St. Paul Travelers Taking $1.6 B Charge

By Susanne Sclafane

NU Online News Service, July 23, 12:12 p.m. EDT?The St. Paul Travelers Companies said today it is seeking Securities and Exchange Commission guidance on correct accounting treatment for a $1.625 billion addition to reserves it is making in the second quarter.[@@]

The insurer formed from the merger of Travelers Property Casualty Corp. and The St. Paul Companies on April 1 said it is uncertain whether it will record a net income gain or net loss after accounting for the action.

Among the items cited for the reserve increase were surety claims, rising construction defect claims and provisions for uncollectible reinsurance.

The issue in question is whether this will be treated as an adjustment to the opening balance sheet of the merged companies, with no hit to second-quarter income, or whether the adjustment will indeed flow through the income statement.

Under the first scenario?no income adjustment?the company expects to report second-quarter income in the range of $775-to-$800 million, or $1.16 to $1.20 per share.

Under the second scenario, a second-quarter net loss would be reported?ranging from $275-to-$300 million, or 42 cents to 45 cents per share.

"We don't have a bias" with respect to which alternative is ultimately deemed to be correct by the SEC, said Jay Fishman, chief executive officer of St. Paul Travelers, this morning, during what he characterized as an unusual conference call.

The unusual situation that prompted the conference call was that it became apparent that there was an inconsistency in the accounting literature that even the firm's auditors couldn't puzzle through, which would not be sorted out in time to report solid second-quarter numbers on schedule, he said.

"We're quite comfortable with either indication," he said, noting that the simple desire to do the accounting correctly led the company to approach the SEC.

"It is clearly an area that is unclear to us," said Jay Benet, chief financial officer, who also explained the components of the reserve charge. The bulk of a $1.625 billion charge?$1.17 billion of it?is a "conforming adjustment," he said, explaining that the $1.17 billion amount is being taken so that the accounting and actuarial methods of The St. Paul conform to the methods of Travelers, the acquiring company.

Breaking that $1.17 billion down further, he said, $375 million related to conforming methods with respect to surety reserves, $500 million for construction defect, and $295 million related to reserves for uncollectible reinsurance and co-surety participations.

Additional reserves were put up to strengthen surety reserves for one particular construction contractor and issues relating to that contractor's financial condition ($250 million). Another $155 million reserve was necessitated by the commutation of reinsurance contract, which changed the reinsurance recoverable amount.

The company also announced some prior-year reserve developments?including some favorable items (such as $190 million related to a takedown of reserves for losses arising from the Sept. 11 attacks), as well as unfavorable developments, (like a $205 million boost in environmental reserves).

"What's not on this list is asbestos," Mr. Benet said, noting that an annual study of asbestos reserves is in progress. He said that the only area of asbestos reserving so far that gives any indication that it could prompt some further adjustment is the smaller claims area.

In that area, the company is evaluating what is an appropriate survival ratio (reserve-to-average calendar-year payment ratio) for such claims.

At one point during the call, an analyst directly addressed Mr. Fishman about whether all areas of reserve deficiency had been identified. "We can basically hold your feet to the fire and say this is it," the analyst said, prompting a quick "yes" from Mr. Fishman.

"Only with the caveat on the asbestos," he added after a brief pause, referring to the survival ratios reevaluation, but stressing that he wasn't predicting that an asbestos adjustment was imminent in the fourth quarter.

During the call, Mr. Fishman also spoke specifically about the $500 million construction reserve adjustment, noting that the boost really reflects "a decidedly more pessimistic view of construction defect trends." In the construction defect area, there are a relatively small number of claims in a relatively small number of states, but those continue to rise, he said. One can envision a scenario where this becomes a nationwide and market-wide problem, he said.

He added that the combined St. Paul and Travelers organizations now have a leadership position in the construction insurance marketplace. With that leadership, "we are now embracing" the trends and a more pessimistic view of the trends in our underwriting and our pricing, he said.

In reaction to the news this morning, all the major rating agencies issued statements summarizing rating actions, with most affirming financial strength ratings. A.M. Best, however, lowered various debt ratings, and Fitch lowered the "double-A" financial strength ratings of the Travelers Property Casualty Group to "double-A-minus," grouping the ratings with St. Paul ratings.

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St. Paul Travelers Taking $1.6 B Charge

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