Reserve Charges Mar Qtr. Beyond WTC
As property-casualty insurers continue to assess losses from the World Trade Center mega-catastrophe, and start to quantify the impact of the collapse of Enron on commercial lines results, many are still digging through the damage of a prolonged soft market.
For the first time since National Underwriter began compiling quarterly results for individual insurers, we present results excluding the impact of a catastrophe–the terrorist attacks of Sept. 11. The adjusted results attempt to answer the question of whether improved underwriting and net income would have shown up by year-end 2001, absent the attacks, as experts had predicted.
For a number of companies, such as ACE Ltd., Berkshire-Hathaway, The Chubb Corp., CNA Financial Corp., The Hartford Financial Services Group and Zenith National Insurance Corp., losses from the Sept. 11 terrorist attacks were enough to turn net income into bottom-line losses for the third quarter.
But for twice as many insurers with p-c operations tracked by NU, even with Sept. 11 impacts excluded, bottom-line figures show up in parentheses on our charts to indicate negative earnings for the quarter.
Reserve and restructuring charges were a common theme for 10 out of 11 insurers that reported net losses excluding Sept. 11. Through the first nine months, such charges have slowed underwriting progress for the 32 publicly-traded insurers as a group.
The nine-month combined ratio for this group was roughly 106 without 9-11 losses, compared to 103 for the first nine months of 2000. With the 9-11 losses included, the group's year-to-date combined ratio jumps to 115 for 2001.
The St. Paul Companies was the only insurer of the 11 reporting third-quarter net losses that did not disclose an explicit reserve or restructuring charge. "I won't do this in the future because I consider this 'but for' earnings," Jay Fishman, the new chairman and chief executive officer of St. Paul, said during an October conference call, prefacing his presentation of results excluding the Sept. 11 losses and other catastrophes.
With "but-for" operating earnings-per-share of 48 cents, compared to 72 cents in third-quarter 2000, Mr. Fishman said the decline was "purely a function" of continuing problems in the company's healthcare and international segments. "There's no new news," he said, noting that the problems had been publicly disclosed in prior quarters. (In the second quarter, St. Paul took a $107 million pre-tax charge to boost healthcare reserves.)
"It's time and appropriate to put these problems behind us and move ahead," Mr. Fishman said. Stating that he intends to start off 2002 "with an earnings platform that is not dragged down" by medical malpractice, reinsurance and international problems, he said the risk profile of the company will change.
Putting an end to past problems was the theme of another first-time event–the first call hosted by Prem Watsa, chairman of Toronto-based Fairfax Holdings. Mr. Watsa broke a tradition of silence, "for the last time," he said, to report a third-quarter net loss of C$458 million ($298 million at current exchange rates). The loss is "not a typo," he said, noting that it reflects the impact of 9-11 and C$320 million ($207 million) in reserve charges, primarily for its Crum & Forster and TIG operations.
The reserve deficiency was "surprising and it was embarrassing," he said.
"Do we have an excuse on this? Very simply, it's an industry phenomenon. Company after company has reported development [in] 2001," he said. "That reflects the softness of the markets of the late 1990s. We were a victim of that." He added that with the new management teams of Crum & Forster and TIG in place for only two years since Fairfax acquired them, "it was tougher to get to the bottom of reserves than it would be in a more normal environment."
"The past is now behind us and we're ready to face the future," said Mr. Watsa, sometimes referred to as the "Canadian Warren Buffett."
"Would we buy these companies again today? You be the judge," he said, reporting that their book values are each higher than the purchase prices in spite of reserve strengthening. "With both, we have a major presence in the commercial insurance market just as these markets are tightening significantly," he added.
On news of the reserve hit, however, rating agencies judged Fairfax harshly. A.M. Best took the latest action–downgrading TIG to "B-double-plus" (very good) from "A-minus" (excellent).
Behind Fairfax, Vesta Insurance Group in Birmingham, Ala., with a $37.1 million net loss, had the second biggest drop in third-quarter earnings. A $30 million charge to strengthen reserves for discontinued commercial and reinsurance operations, and another $30 million to settle a securities litigation, contributed to a 1,000 percent decline.
