted from the consolidation of the
Company's automobile insurance operations into a new operating unit,
Reliance Personal.
Net premiums written, net premiums earned, underwriting gain (loss) and
combined ratios for each of the property and casualty insurance operating
units are as follows (dollars in thousands):
Quarter Ended September 30
----------------------------
1999 1998
--------- ---------
Net Premiums Written
Reliance National (1) ..... 253,029 $ 219,197
Reliance Insurance ........ 195,412 215,749
Reliance Reinsurance ...... 64,905 60,371
Reliance Surety ........... 55,444 56,390
Reliance Personal (1) ..... 84,961 57,156
Other ..................... 37 (325)
--------- ---------
$ 653,788 $ 608,538
========= =========
Net Premiums Earned
Reliance National (1) ..... $ 317,476 $ 235,944
Reliance Insurance ........ 193,955 191,394
Reliance Reinsurance ...... 77,144 67,033
Reliance Surety ........... 52,212 51,294
Reliance Personal (1) ..... 78,452 42,717
Other ..................... 54 (41)
--------- ---------
$ 719,293 $ 588,341
========= =========
Underwriting Gain (Loss)
Reliance National (1) ..... $ (59,647) $ (9,851)
Reliance Insurance ........ (18,442) (11,698)
Reliance Reinsurance ...... (7,334) (2,949)
Reliance Surety ........... 12,182 13,620
Reliance Personal (1) ..... (7,302) (4,355)
Other ..................... 1,174 (1,107)
--------- ---------
$ (79,369) $ (16,340)
========= =========
Combined Ratios (2)
Reliance National (1) ..... 117.9% 103.1%
Reliance Insurance ........ 108.9% 105.8%
Reliance Reinsurance ...... 109.6% 104.3%
Reliance Surety ........... 76.8% 73.3%
Reliance Personal (1) ..... 109.3% 110.2%
Consolidated .............. 110.3% 102.3%
(1) In the first quarter of 1999, the Company consolidated its
non-standard automobile operation, Reliant, formerly part of
Reliance National, with Reliance Direct into a new operating unit,
Reliance Personal. Prior period results of Reliance National have
been restated to reflect the transfer of Reliant.
(2) Calculated on a GAAP basis, after policyholders' dividends. Combined
ratios for Other are not presented since they are not meaningful.
20
<PAGE>
Net premiums written, net premiums earned, underwriting gain (loss) and
combined ratios for each of the property and casualty insurance operating
units are as follows (dollars in thousands):
<TABLE>
<CAPTION>
Nine Months Ended September 30
-------------------------------------------------------
1999 1998
--------------------------------- -----------
Excludes effect of
reserve strengthening
and cost of
ceding losses (2)
---------------------
<S> <C> <C> <C>
Net Premiums Written
Reliance National (1) $ 848,194 $ 900,894 $ 769,334
Reliance Insurance 552,252 576,752 577,020
Reliance Reinsurance 197,448 208,448 172,357
Reliance Surety 158,853 158,853 148,185
Reliance Personal (1) 255,735 255,735 152,114
Other 61 61 (283)
----------- ----------- -----------
$ 2,012,543 $ 2,100,743 $ 1,818,727
=========== =========== ===========
Net Premiums Earned
Reliance National (1) $ 803,407 $ 856,107 $ 715,953
Reliance Insurance 551,956 576,456 548,004
Reliance Reinsurance 178,231 189,231 155,894
Reliance Surety 153,603 153,603 144,964
Reliance Personal (1) 206,752 206,752 104,308
Other 104 104 333
----------- ----------- -----------
$ 1,894,053 $ 1,982,253 $ 1,669,456
=========== =========== ===========
Underwriting Gain (Loss)
Reliance National (1) $ (272,406) $ (101,406) $ (18,615)
Reliance Insurance (142,162) (37,262) (36,366)
Reliance Reinsurance (57,899) (8,499) (3,995)
Reliance Surety 29,994 34,094 39,436
Reliance Personal (1) (52,394) (52,394) (7,893)
Other 69 1,069 (869)
----------- ----------- -----------
$ (494,798) $ (164,398) $ (28,302)
=========== =========== ===========
Combined Ratios (3)
Reliance National (1) 133.2% 111.2% 102.2%
Reliance Insurance 125.3% 105.9% 106.3%
Reliance Reinsurance 132.4% 104.5% 102.6%
Reliance Surety 80.5% 77.8% 72.7%
Reliance Personal (1) 125.3% 125.3% 107.6%
Consolidated 125.7% 108.0% 101.4%
</TABLE>
(1) In the first quarter of 1999, the Company consolidated its
non-standard automobile operation, Reliant, formerly part of
Reliance National, with Reliance Direct into a new operating unit,
Reliance Personal. Prior period results of Reliance National have
been restated to reflect the transfer of Reliant.
