Asbestos Issues Impacting ACE, The Hartford Ratings ACE Limited and The Hartford Financial Services Group Inc. reported robust quarterly returns last week, but with rating firms those results were overshadowed by company announcements related to asbestos reserves.

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

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

After taxes and reinsurance, the reserve boost will result in a charge of $354 million, which will be taken into account in its fourth-quarter results (scheduled to be announced Feb. 5), said the Bermuda-based insurer. The firm acquired old asbestos liabilities when it bought Philadelphia-based CIGNA Corp.'s property-casualty business three years ago.

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

“ACE's total asbestos reserves are now at the high end of the range calculated by our internal analysis and are consistent with the actuarial consulting firm's best estimate,” said Brian Duperreault, chairman and chief executive officer at ACE, in a statement.

The ACE management believes there are favorable trends in the judicial environment regarding the company's asbestos liabilities, Mr. Duperreault added. The company said the reserve strengthening reflects a more conservative view and assumes that there will be no such future improvements.

Dominic J. Frederico, president and chief operating officer at ACE, said during last week's earnings call that the reserve increase was prompted by the findings of an internal task force, which performed an extensive review of the company's asbestos reserving process.

The task force, he explained, reviewed the policyholder files representing more than 70 percent of the direct asbestos unpaid liabilities on known accounts as of September 2002.

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

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

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

Morgan Stanley in New York took a positive view of ACE's reserve strengthening. It argued in its report that ACE shares, which are traded on the New York Stock Exchange, will react favorably because the cost may be less than what the market has been expecting since much 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, some rating agencies took a cautious approach to the news.

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

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

“These reserves have historically been factored into the financial strength rating on the group, but the magnitude of such a reserve strengthening was not,” Mr. Loeloff told National Underwriter.

One of the concerns is that the reserve boost uses ACE's remaining $533 million of adverse development reinsurance protection from National Indemnity and leaves the group exposed to potential additional adverse development on asbestos exposures.

“They had $1.25 billion in coverage from National Indemnity and what was considered an adequate protection at the time has been fully depleted after three and a half years,” Mr. Loeloff noted.

S&P is currently in the process of reviewing ACE's overall operations and will continue to separately monitor each operating segment's financial strength, capital adequacy, and ability to reduce exposure to prospective adverse loss development and credit risk.

“We have concerns on ACE's capital adequacy related to asbestos reserves, and accumulated credit risks associated with reinsurance recoverable and managed run-offs associated with other CIGNA lines and discontinued business lines since 1999,” Mr. Loeloff said. But S&P expects that ACE will make efforts to maintain its capital adequacy at a level consistent with, or better than, its existing financial strength ratings, he added.

New York-based Moody's Investors Service also placed its ratings of ACE and some of its subsidiaries on review for a possible downgrade immediately following the insurer's asbestos announcement.

Moody's said the rating review was prompted primarily by the combination of the magnitude of the reserve charge and the prospective increase in ACE's leverage profile because of its proposed recapitalization through the debt issuance. “Something that took us by surprise was the size of the reserve charge, on both a gross and net basis,” said Moody's analyst James Eck.

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

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

Fitch stated that it anticipates responding to its Rating Watch status when The Hartford releases its study, or possibly sooner if some uncertainties are resolved earlier. The rating agency also predicted that The Hartford is likely to take a reserve charge at the completion of the study.

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

Moody's also took action on the announcement. While confirming its ratings on The Hartford and its subsidiaries, the rating agency changed 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's property-casualty intercompany pool.

Additionally, A.M. Best Company Inc. placed under review the commercial paper and debt ratings of The Hartford and Hartford Life, 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 its surplus,” said Joyce Sharaf, managing senior financial analyst for the 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, the holding company's cash-flow needs will increase,” Ms. Sharaf told National Underwriter.

She added that the company's cash-flow coverage is already low and that any additional cash outflow would be beyond her expectation. “Therefore, their debt ratings went under review in the anticipation that any increase in the holding company's cash needs will cause debt ratings to be downgraded,” Ms. Sharaf said.

Reproduced from National Underwriter Edition, February 3, 2003. Copyright 2003 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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