U.S. insurers are closing the gap between their asbestos reserves and liabilities, but the shortfall remains in the billions of dollars, one leading rating agency warns.

The U.S. property-casualty industry’s overall funding shortfall for asbestos liabilities is about $10 billion, to go along with a $24 billion gap for non-asbestos environmental liabilities, according to a special report by A.M. Best.

However, on the positive side, the combined $34 billion gap represents a sharp decrease from the combined asbestos and environmental liability shortfall of $56 billion in 2001.

“Essentially all of this improvement had occurred on the asbestos side of the A&E equation,” managing senior financial analyst Gerard Altonji noted in the report.

While the Oldwick, N.J.-based rating agency has not changed its estimate of ultimate asbestos losses (which still stands at the $65 billion level estimated in 2001), the asbestos reserve shortfall was roughly $28 billion back then–nearly three times the level A.M. Best is now estimating for year-end 2004. The environmental reserve shortfall was $25 billion in 2001.

Insurance industry asbestos reserving lagged behind environmental reserving until 2001, but Mr. Altonji noted that as a result of “the unprecedented level of [asbestos] reserve strengthening taken in recent years,” current asbestos reserves represent 70 percent of estimated future loss payments.

Total funding, which includes reserves and losses paid to date, equals roughly 85 percent of ultimate losses.

However, Mr. Altonji also noted that the decrease in the asbestos shortfall level represents an average over the entire U.S. property-casualty industry–and that “a significant number of insurer groups remain underfunded by relatively wide margins.”

Eight groups posted asbestos incurred losses of $100 million or more in 2004, and 15 groups have averaged annual incurred losses above that amount over the prior five years, according to the A.M. Best analysis, which is based on data from Footnote 33 of the annual statements of p-c insurers.

According to Mr. Altonji’s report, St. Paul Travelers led that pack with average annual asbestos losses of nearly $1 billion, followed by the Hartford Insurance Group, which averaged nearly $650 million annually.

Looking at historical trends for the industry overall, the report noted that annual industrywide incurred losses for asbestos decreased steadily in the mid-1990s, hitting a low of $885 million in 1997, before increasing dramatically at the turn of the century to a high of $8 billion in 2002.

Annual asbestos losses have retreated somewhat since then, with industrywide losses of $6 billion in 2003 and less than $4 billion in 2004.

On the environmental front, in 2004 the industry posted its first incurred loss total above $1 billion since 1998, Best reported, noting that $1.4 billion in environmental incurred losses were recorded in the Footnote 33 information that the rating agency compiled.

In contrast to the high levels of asbestos reserving recorded in recent years, reserve strengthening for environmental losses has languished since 1998, with total environmental incurred losses for the industry reaching only $3 billion for all years since 1999, according to the Best analysis. In contrast, prior to 1999, in each of the years from 1991-to-1998, annual environmental incurred losses had exceeded $1 billion, Best said.

While the most recent Best report, like the rating agency’s prior reports, sets forth several reasons that support the industry position not to rush to increase funding levels for environmental losses, it also outlines concerns about a “second, perhaps more slowly moving wave” of losses for pollution, property dimunition and natural resource damage claims.

With respect to asbestos, the report discusses hopes for relief from the burdens of asbestos liability through reform at the federal level. However, even if legislation known as the Fairness in Asbestos Injury Resolution (FAIR) Act had been approved by Congress and signed into law, Mr. Altonji said flaws in the bill potentially allowing asbestos plaintiffs to return to the tort system and its requirement that insurers pay into a trust fund would have caused further legal problems.

“Passage of the FAIR Act likely would have resulted in significant litigation as insurers argued over their individual shares of the proposed $46 billion [trust fund] contribution, the constitutionality of requiring insurers to turn over their asbestos reserves, the finality of insurers’ liability and other issues,” he said.

With the passage of reforms in several states, however, “insurers may have some reason to be optimistic in the medium term,” he said, noting later that as long as those reforms are done on a state-by-state basis, there will be “opportunities” for litigation.

Overall, Mr. Altonji said in the report that he expects multibillion-dollar losses to continue for the insurance industry, but at a more “measured” pace.

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