Asbestos Issues Impacting ACE, The HartfordRatings ACE Limited and The Hartford Financial ServicesGroup Inc. reported robust quarterly returns last week, but withrating firms those results were overshadowed by companyannouncements related to asbestos reserves.

ACE Limited said Jan. 27 it is expanding its asbestos reservesby some $2.2 billion. The announcement followed action by Hartford,Conn.-based Travelers Property Casualty Corp., which recentlyboosted its asbestos reserves by some $2.45 billion.

The ACE increase would be offset by $1.86 billion ofreinsurance, including $533 million from National IndemnityCompany, part of Berkshire Hathaway in Omaha, Neb., ACE stated.

After taxes and reinsurance, the reserve boost will result in acharge of $354 million, which will be taken into account in itsfourth-quarter results (scheduled to be announced Feb. 5), said theBermuda-based insurer. The firm acquired old asbestos liabilitieswhen it bought Philadelphia-based CIGNA Corp.'s property-casualtybusiness three years ago.

Excluding the asbestos charge, ACE projected an operating incomeof 92 cents per share for its fourth quarter, which would beatanalyst estimates by three cents, the company said.

“ACE's total asbestos reserves are now at the high end of therange calculated by our internal analysis and are consistent withthe actuarial consulting firm's best estimate,” said BrianDuperreault, chairman and chief executive officer at ACE, in astatement.

The ACE management believes there are favorable trends in thejudicial environment regarding the company's asbestos liabilities,Mr. Duperreault added. The company said the reserve strengtheningreflects a more conservative view and assumes that there will be nosuch future improvements.

Dominic J. Frederico, president and chief operating officer atACE, said during last week's earnings call that the reserveincrease was prompted by the findings of an internal task force,which performed an extensive review of the company's asbestosreserving process.

The task force, he explained, reviewed the policyholder filesrepresenting more than 70 percent of the direct asbestos unpaidliabilities on known accounts as of September 2002.

The review process also included an examination of pending claiminventory and projections of future filings, characterization ofinjury types and projection of future distribution by injury type,the total coverage profile for the account and ACE's share of thatcoverage profile, as well as products and non-productsexposures.

ACE's internal study also coincided with a third-party actuarialreserve review required by the Pennsylvania Insurance Department aspart of the acquisition of CIGNA's p-c operations.

“Today's announcement is the culmination of ACE's review of bothof these studies,” Mr. Frederico said. “Given the uncertainty inthe asbestos environment and the variability of future projections,senior management felt it prudent to take a more conservativereserving approach.”

Morgan Stanley in New York took a positive view of ACE's reservestrengthening. It argued in its report that ACE shares, which aretraded on the New York Stock Exchange, will react favorably becausethe cost may be less than what the market has been expecting sincemuch of the charge will be covered by reinsurance.

But despite ACE's statement of “conservative reserving approach”and a strong projection of its fourth-quarter performance, somerating agencies took a cautious approach to the news.

Standard & Poor's Ratings Services, for instance, set aCredit Watch with negative implications its “A-plus” financialstrength ratings for members of the ACE group and its “triple-B”ratings for the members of the Brandywine Group, which houses themajority of ACE's asbestos and environmental run-off exposures.

“It was a problem that we knew was looming out there, and thecompany addressed it in an appropriate fashion,” said FrederickLoeloff, director at S&P in New York.

“These reserves have historically been factored into thefinancial strength rating on the group, but the magnitude of such areserve strengthening was not,” Mr. Loeloff told NationalUnderwriter.

One of the concerns is that the reserve boost uses ACE'sremaining $533 million of adverse development reinsuranceprotection from National Indemnity and leaves the group exposed topotential additional adverse development on asbestos exposures.

“They had $1.25 billion in coverage from National Indemnity andwhat was considered an adequate protection at the time has beenfully depleted after three and a half years,” Mr. Loeloffnoted.

S&P is currently in the process of reviewing ACE's overalloperations and will continue to separately monitor each operatingsegment's financial strength, capital adequacy, and ability toreduce exposure to prospective adverse loss development and creditrisk.

“We have concerns on ACE's capital adequacy related to asbestosreserves, and accumulated credit risks associated with reinsurancerecoverable and managed run-offs associated with other CIGNA linesand discontinued business lines since 1999,” Mr. Loeloff said. ButS&P expects that ACE will make efforts to maintain its capitaladequacy at a level consistent with, or better than, its existingfinancial strength ratings, he added.

New York-based Moody's Investors Service also placed its ratingsof ACE and some of its subsidiaries on review for a possibledowngrade immediately following the insurer's asbestosannouncement.

Moody's said the rating review was prompted primarily by thecombination of the magnitude of the reserve charge and theprospective increase in ACE's leverage profile because of itsproposed recapitalization through the debt issuance. “Somethingthat took us by surprise was the size of the reserve charge, onboth a gross and net basis,” said Moody's analyst James Eck.

The Hartford Financial Services Group Inc. was another majorinsurer that became a target for rating agencies' scrutinyfollowing its announcement on asbestos reserves. Accompanying itsreport of strong fourth-quarter results, including a net income of$258 million, was the Hartford, Conn.-based carriers asbestosannouncement. The firm said a study of the exposure should be readyin the second or third quarter.

The Hartford's announcement drew an immediate reaction fromseveral rating agencies. Fitch Ratings in New York said it hasplaced fixed income ratings for The Hartford, as well as its“double-A” insurer financial strength ratings for the Hartford FireIntercompany Pool, on a Rating Watch Negative status.

Fitch stated that it anticipates responding to its Rating Watchstatus when The Hartford releases its study, or possibly sooner ifsome uncertainties are resolved earlier. The rating agency alsopredicted that The Hartford is likely to take a reserve charge atthe completion of the study.

If that forecast proves correct, it would follow The Hartford'sreserve strengthening actions from last year. In July 2002, thecompany shifted $540 million from all other claims reserves to theasbestos category and, later in the year, it added an extra $30million.

Moody's also took action on the announcement. While confirmingits ratings on The Hartford and its subsidiaries, the rating agencychanged its debt-ratings outlook for the company to “negative” from“stable.” It also placed a “negative” outlook on its “Aa3″insurance financial strength ratings for members of The Hartford'sproperty-casualty intercompany pool.

Additionally, A.M. Best Company Inc. placed under review thecommercial paper and debt ratings of The Hartford and HartfordLife, and the ratings were also given negative implications.

“We believe The Hartford will most likely take a reserve charge.Subsequent to that, The Hartford will likely look to replenish itssurplus,” said Joyce Sharaf, managing senior financial analyst forthe Oldwick, N.J.-based rating firm.

To boost surplus, “There are perhaps only two ways to do that:to raise debt or equity. When you raise either debt or equity, theholding company's cash-flow needs will increase,” Ms. Sharaf toldNational Underwriter.

She added that the company's cash-flow coverage is already lowand that any additional cash outflow would be beyond herexpectation. “Therefore, their debt ratings went under review inthe anticipation that any increase in the holding company's cashneeds will cause debt ratings to be downgraded,” Ms. Sharafsaid.

Reproduced from National Underwriter Edition, February 3, 2003.Copyright 2003 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.