S&P Reports on U.S. P/C Industry Financial Condition

May 11, 2004

Standard & Poor’s Credit Market Services has issued a report on the U.S. P/C industry, which notes that the rating agency is maintaining its negative rating outlook on this sector of the commercial insurance industry, due primarily to “reserve shortfalls” that “continue to plague U.S. property/casualty insurers despite their strong earnings reports in 2003.”

“While some reserving error is explained by simple uncertainty, a good deal is caused by deliberate earnings management,” stressed Mark Puccia, credit analyst and managing director in S&P’s Insurance Ratings group. “This practice could land insurers in hot water, especially since the Sarbanes-Oxley Act took effect.”

S&P noted that “In 2002 and 2003, commercial p/c insurers added more than $40 billion to their reserves, with major contributions for workers’ compensation, medical malpractice, and commercial multiperil, yet they also released $5 billion for the new 2002 accident year, which could turn out to be premature.

“The newly reported figures reaffirm Standard & Poor’s heightened concerns over the commercial insurance industry’s inability to accurately forecast reserves, which it highlighted in an article it published last November entitled ‘Insurance Actuaries-A Crisis of Credibility.'”

S&P indicated that “despite the mixed messages,” it remains concerned that reserves for old business will need further strengthening. It cited projections from Morgan Stanley that range as high as $60 billion, excluding reserves for asbestos and environmental claims.

Addressing reinsurance, S&P said it “represents a wild card. In aggregate, U.S. commercial p/c insurers expect to recover about $100 billion from reinsurers, an amount that has steadily increased over the years as insurers write comparatively more long-tailed liability business. But given the increasingly contentious nature of reinsurance relationships, recoveries are anything but certain.”

S&P added that it didn’t expect consistently conservative reserving practices to come from within the industry. “Only the combined force of regulators, investors, and the actuarial profession is powerful enough to break the habit of cycle-driven reserving,” observed Steven Dreyer, S&P’s managing director in Insurance Ratings. “These parties must use their influence on the management of insurance companies to do the right thing.”

The full article, “Reserving Judgment: U.S. P/C Insurers Fall Short Again,” is available on RatingsDirect, Standard & Poor’s Web-based research analysis system. If you are not a RatingsDirect subscriber, you may purchase a copy of the article by calling 212-438-9823 or sending an e-mail to: research_request@standardandpoors.com.

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