(2) Excludes the $227.2 million pretax charge for increasing net loss
reserves and $103.2 million pretax charge for amounts ceded to
reinsurers for assuming losses under various stop loss treaties
which were recorded in the first nine months of 1999.
(3) Calculated on a GAAP basis, after policyholders' dividends. Combined
ratios for Other are not presented since they are not meaningful.
21
<PAGE>
RELIANCE NATIONAL
The increase in net premiums written and net premiums earned in the third
quarter and first nine months of 1999, when compared to the corresponding
1998 periods, reflects increased writings in Accident and Health and
higher foreign sourced premiums, partially offset by lower net premiums in
Casualty Risk Services.
The increase in the third quarter 1999 underwriting loss, when compared to
the corresponding prior year quarter, resulted from an increase in
catastrophe claims, which were $32.2 million in 1999, primarily from
international catastrophes, compared to $4.0 million in 1998. In addition,
the third quarter 1999 underwriting results were adversely affected by
losses from business that the Company has either previously cancelled or
had decided not to renew. The underwriting results in the first nine
months of 1999 included a loss of $171.0 million from the second quarter
increase in net loss reserves and the cost of ceding losses to reinsurers.
Due to the Company's decision to cancel or not to renew certain
under-performing business, Reliance National expects premium writings in
2000 to be lower than those in 1999.
On October 13, 1999 the Company's Board of Directors approved a
preliminary plan to spin off to shareholders 10% of Point, Click and Bind,
Inc. See note 13 to the unaudited consolidated financial statements for
further discussion.
RELIANCE INSURANCE
The decline in net premiums written in the third quarter of 1999, when
compared to the third quarter of 1998, reflects the decision to curtail
writing certain under-performing property and transportation lines of
business in the Specialty division. These declines were partially offset
by increased writings in the Commercial Accounts and Large Accounts
divisions, particularly in workers' compensation. The decline in net
premiums written in the first nine months of 1999, when compared to the
first nine months of 1998, is primarily the result of ceding of $24.5
million of premiums in the second quarter of 1999 to various stop loss
treaties.
The increase in the third quarter 1999 underwriting loss, when compared to
the corresponding prior year period, reflects increased losses in
commercial automobile and general liability lines of business, partially
offset by lower catastrophe claims. The underwriting results in the first
nine months of 1999 included a loss of $104.9 million from the second
quarter increase in net loss reserves and the cost of ceding losses to
reinsurers.
RELIANCE REINSURANCE
The increase in net premiums written and net premiums earned in the third
quarter and first nine months of 1999, when compared to the prior year
periods, reflects new reinsurance treaties.
The increase in the underwriting loss in the third quarter of 1999, when
compared to the corresponding prior year period, resulted from increased
losses in marine and aviation lines of business. Reliance Reinsurance will
not renew these lines of business. The underwriting results in the first
nine months of 1999 included a loss of $49.4 million from the second
quarter increase in net loss reserves and the cost of ceding losses to
reinsurers.
