S&P’s Discusses Latest P/C Insurers’ Asbestos Exposure

January 28, 2003

Standard & Poor’s commented on the spate of recent additions to reserves for asbestos claims by insurers, which raises anew the issue of reserve adequacy in the property/casualty industry.

In its December 2002 outlook for U.S. commercial lines insurers, Standard & Poor’s indicated that the rash of new asbestos-related claims and their impact on insurers’ reserves could lead to further downgrades in the industry for the first half of 2003. As companies rush to finalize their 2002 financial statements, the fourth quarter is truly turning into the “kitchen-sink” quarter predicted by Standard & Poor’s and other industry observers. In less than two weeks, two major commercial lines writers -Travelers Property Casualty Corp. (Travelers) and ACE Ltd. (ACE) -have announced huge increases
in their reserves for asbestos following completion of comprehensive studies. Travelers and ACE increased their gross reserves for asbestos by $2.5 billion and $1.9 billion, respectively.

These actions cap what had already been a very active year for insurers on the asbestos front. The Hartford Financial Services Group Inc. boosted its asbestos reserves by $600 million in 2002 by
reclassifying existing reserves from other lines. The St. Paul Cos. Inc,
Fireman’s Fund Insurance Co. (Allianz), and The Chubb Corp. also took
substantial charges for asbestos reserve strengthening in 2002.

Since early 2001, there have been a number of developments in the
asbestos litigation environment that have changed the landscape for insurers. As Standard & Poor’s has previously pointed out, a new class of claimants has begun to emerge: individuals who have been exposed to asbestos but do not show any signs of illness. These so-called unimpaired claimants account for most of the recent claims presented to insurers. At the same time, the number of
traditional defendants – companies that produced asbestos or products containing asbestos – has been declining as companies sought bankruptcy protection. In response to this trend, plaintiff attorneys have expanded the pool of defendants – and, consequently, the number of policyholders reporting claims to their insurers – by filing lawsuits against companies that used or
installed products containing asbestos.

In late 2001, Standard & Poor’s expectation was that the industry would have to put up an incremental $5 billion-$10 billion of reserves to cover asbestos claims adequately. Another expectation was that asbestos-related charges would add one to two points to the industry’s combined ratio for 2002.

These latest company actions call both assumptions into question. Further, the magnitude of these charges raises serious questions about the adequacy of reserves currently held by other insurers with exposure to asbestos claims. It is worth noting that both Travelers and ACE more than tripled their asbestos reserves from the levels held at year-end 2001. These startlingly high reserve additions highlight the difficulty of making industry-wide ultimate loss
estimates and cast doubt on the widely used survival ratio as a metric to assess reserve adequacy for any insurer.

Many insurers and industry observers have suggested that with the
Republican Party now in control of both houses of Congress, the environment is ripe for the passage of legislation creating a global settlement of the asbestos litigation issue. However, Congress’s record on tort reform is not encouraging, and even proponents of a global settlement are quick to note that success is far from assured.

Standard & Poor’s feels that Travelers and ACE are being prudent in assuming no significant change in the current legal environment, even as they work with manufacturers and politicians to bring about a legislative solution to asbestos litigation. By implication, insurers
with significant exposures that have not materially added to their asbestos reserves to reflect this new environment of claims could be under-reserved.

Standard & Poor’s concern is that these companies might be less well reserved for asbestos than their counterparts that are now incorporating the deteriorating litigation environment in their reserves and therefore face the prospect of further material adverse reserve development. Standard & Poor’s views reserve deficiencies created by environmental changes differently from deficiencies that result from the ongoing underpricing of coverage for traditional risks. The deteriorating legal environment for asbestos defendants falls into the former category and is not viewed by Standard & Poor’s as reflecting negatively on management or as a sign of lax underwriting. However, correcting the reserve deficiency does create a capital hole that needs to be filled to maintain capital adequacy.

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