New Fitch Report Estimates Billions in Asbestos Liability Costs

Fitch Ratings released a special report, “Asbestos: Impact on the U.S. Insurance Industry,” describing how future claims will affect property and casualty insurers. The report includes estimates of insurers’ future asbestos liability, a survival ratio target for the property/casualty industry, and ratings implications.

Prior to the report’s release, Fitch managing director Keith Buckley held a conference call recently to highlight major findings included therein. Buckley began by recapping the history of the asbestos liability issue, and then identified recent developments and how they could affect carriers.

New developments
“The most important (new development) … is the entry of new peripheral defendants,” Buckley said. “The suits have moved from being against the manufacturers and distributors to those who own property that has asbestos, or those that used it in very small quantities.

“Back in the ’80s there were about 300 asbestos defendants,” he continued. “Right now it’s estimated there are over 2,400. So it has been a huge surge in growth in the number of defendants out there.”

Buckley also noted an increasing trend in which defendants file asbestos liability claims under their general liability policies, rather than their products liability policies. “There have been a few cases where defendants working with their insurance companies have been successful in reopening previously settled claims and moving them from products liability claims to general liability claims,” he explained. “That’s typically been the case for manufacturers who also had installation activities, where more of a general liability exposure could be argued … What’s most important there is that product liability policies typically contain an aggregate policy limit, whereas general liability policies generally do not. So the amount of monies you can collect on the general liability policy is higher than the products liability policy.”

Buckley also mentioned recent tort reform and asbestos litigation efforts, but downplayed the likelihood of any legislative remedy in the near future: “Given that this year is an election year, no one is really expecting anything to happen in the near term … Certainly, trends have not been favorable the last few years, and there doesn’t look to be a solution from a legislative perspective in sight.”

Future liability
According to Buckley, the insurance industry’s net amount of ceded reinsurance annual payments for asbestos liability have averaged from $1.6 billion to $1.7 billion over the past several years. Total cumulative asbestos payments were $24 billion as of the end of 2001. Insurers currently carry reserves of $15 billion for future claims.

“So, you’re talking an incurred amount in total that would add the $24 billion and the $15 billion, or about $39 billion that’s thus far been incurred by the U.S. property and casualty industry,” Buckley said.

The actuarial estimate of ultimate asbestos costs for the U.S. insurance industry range from $55-$70 billion. Total costs for the U.S. economy, including costs borne by non-U.S. reinsurers and uninsured amounts, total between $200 and $275 billion.

Fitch estimates that current reserve shortfalls for the U.S. property/casualty industry range between $10 and $35 billion, and that most of the asbestos payments should be made over the next 20 years. Such reserving shortfalls can be absorbed without the emergence of wide-spread solvency problems. Fitch holds that reserving shortfalls will be recognized into financial statements through a combination of one-time “shock losses” as well as a “slow bleed” to depress future earnings for many years. The historic asbestos earnings drag has averaged 1.7 combined ratio points for the commercial lines/reinsurance sectors over the past few years. However, Fitch believes that “shock losses” will become more prevalent as insurers feel external and internal pressures to ‘true up’ their reserves through single large charges.

Buckley explained that Fitch developed low, middle, and high future liability estimates. The low estimate included $49 billion in ultimate claims, $25 billion of which will be in future payments. Of that $25 billion, $10 billion is unfunded.

Fitch’s middle estimate included $62 billion in ultimate claims, and $38 billion in future payments. Of those future payments, $23 billion is unfunded.

Finally, Fitch’s high estimate totals $74 billion in ultimate claims, and $50 billion in future payments. Thirty-five billion of that $50 billion is unfunded.

The insurance industry’s 2001 normalized asbestos survival ratio was just under 9 times (x). This compares to a survival ratio target developed by Fitch of 16x using risk-adjusted present value analysis. Though Fitch believes survival ratio analysis is useful for aggregate industry analysis, it is much less useful at the company level due to potentially wide variances in the speed of company payment patterns that can distort results.

Should reserves be discounted?
Buckley explained that a key issue facing insurers is whether to discount reserves for asbestos claims using a present value approach, even though those claims will be paid out over the next 20 years.

The Fitch report actually advises against such a move, especially for carriers using portfolio rates. Discounting asbestos at a portfolio rate is discouraged because the amount and timing of claim payments are uncertain. Fitch holds that discounting at a portfolio rate is only appropriate for future claims payments that are certain, such as structured settlements. If a discounting approach is used for claims for which the amount and timing is uncertain, a risk-adjusted discount rate that is materially lower than a portfolio rate should be used.

Ratings could get burned
Fitch expects the continuance of asbestos claims to have a moderate negative impact on a select number of commercial lines insurers’ and reinsurers’ credit ratings. Downgrades will most likely result for those who suffer shock losses that weaken capital, or those who allow deficiencies to grow unchecked. The company recommended that carriers conduct detailed analyses of their asbestos exposures.