22
<PAGE>
RELIANCE SURETY
The decline in net premiums written in the third quarter of 1999, when
compared to the corresponding 1998 period, reflects lower contract surety
premiums particularly in small contractor business. This decline was
offset by growth in commercial surety. The increase in net premiums
written and net premiums earned in the first nine months of 1999, when
compared to the first nine months of 1998, reflects increases in both
contract and commercial surety premiums.
The decline in underwriting profit in the third quarter of 1999, when
compared to the third quarter of 1998, reflects an increase in contract
surety losses especially in the small contractor line. Underwriting income
in the first nine months of 1999 includes a $4.1 million increase in net
loss reserves.
On October 27, 1999, the Company filed a registration statement to sell up
to 20% of Reliance Surety in a public offering. See note 13 to the
unaudited consolidated financial statements for further discussion.
RELIANCE PERSONAL
Reliance Personal was created in late March 1999 by consolidating Reliance
National's non-standard automobile operation, Reliant, with Reliance
Direct which formerly was a separate operating unit. As a result of the
consolidation, a $24 million restructuring charge was recorded by Reliance
Personal in the first quarter of 1999. In November 1999, the Company
entered into an agreement to transfer to a third party substantially all
the assets and non-insurance liabilities related to policies written by
Reliance Direct. See note 4 to the unaudited consolidated financial
statements for further discussion of this transfer.
The increase in net premiums written and net premiums earned in the third
quarter and the first nine months of 1999, when compared to the
corresponding prior year periods, resulted from growth in non-standard
automobile writings.
The increase in the underwriting loss in the third quarter of 1999, when
compared to the third quarter of 1998, resulted from increased losses in
the non-standard automobile line. As a result of the increased losses,
Reliance Personal will seek price increases and use more stringent
underwriting criteria in certain states. The increase in the underwriting
loss in the first nine months of 1999, when compared to the first nine
months of 1998, also reflects the $24 million restructuring charge.
PROPERTY AND CASUALTY INSURANCE INVESTMENT RESULTS
Net investment income of the property and casualty insurance operations
declined in the third quarter and first nine months of 1999 to $72.1
million and $216.6 million from $74.9 million and $219.3 million in the
corresponding 1998 periods. These declines resulted from an increase in
interest accrued on insurance funds held on behalf of reinsurers in
connection with certain stop loss treaties and, in the third quarter of
1999, by the Company reducing its holdings of certain high yielding
foreign denominated fixed income securities.
Gains on sales of investments in the third quarter of 1999 was $3.2
million resulting primarily from sales of equity securities, compared to a
gain of $1.5 million in the third quarter of 1998. Gains on sales of
investments in the first nine months of 1999 was $9.6 million which
included
23
<PAGE>
a write-down of $9.3 million of the Company's investment in Zenith. Gains
on sales of investments in the first nine months of 1998 were $107.1
million which resulted from sales of equity securities.
INVESTMENT PORTFOLIO
At September 30, 1999, the Company's investment portfolio aggregated $3.89
billion (at cost), of which 92% was invested in fixed maturities and 8%
was invested in equity securities. The Company seeks to maintain a
diversified and balanced fixed maturity portfolio representing a broad
spectrum of industries and types of securities and invests in investment
grade securities (those rated "BBB" or better by Standard and Poor's) and,
to a lesser extent, non-investment grade securities and non-rated
securities.
Fixed maturity securities classified as held for investment consist
primarily of corporate securities of which substantially all are rated
investment grade. Fixed maturity securities classified as available for
sale consist of corporate, U.S. Treasury and Government National Mortgage
Association (GNMA) securities. At September 30, 1999, the carrying values
of non-investment grade securities and securities not rated by Standard
and Poor's were $452.0 million (13% of the fixed income portfolio) and
$187.6 million (5% of the fixed income portfolio), respectively.
Substantially all of the Company's non-investment grade and non-rated
securities are classified as available for sale.
