Notes to Consolidated Financial Statements the St. Paul Companies

Notes to Consolidated Financial Statements The St. Paul Companies 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES accounts to U.S. GAAP on a quarterly basis. Quarterly financial state- Accounting Principles — We prepare our consolidated financial ments are prepared for Lloyd’s syndicates, using the Lloyd’s three- statements in accordance with United States generally accepted year accounting basis, which are subsequently converted to U.S. accounting principles (“GAAP”). We follow the accounting standards GAAP.Since Lloyd’s accounting does not currently recognize the con- established by the Financial Accounting Standards Board (“FASB”) cept of earned premium, we calculate earned premium as part of the and the American Institute of Certified Public Accountants (“AICPA”). conversion to GAAP. We recognize written premium for U.S. GAAP Consolidation — We combine our financial statements with those purposes quarterly, and assume that it is written at the middle of each of our subsidiaries and present them on a consolidated basis. The quarter (i.e., evenly throughout each period), effectively breaking the consolidated financial statements do not include the results of mate- calendar year into earning periods of eighths. rial transactions between our subsidiaries and us or among our sub- Revenues in our Health Care segment include premiums gener- sidiaries. Certain of our foreign underwriting operations’ results, and ated from extended reporting endorsements. Our medical liability the results of certain of our investments in partnerships, are recorded claims-made policies give our insureds the right to purchase a report- on a one-month to one-quarter lag due to time constraints in obtaining endorsement, which is also referred to as “tail coverage,” at the ing and analyzing such results for inclusion in our consolidated finan- time their policies expire. This endorsement protects an insured cial statements on a current basis. In the event that significant events against any claims that arise from a medical incident that occurred occur during the lag period, the impact is included in the current while the claims-made policy was in force, but which had not yet been period results. reported by the time the policy expired. Premiums on these endorse- During 2001, we eliminated the one-quarter reporting lag for cer- ments are fully earned as revenue, and the expected losses are tain of our primary underwriting operations in foreign countries. The reserved, at the time the endorsement is written. effect of reporting these operations on a current basis was a $31 mil- We record premiums that we have not yet recognized as revenues lion increase to our 2001 pretax loss on continuing operations. as unearned premiums on our balance sheet. Assumed reinsurance Related Party Transactions — The following summarizes our premiums are recognized as revenues proportionately over the con- related party transactions: tract period. Premiums earned are recorded in our statement of oper- Indebtedness of Management — We have made loans to certain ations, net of our cost to purchase reinsurance. current and former executive officers for their purchase of our com- Insurance Losses and Loss Adjustment Expenses — Losses rep- mon stock in the open market. These are full-recourse loans, further resent the amounts we paid or expect to pay to claimants for events secured by a pledge of the stock purchased with the proceeds. The that have occurred. The costs of investigating, resolving and process- loans accrue interest at the applicable federal rate for loans of such ing these claims are known as loss adjustment expenses (“LAE”). We maturity. Loans to former executive officers are being repaid in accor- record these items on our statement of operations net of reinsurance, dance with agreed-upon terms.The total amount receivable under this meaning that we reduce our gross losses and loss adjustment program, included in “Other Assets”, on December 31, 2002 and 2001 expenses incurred by the amounts we have recovered or expect to was $7 million and $10 million, respectively. This program was termi- recover under reinsurance contracts. nated effective March 20, 2002; consequently, no new loans were Reinsurance — Written premiums, earned premiums and incurred made after that date. insurance losses and LAE all reflect the net effects of assumed and Indebtedness of Venture Capital Management — We have made ceded reinsurance transactions. Assumed reinsurance refers to our loans to certain members of management of our Venture Capital acceptance of certain insurance risks that other insurance companies investment operation.The loans are secured by each individual’s own- have underwritten. Assumed reinsurance has, for the most part, been ership interest in the limited liability companies that hold most of our written through our St. Paul Re operation. During 2002, we transferred venture capital investments, and accrue interest at the applicable fed- our ongoing business previously written through St. Paul Re to eral rate for loans of such maturity.The total amount receivable under Platinum Underwriters Holdings, Ltd. See Note 2 for a more detailed this program, included in “Other Assets” at December 31, 2002 and discussion of this transfer. Ceded reinsurance means other insurance 2001, was $7 million and $6 million, respectively. companies have agreed to share certain risks with us. Reinsurance Discontinued Operations — In 2001, we sold our life insurance accounting is followed for assumed and ceded transactions when risk operations, and in 2000, we sold our nonstandard auto business. transfer requirements have been met.These requirements involve sig- Accordingly, the results of operations for all years presented reflect nificant assumptions being made related to the amount and timing of the results for these businesses as discontinued operations. expected cash flows, as well as the interpretation of underlying con- Reclassifications — We reclassified certain amounts in our 2001 tract terms. and 2000 consolidated financial statements and notes to conform to Insurance Reserves — We establish reserves for the estimated the 2002 presentation. These reclassifications had no effect on net total unpaid cost of losses and LAE, which cover events that occurred income, or common or preferred shareholders’ equity, as previously in 2002 and prior years. These reserves reflect our estimates of the reported for those years. total cost of claims that were reported to us (“case” reserves), but not Use of Estimates — We make estimates and assumptions that yet paid, and the cost of claims incurred but not yet reported to us have an effect on the amounts that we report in our consolidated (“IBNR”). We reduce our loss reserves for estimated amounts of sal- financial statements. Our most significant estimates are those relating vage and subrogation recoveries. Estimated amounts recoverable from to our reserves for property-liability losses and loss adjustment reinsurers on paid and unpaid losses and LAE, net of an allowance for expenses. We continually review our estimates and make adjustments estimated unrecoverable amounts, are reflected as assets. as necessary, but actual results could turn out to be significantly dif- For reported losses, we establish reserves on a “case” basis within ferent from what we expected when we made these estimates. the parameters of coverage provided in the insurance policy or reinsurance agreement. For IBNR losses, we estimate reserves using estab- ACCOUNTING FOR OUR PROPERTY-LIABILITY lished actuarial methods. Our case and IBNR reserve estimates UNDERWRITING OPERATIONS consider such variables as past loss experience, changes in legislative Premiums Earned — Premiums on insurance policies are our conditions, changes in judicial interpretation of legal liability and policy largest source of revenue. We recognize the premiums as revenues coverages, and inflation. We consider not only monetary increases in evenly over the policy terms using the daily pro rata method or, in the the cost of what we insure, but also changes in societal factors that case of our Lloyd’s business, the one-eighths method. The one- influence jury verdicts and case law and, in turn, claim costs. eighths method reflects the fact that we convert Lloyd’s syndicate The St. Paul Companies 2002 Annual Report 63 Because many of the coverages we offer involve claims that may expected ultimate losses provided by the syndicates. The results of our not ultimately be settled for many years after they are incurred, sub- operations at Lloyd’s are recorded on a one-quarter lag due to time jective judgments as to our ultimate exposure to losses are an integral constraints in obtaining and analyzing such results for inclusion in our and necessary component of our loss reserving process. We record consolidated financial statements on a current basis. (Also see discus- our reserves by considering a range of estimates bounded by a high sion under “Premiums Earned” above.) and low point. Within that range, we record management’s best esti- Policy Acquisition Expenses — The costs directly related to writing mate. We continually review our reserves, using a variety of statistical an insurance policy are referred to as policy acquisition expenses and and actuarial techniques to analyze current claim costs, frequency consist of commissions, state premium taxes and other direct under- and severity data, and prevailing economic, social and legal factors. writing expenses. Although these expenses are incurred when

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