Fitch: Insurers' Reserves Deficient by $77 Billion

By Gary Mogel

NU Online News Service, Nov. 19, 4:20 p.m.EDT?Despite recent well-publicized reserve strengtheningby many insurers, loss reserves may still be deficient by as muchas $77 billion, according to New York-based Fitch Ratings Ltd.

Fitch executives said some reserving problems may have beenexacerbated with some companies that counted on legislation to helpwith asbestos losses.

The $77 billion shortfall, Fitch said, equates to approximatelya quarter of the property-casualty insurance industry's statutorycapitalization.

During a teleconference today, explaining and expanding upon aspecial report released this month by his company, James B. AudenFitch's Chicago-based senior director noted that the reserveshortfall is attributable to three factors.

"First, there is up to a $38 billion deficiency for accidentyears 1997 through 2002," Mr. Auden said. "In addition, asbestosreserves for policies written prior to the early 1970s are short byas much as $29 billion. There is also an up to $10 billiondeficiency related to ?latent' exposures, such as environmentaldamage, silica, tobacco, and future mass tort litigation."

According to Keith M. Buckley, a Chicago-based Fitch managingdirector who moderated the teleconference, "cheating" and "beingwrong" are the two main reasons for the deficiency problem.

"Cheating is when insurance company management ?smoothesearnings' by booking reserves at the low end of the range," Mr.Buckley explained. He noted that reserves are by their nature anestimate, giving creative managers room to manipulate. Mr. Buckleypointed out that such manipulation is more apt to occur whenmanagement wants to minimize reserves for losses [and resultingloss ratios] under policies with low premiums that were writtenduring the soft market.

On a hopeful note, Mr. Buckley predicted that heightenedscrutiny by state regulators, combined with corporate disclosurerequirements of the Sarbanes-Oxley Act, would diminish suchcheating.

"Being wrong," Mr. Buckley continued, is when reserves are ingood faith miscalculated. "Actuarial science is sophisticatedguesswork," he said. "Even best practices can lead to the wrongassumptions."

"It's not that actuaries are dumb," Mr. Buckley assured hisaudience. "It's more that the future just doesn't like to bepredicted."

Resuming his outline of the industry's reserving woes, Mr. Audennoted that the largest deficiencies are in the long-tail casualtylines, with general liability, medical malpractice, and workers'compensation having the highest reserve shortfalls?up to 25 percentfor recent accident years.

"The chronic underpricing of the late 1990s" was the mainculprit, according to Mr. Auden. He also mentioned rising medical,litigation, and settlement costs as contributing factors.

"All of this has a material?but not devastating?impact on theindustry's capital position," added Mr. Auden. "Statutory capitalwas overstated by 10 to 17 percent of year-end 2002 surplus."

Turning to the asbestos factor, Mr. Buckley stated that Fitch isincreasing its target "survival ratio"?the ratio of asbestosreserves to average paid losses for three years--to 17.5-times from16-times.

"Altered loss cost estimates" was cited by Mr. Buckley as theprincipal reason for the increase in this ratio. He also noted thatFitch's ratio for the asbestos exposure is considerably higher thanother rating firms. "The difference is that Fitch's calculationdoes not discount for the time value of money as much as theseother firms," he said.

"Asbestos reserves were increased by about $12 billion in 2002,so the hole is getting filled, but not on a dollar-for-dollar basisin relation to the shortfall," Mr. Buckley said.

He also flatly stated that he sees little or no chance formeaningful asbestos reform in the near future. "The Hatch bill[which proposed a $108 billion trust fund for people with asbestosinjuries] was a good concept, but it was destroyed by the politicalsystem and special interest groups," noted Mr. Buckley.

According to Mr. Buckley, the Hatch bill would have had theharmful albeit unintended effect of exacerbating the asbestosreserving problem. "Some insurers slowed their recognition ofreserves because they expected relief from the bill," he explained."We may be seeing more ?catch-up' charges," he added, as insurersincrease reserves to account for the lack of a governmentalsolution.

"Reserve shortfalls are a drag on future earnings, as well asbeing the number one cause of insurer insolvency," Mr. Buckleypointed out. "These shortfalls are also the key reason Fitch ismaintaining a ?negative' outlook for the property-casualtyinsurance industry," he said.