INFORMATION TECHNOLOGY OPERATIONS
RCG Information Technology, Inc. ("RCG"), a subsidiary of the Company,
provides computer-related services to large corporate clients throughout
the United States. Information technology revenues decreased to $54.6
million and $181.6 million in the third quarter and first nine months of
1999 from $64.4 million and $182.0 million in the corresponding 1998
periods. The decrease in third quarter 1999 revenue can be attributed to
an overall slowdown in the demand for certain consultant skill sets and a
decline in solutions business reflecting the reluctance of clients to
begin new technology initiatives until the impact of Year 2000 on their
systems is known. Gross margins (revenues less cost of services) were
$17.5 million and $60.3 million, or 32% and 33% of revenues, in the third
quarter and first nine months of 1999 compared to $20.8 million and $57.0
million, or 32% and 31% of revenues, in the corresponding prior year
periods. Pretax income declined to $2.0 million and $11.6 million in the
third quarter and first nine months of 1999 from $5.3 million and $14.6
million in the corresponding prior year periods. The decline in pretax
income in the first nine months of 1999, when compared to the first nine
months of 1998, resulted from higher selling, general and administrative
expenses associated with investments in technical and sales capabilities.
INTEREST EXPENSE
Interest expense declined to $15.2 million and $46.3 million in the third
quarter and first nine months of 1999 from $18.9 million and $61.7 million
in the corresponding 1998 periods. These declines resulted from lower
levels of debt outstanding. Since January 1, 1998, the Company has reduced
its debt by $186 million.
EQUITY IN INVESTEE COMPANIES
On October 25, 1999, the Company completed the sale of its entire
investment in Zenith for cash proceeds of $184.1 million. In anticipation
of the sale, the Company wrote-down its investment in Zenith by $9.3
million in the second quarter of 1999 and, effective July 1, 1999, no
longer accounted for Zenith under
24
<PAGE>
the equity method of accounting. The Company's investment in Zenith has
been reclassified from investment in investee company to other assets in
the accompanying unaudited consolidated balance sheet.
Equity in investee companies was $1.3 million in the third quarter of
1999, representing only the equity income from the Company's investment in
LandAmerica Financial Group, Inc. ("LandAmerica"), compared to $6.4
million in the third quarter of 1998 which included equity income from
both LandAmerica and Zenith. Equity in investee companies for the nine
months ended September 30, 1999 was $29.6 million which included a gain of
$24.9 million representing the Company's pro rata portion of a gain
realized by Zenith. Equity in investee companies for the first nine months
of 1998 was $17.0 million.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal sources of funds consist of dividends, advances
and net tax payments from its subsidiaries. These payments aggregated
$131.6 million for the nine-month period ended September 30, 1999.
Dividends paid by Reliance Insurance Company were $136.0 million in the
first nine months of 1999. The Company's ability to receive cash dividends
has depended upon and continues to depend upon the dividend paying ability
of its insurance subsidiaries. The Insurance Law of Pennsylvania, where
Reliance Insurance Company (the Company's principal insurance subsidiary)
is domiciled, limits the maximum amount of dividends which may be paid
without approval by the Pennsylvania Insurance Department. Under such law,
Reliance Insurance Company may pay dividends during the year equal to the
greater of (a) 10% of the preceding year-end policyholders' surplus or (b)
the preceding year's statutory net income. Furthermore, the Pennsylvania
Insurance Department has broad discretion to limit the payment of
dividends by insurance companies. During 1999, $585.3 million would be
available for dividend payments by Reliance Insurance Company under
Pennsylvania law. There is no assurance that Reliance Insurance Company
will meet the tests in effect from time to time under Pennsylvania law for
the payment of dividends without prior Insurance Department approval or
that any requested approval will be obtained. Reliance Insurance Company
has been advised by the Pennsylvania Insurance Department that any
required approval will be based upon a solvency standard and will not be
unreasonably withheld. Any significant limitation of Reliance Insurance
Company's dividends would adversely affect the Company's ability to
service its debt and to pay dividends on its common stock.
Reliance Insurance Company collects and invests premiums prior to payment
of associated claims, which are generally made months or years subsequent
to the receipt of premiums. Reliance Insurance Company carefully monitors
its cash, short-term investments and marketable securities to maintain
adequate balances for the timely payment of claims and other operating
requirements. At September 30, 1999, Reliance Insurance Company had $293
million of cash and short-term investments.