But it was what was left after the charges were removed–a 69 percent drop in operating earnings for continued operations–that blindsided analysts and investors, who were pre-warned about the settlement charge. Although executives chalked up the decline to frequency and severity of auto and homeowners claims–and a non-systematic problem for Pennsylvania uninsured motorists–Vesta's earnings release precipitated a stock drop of more than 50 percent.
As Mr. Watsa reported, reserve charges were typical for p-c insurers in the third quarter, as were charges taken to restructure and exit lines of business. SAFECO in Seattle announced the biggest reserve charge–$240 million pre-tax, consisting of $90 million for prior-year construction defect claims, $80 million for workers' comp and $70 million for other items. In addition:
Allstate in Northbrook, Ill., increased reserves by $80 million after-taxes, primarily for homeowners.
American Financial Group in Cincinnati recorded a $100 million pre-tax charge–increasing asbestos reserves by $136 million and taking down environmental reserves by $36 million.
HCC Insurance Holdings in Houston recorded an after-tax charge of $29.6 million to its exit workers' comp.
Markel Corp. in Richmond, Va., strengthened reserves $68 million–$39 million for Markel International's discontinued lines and $29 million for a New York contractors' book it no longer writes.
W.R. Berkley Corp. withdrew from personal lines and shut the alternative markets division of its reinsurance operation, putting a $40 million after-tax loss on its books.
Other companies with charges were Mutual Risk Management ($17.5 million after-tax, writing off reinsurance from Reliance Group), Selective Insurance ($12 million pre-tax to boost personal auto and workers' comp reserves), XL Capital Ltd. ($103.7 million after-tax for catastrophes other than 9-11 and development in Lloyd's operations), GAINSCO ($6.2 million pre-tax for discontinued trucking), and The Midland Company (amount undisclosed to withdraw from some commercial business).
Looking ahead, Chicago-based CNA, which bumped after-tax reserves up $1.7 billion in the second quarter, said it will record a restructuring charge in excess of $100 million in the fourth quarter as it consolidates operations, exits the variable life and annuity businesses, and cuts 10 percent of its work force.
CNA was also one of several insurers to put a preliminary figure on its exposure to the collapse of Enron, the Houston-based energy trader that filed for bankruptcy last week. CNA, CNA Surety, The Chubb Corp., The St. Paul and The Hartford have each estimated after-tax exposures related to surety bonds, with Chubb estimating $220 million; St. Paul, $64 million; CNA, $50 million; and CNA Surety, $5 million. St. Paul also said it had $19 million of exposure from reinsurance and directors and officers liability, while Hartfords $20 million is for surety, D&O and reinsurance.
Analysts at Fitch in New York have estimated that Enrons fall could cost insurers more than $2 billion, with the most significant exposures coming from D&O, professional liability coverage for Enrons auditor, Arthur Anderson, and guarantees on Enrons projects.
Fitch also said that some monoline bond insurers and reinsurers have indirect exposure to Enron in providing reinsurance for credit derivatives, noting that Enron was one of the most actively traded names in the credit default swaps market. (Sellers of credit default swaps, like insurers, guarantee payment of a bonds full value if a default occurs in exchange for a premium payment.)
Separately, Standard & Poors in New York said some insurers have direct investment exposure to debt issued by Enron, putting the value for p-c insurers at about $900 million. Hartford, for example, will write-down or sell $92 million in securities, taking a $40 million charge.
Fiduciary liability exposures that might result from lawsuits by Enron employees whose 401(k) accounts lost value when Enron stock plummeted have also not been cited as potential exposures for insurers. Generally, such risks can be covered through stand-alone policies or in blended D&O/fiduciary forms.
Enron is familiar to readers of NU because of its pioneering work on weather insurance and derivatives. Although Enron once revealed that it passed off the extremes of weather risk to reinsurers, experts have not highlighted this as a significant exposure to the p-c industry.
Reproduced from National Underwriter Property & Casualty/Risk & Benefits Management Edition, December 10, 2001. Copyright 2001 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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