Fitch: Asbestos Reserves May Fall Short

Unless the insurance industry changes its ways, it may find that its reserves for future asbestos-related claims are off by as much as $13 billion, according to a recent study by Fitch Rating.

Keith M. Buckley, managing director of the Chicago-based firm that rates the economic strength of financial institutions, said in a recent teleconference that Fitch estimates total cumulative payments on asbestos-related claims at about $24 billion as of year-end 2001.

Fitch also estimates that the amount of reserves carried by the U.S. commercial property-casualty industry as of year-end 2001 was just under $15 billion. As Mr. Buckley explained, this means that the U.S. p-c industry so far has incurred liability of $39 billion.

He stated that the current survival ratio (reserves to average annual paid asbestos claims) of the p-c industry was “a little over nine times” at the end of 2001. He explained that Fitch took the amount of current reserves for asbestos-related claims and divided by the last three years' average payments “to get a sense of how many years of payments have been funded.”

He also noted that actuarial firms Tillinghast-Towers Perrin and Milliman USA estimated last year that future ultimate asbestos liabilities for the U.S. insurance industry will range from $55 billion to $70 billion.

In Fitch's view, this represents unfunded amounts of $16 billion to $31 billion, Mr. Buckley said. (He arrived at these figures by subtracting the incurred liability of $39 billion from the actuarial range.).

For rating purposes, Fitch set a wider range of estimates for future asbestos liabilities, he said:

For the low-end: Fitch has assumed $49 billion in ultimate claims, with future payments of $25 billion ($49 billion in ultimate claims minus the $24 billion already paid out.).

With the industry's just-under $15 billion in reserves, this low estimate implies an unfunded amount of $10 billion, Mr. Buckley said.

“That low-end assumes that things will get somewhat better and that sometrends will stabilizebut that it will still be a challenging environment for the industry,” Mr. Buckley said.

He added that the industry in the aggregate seems to line up with Fitch's low-end estimate.

For the mid-range: Fitch assumes $62 billion in ultimate claims, with $38 billion in future payments. Mr. Buckley said “this implies $23 billion unfunded at this point.”

For the high-end: Fitch assumes $74 billion in ultimate claims, with about $50 billion in future payments and $35 billion in unfunded claims. Mr. Buckley classified this as “conservative.”

He also delved into whether reserves for asbestos should be discounted using the present value approach in view of the fact that insurers will be paying out claims over the next 20-plus years.

Fitch believes that an insurer that discounts “long-tail general liabilities” should use a risk-adjusted discount rate due to the great degree of uncertainty surrounding the amount and timing of such claims, Mr. Buckley said.

He then described a grid developed by Fitch that looks at the range of high, mid- and low future payments estimates under various discount scenarios–zero percent, 3 percent and 6 percent–to determine what the reasonable range of survival ratios may be.

For a low payment stream and zero percent discount rate (that is, no discounting), the implied survival ratio for the industry is 14.7 times.

The 3 percent “middle of the road” discount rate is 11 times, and at 6 percent or “portfolio rate,” the survival ratio is 8.5, Mr. Buckley said.

For the middle payment stream at zero percent discount, the survival ratio is 22 times, at 3 percent it is 16 times, and at 6 percent it is 12 times, he stated.

For the high payment stream, at zero percent the survival ratio is 30 times, at 3 percent it is 21 times, and at 6 percent it is 16 times.

In Fitch's view, 16 times is the appropriate survival ratio for the p-c industry and is the one that Fitch will ultimately use as a basis for its rating standard, Mr. Buckley said.

“The 16 times implies a present value reserving of $27 billion, or a $13 billion shortfall currently relative to the reserves that are set up,” he noted.

He also said that in Fitch's view it may be preferable not to discount asbestos liabilities at all. If they are discounted, it should be by “something significantly less than a portfolio rate,” he continued.

But Fitch believes that the insurance industry is instead “implicitly discounting its [asbestos claims] reserves at a portfolio rate,” Mr. Buckley said.

As to the possible impact on the earnings and capital of the p-c industry, Mr. Buckley suggested “there could be a combination of shock losses anda continuedearnings bleed.”

On the one hand, should the “ultimate shock loss scenario” occur and the industry goes to the 16 times survival ratio “in one fell swoop,” Mr. Buckley said, based on the capital of the commercial property-casualty industry and U.S. reinsurance industry, the shock loss would be less than 10 percent of capital.

“I don't think we're talking about a widespread solvency problem,” he said.

Even if only 25-to-30 insurance companies absorbed most of the shock loss, Mr. Buckley believes those insurers “have the capital to handle this type of charge without broad-based solvency issues.”

But if insurers do not shore up reserves and they continue with the current 9 times survival ratio, he predicted “a continued earnings bleed in probably the $2 billion range for many years until these reserves are brought up to where they need to be.”

Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, August 5, 2002. Copyright 2002 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.

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Fitch: Asbestos Reserves May Fall Short

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