For the nine months ended September 30, 1999, the Company generated $8.9
million of cash flow from operating activities. In conjunction with the
tax settlement described in note 3 to the unaudited consolidated financial
statements, the Company made a $42.7 million payment, primarily interest,
to the Internal Revenue Service in the third quarter of 1999. The Company
utilized $44.1 million of cash flow from operating activities in the nine
months ended September 30, 1998. Operating cash flow in 1998 was adversely
affected by increased tax payments resulting from higher amounts of
taxable income due, in part, to gains on sales of subsidiaries and
investments.
25
<PAGE>
The Company generated $33.4 million of cash flow from investing activities
for the nine months ended September 30, 1999, primarily from the net sales
of marketable securities. The Company generated $248.4 million of cash
flow from investing activities for the nine months ended September 30,
1998, primarily from the sale of subsidiaries.
For the nine months ended September 30, 1999, the Company used $41.3
million of cash flow for financing activities, principally for the payment
of dividends and purchase of treasury stock. For the nine months ended
September 30, 1998, the Company used $206.5 million of cash flow for
financing activities. During the first nine months of 1998, the Company
purchased $179.3 million of its outstanding senior notes and senior
subordinated debentures. These purchases resulted in an after-tax
extraordinary charge of $7.5 million, net of a $4.0 million tax benefit.
The Company has a revolving credit facility with various banks providing
for aggregate maximum outstanding borrowings of $100 million. At September
30, 1999, borrowings aggregating $71 million were outstanding under the
facility. The Company had $717.1 million of debt outstanding at September
30, 1999, with $509 million maturing prior to December 31, 2000, including
$221 million of bank borrowings due March 31, 2000. The Company expects to
repay these amounts by refinancing and/or raising capital.
Maintaining appropriate levels of statutory policyholders' surplus is
considered important by the Company's management, state insurance
regulatory authorities and the agencies that rate the insurers'
claims-paying abilities and financial strength. Failure to maintain
certain levels of statutory policyholders' surplus could result in
increased scrutiny or, in some cases, action taken by state regulatory
authorities and/or downgrades in an insurer's ratings. In the third
quarter of 1999, Standard and Poor's and Moody's Investor Service placed
the ratings of the Company's senior notes, senior subordinated debentures
and the claims paying rating of Reliance Insurance Company on credit watch
with negative implications. In addition, A.M. Best & Company ("Best")
placed the "A- (Excellent)" rating of Reliance Insurance Company under
review with negative implications. The Company believes that any downgrade
in its Best rating would adversely affect its ability to underwrite
certain lines of business.
According to various rating agencies, these actions were taken due to
uncertainty relating to the Company's exposure in the "Unicover" workers'
compensation reinsurance facility, the Company's ability to accomplish its
capital raising objectives and refinancing of its debt in light of the
continued uncertainty with Unicover. The Company has entered into
settlement discussions and believes that there is a reasonable likelihood
that these discussions will result in contingent settlement agreements.
(See note 11 to the unaudited consolidated financial statements for a
discussion of the "Unicover" exposure.) The Company has also initiated a
number of capital raising activities. However, there can be no assurance
that it will be able to satisfactorily address the concerns of the rating
agencies.
The Company and its subsidiaries are involved in certain litigation
arising in the course of their businesses, some of which involve claims of
substantial amounts. See note 12 to the unaudited consolidated financial
statements for further discussion.
YEAR 2000
In general, the year 2000 issue concerns many existing computers and
software products which were originally coded to accept only two digit
entries in the date code field. These computers and software products will
need to be either replaced or reprogrammed in order for computer systems
to distinguish 21st century dates from 20th century dates.
26
<PAGE>
Company Information Technology. The Company's insurance policies contain
date sensitive data, such as policy expiration dates and premium payment
dates. If the Company's material computer systems are not year 2000
compliant, the Company's business operations, including claims and
premiums processing operations, financial reporting systems and actuarial
calculations, could be materially adversely affected.
