Liberty Hikes Pollution Reserves $316Million

Liberty Mutual announced a pollution reserve boost of more than$300 million last week an action that did not disturb an improvingearnings picture for 2004.

While the reserve hike nearly doubled the level of theBoston-based insurer's pollution reserves, and while results werealso pummeled by $697 million in net pre-tax catastrophe losses,Liberty's net income still jumped 46.3 percent for the year to $1.2billion from $851 million in 2003.

The 2003 result had been adversely impacted by a third-quarteraction to boost pre-tax reserves related to asbestos losses by $331million, and prior-year reserve charges totaling close to $400million for non-asbestos claims, including California workers'compensation.

The 2003 asbestos charge which brought asbestos reserves abovethe $1 billion level was one in a string of small reserve charges(averaging $250 million each) over a period of five years. The 2004pollution pre-tax charge$316 million on a net basis ($327 million,gross) brought year-end net pollution reserves to $553 million, upfrom $287 million at the beginning of the year.

During a conference call last week, executives did not reportany unusual claims activity that prompted the pollution reservingaction. In fact, Corporate Actuary Robert Muleski reported somefavorable trends, including declines in newly reported claims.

Turning from reserving to pricing, Chairman and Chief ExecutiveEdmund Kelly painted a somewhat disturbing picture of trends in themarket. “Generally we would say its a rational market, but we areseeing finally some behaviors that make us recall 1997 and 1998,and we are going to have towalk away from business in commerciallines,” he said during the conference call.

He gave a particular example of a large national account, forwhich a competitor priced the excess workers' comp component 30percent below Liberty and set fees for services 35-to-40 percentlower. “We're never happy to lose a large piece of business, butirrational competition is starting to show its ugly head,” hesaid.

When asked by an analyst to describe the competitor, Mr. Kellyresponded: “In large national-account business, there are a handfulof household names” participating in the market.

An excess workers' comp pricing mistake “won't emerge for four,five, six years, so it's very easy for underwriters to doirrational things,” he added. However, the degree of irrationalityin this instance is surprising at this stage of the cycle, he said.“There's much more aggressive pricing than one would have expectedgiven the comments [being reported] out in the industry.”

Mr. Kelly also said that in other areas of the market, “somemoderation of price increases” was becoming apparent, but that itwas not “too disturbing,” unlike the large-account situation. “Onan account of that nature and that size, to see behavior such as wesaw that is indicative that the price discipline the industry istalking about goes by the boards very quickly when the situationarisesAlthough it's a one-off case, the canary has sort of droppeddead in the cage,” he said.

He went on to respond to a question about the length of thecycle, offering little optimism. “We all talk about [Sarbanes-Oxleycorporate governance rules] and closer scrutiny and all that, [but]humans will misbehave when they can.”

Mr. Kelly also commented on two areas where significant pricedeclines are becoming evident in property and directors andofficers liability, with property cuts less of a problem. “When onemakes allowance for catastrophe losses, property results are stillstrong, so there is room for price reductions,” he said, notingthat adequate returns are still achievable.

In the D&O area, on the other hand, he said that 15 percentprice declines “just don't make a lot of sense” given the level oflitigation.

While Mr. Kelly was bearish on pricing trends, he said heremains bullish on mergers and acquisitions in the industry and forLiberty. “The North American market is a mature marketConsolidationis going to happen. It's clear,” he said.

“We have been a very aggressive acquirer. We view it as a corecompetency at this stage,” he added noting, however, he is a littlebit concerned about what prices will be for target companies. Henoted a particular example in which a Japanese company paidsix-times book value multiples of what Liberty was willing to offerfor an Asian book of business.

During the conference call, Chief Financial Officer DennisLangwell reported that strong net written premium growth for 2004was driven by M&A activity. Net premiums grew nearly 20percent?$2.8 billion to $17.3 billion in 2004, he said, noting that$1.3 billion of the jump related to acquisitions (including $977million from the Prudential Financial acquisition announced in2003). For the year, the overall combined ratio improved to 102.9,compared to 104.5 in 2003.

For the fourth quarter, Liberty Mutual reported net income of$565 million, up 30 percent from $435 million for fourth-quarter2003.

During the conference call, executives were also asked aboutasbestos reserves, which were not increased in 2004 as they hadbeen in 2003.

“Nothing has happened since then that has led us to question ourreserves,” Mr. Kelly said. Still, he said Liberty Mutual would doanother ground-up study this year. “But at this stage, there'snothing that we see that would lead us to believe there will be anincrease or decrease for asbestos,” he said.

Reproduced from National Underwriter Edition, March 4, 2005.Copyright 2005 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.