In the third quarter of 1999, the Company completed the transfer of the
data from one noncompliant claims processing system to a year 2000
compliant system, the replacement of another claims processing system, and
a second round of compliance assurance testing on certain of its claims
and premiums processing systems and corporate financial recording and
reporting systems. All of the Company's claims and premiums processing
systems and corporate financial recording and reporting systems either
have been remediated or replaced and the Company believes they are year
2000 compliant. In addition, the Company in the third quarter of 1999
completed the remediation, and the compliance assurance testing, of
certain of its actuarial systems. The Company believes its actuarial
systems are year 2000 compliant.
Third Party Information Technology. Even if all of the Company's computer
systems and software products are year 2000 compliant, the failure of
third parties with whom the Company does significant business to be year
2000 compliant could materially adversely affect the financial position,
results of operations or cash flows of the Company. Accordingly, as part
of its year 2000 process, the Company has completed its process of
identifying certain third parties with whom the Company does significant
business to determine whether such third parties are, or will be, year
2000 compliant. The Company sent year 2000 compliance questionnaires to
its property managers, third party administrators, major reinsurers,
reinsurance intermediaries, insurance brokers and agents, employee benefit
providers, government and private agencies to which the Company
electronically transmits, and from which the Company electronically
receives, financial and other information, and to financial institutions
and other vendors with which the Company does significant business. The
Company also conducted systems testing with certain of these third
parties, a process which it completed in the third quarter of 1999.
In assessing the year 2000 readiness of the third parties who responded to
its inquiries, the Company relied on the statements of such third parties
and in most cases did not independently verify the accuracy of such
statements. Of the responses that the Company has received to date, no
third party has advised the Company that it has a year 2000 issue that
would have a material adverse effect on the Company. While the Company has
taken, and is taking, what it believes are appropriate safeguards based on
the assumption that the information provided by third parties who have
responded is accurate, there can be no assurances that the failure of such
third parties to be year 2000 compliant will not have a material adverse
effect on the Company's financial position, results of operations or cash
flows in future financial periods, if the information provided by such
third parties is not accurate.
Of the approximately 1,350 third parties of whom the Company has made
inquiries, approximately eleven percent did not respond, and approximately
ten percent responded in a manner that the Company believes requires
follow-up. The Company is continuing to follow up with such third parties.
27
<PAGE>
Contingency Plans. As part of the Company's year 2000 process, the
Company's business units were asked to formulate contingency plans to deal
with situations in which various systems of the Company, or of third
parties with whom the Company does business, are not year 2000 compliant.
The contingency plans produced by the Company address matters including
alternative means of recording and processing information if the Company's
computer systems could not process information due to a year 2000 problem,
alternative means of transmitting information if the Company's e-mail
system and fax machines were rendered unusable due to a year 2000 problem,
and alternative supply and distribution channels if selected key business
partners were unavailable due to a year 2000 problem. Both the process of
completing contingency plans and the review of such plans by the Company's
year 2000 program office were substantially completed in the third quarter
of 1999.
Costs. Through September 30, 1999, the Company had incurred $6.6 million
to address the year 2000 issue and expects to incur additional costs of
$1.0 million. The Company has increased the estimate of total expected
costs set forth in its June 30, 1999 Quarterly Report on Form 10-Q by an
additional $200,000. This increase is attributable, in part, to increases
in the cost of completing the second round of compliance assurance
testing.
Insurance Policies. As an insurer, the Company may incur losses and loss
adjustment expenses (including attorneys' fees and other legal expenses)
arising from property and casualty insurance claims by its insureds, who
may incur losses or expenses as a result of the failure of such insureds,
or the customers or vendors of such insureds, to be year 2000 compliant.
The Company has received notice of a small number of potential claims, and
actual claims, from its insureds, and is reviewing its exposures, if any,
under these policies. The Company is continuing to review its exposures
under its other policies with respect to year 2000 noncompliance by its
insureds, and the third parties who do business with its insureds, through
various means which include communications with insureds and distribution
of year 2000 written questionnaires. The Company has implemented what it
believes to be appropriate strategies to manage and mitigate such
exposures including, without limitation, policy exclusions and
reinsurance. However, because coverage determinations depend on unique
factual situations, specific policy language and other variables, it is
not possible to determine in advance whether and to what extent insureds
will incur losses or expenses, the amount of the losses or expenses or
whether any such losses or expenses would be covered under the Company's
insurance policies.
FORWARD LOOKING INFORMATION
Certain statements in this document may be considered to be "forward
looking statements" as that term is defined in the Private Securities
Litigation Reform Act of 1995, such as statements that include the words
"expects", "probable", "estimate", or similar expressions. Such statements
are subject to certain risks and uncertainties. The factors which could
cause actual results to differ materially from those suggested by any such
statements include, but are not limited to, those discussed or identified
from time to time in the Company's public filings with the Securities and
Exchange Commission and specifically to: risks or uncertainties associated
with general economic conditions including changes in interest rates and
the performance of the financial markets, changes in domestic and foreign
laws, regulations and taxes, changes in competition and pricing
environments, regional or general changes in asset valuations, the
occurrence of significant natural disasters, the inability to reinsure
certain risks economically, the adequacy of loss reserves, as well as
general market conditions, competition, pricing and restructurings.
28
<PAGE>
RELIANCE GROUP HOLDINGS, INC. AND SUBSIDIARIES
PART II. OTHER INFORMATION
- --------------------------------------------------------------------------------
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
27. Financial Data Schedule.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed during the quarter ended September
30, 1999.
29
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
RELIANCE GROUP HOLDINGS, INC.
----------------------------------------
(Registrant)
Date: November 15, 1999 /s/ George E. Bello
----------------- ----------------------------------------
George E. Bello
Executive Vice President and Controller
(Chief Accounting Officer)
30
<TABLE> <S> <C>
<ARTICLE> 7
<LEGEND>
This schedule contains summary financial information extracted from the
Company's Consolidated Balance Sheet and the Consolidated Statement of
Operations and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> SEP-30-1999
<DEBT-HELD-FOR-SALE> 2,693,173
<DEBT-CARRYING-VALUE> 504,516
<DEBT-MARKET-VALUE> 509,669
<EQUITIES> 783,561
<MORTGAGE> 0
<REAL-ESTATE> 163,244
<TOTAL-INVEST> 4,380,747
<CASH> 82,505
<RECOVER-REINSURE> 6,495,172
<DEFERRED-ACQUISITION> 310,477
<TOTAL-ASSETS> 14,486,886
<POLICY-LOSSES> 8,680,986
<UNEARNED-PREMIUMS> 2,200,996
<POLICY-OTHER> 0
<POLICY-HOLDER-FUNDS> 0
<NOTES-PAYABLE> 717,093
0
0
<COMMON> 11,617
<OTHER-SE> 969,870
<TOTAL-LIABILITY-AND-EQUITY> 14,486,886
1,894,053
<INVESTMENT-INCOME> 216,565
<INVESTMENT-GAINS> 9,608
<OTHER-INCOME> 232,495
<BENEFITS> 1,645,200
<UNDERWRITING-AMORTIZATION> 714,756
<UNDERWRITING-OTHER> 0
<INCOME-PRETAX> (298,338)
<INCOME-TAX> (139,100)
<INCOME-CONTINUING> (129,653)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> (57,850)
<NET-INCOME> (187,503)
<EPS-BASIC> (1.64)
<EPS-DILUTED> (1.64)
<RESERVE-OPEN> 0
<PROVISION-CURRENT> 0
<PROVISION-PRIOR> 0
<PAYMENTS-CURRENT> 0
<PAYMENTS-PRIOR> 0
<RESERVE-CLOSE> 0
<CUMULATIVE-DEFICIENCY> 0
</TABLE>
