Following ACE's recent fourth quarter charge for asbestos-related exposures, Dermott White assesses the industry-wide problem.

It is not that the recent round of asbestos reserve strengthening has taken place per se, but the size of that strengthening that has rattled the US insurance industry. Some insurers have now more than tripled their asbestos reserves from the levels held at year-end 2001 (see Table 1), and their latest moves have re-exposed the reality of the asbestos problem for the industry as a whole.

The roots of the problem lie in the extensive and unmonitored use of asbestos as a tough, fireproof building and manufacturing material for a large part of the last century. But the problem is being prolonged by a rising number of claims and an increasingly complicated legal environment. Although many insurers, rating agencies and consultants have tried to estimate the eventual cost of asbestos claims to the insurance industry, no one yet knows for sure. Now that there is a Republican-dominated administration in the US, many insurers and defendants of asbestos-related lawsuits are hoping for some legislative relief, in the near future, from a legal system that currently favours massive payoffs for asbestos plaintiffs, whether those plaintiffs are showing symptoms of asbestos-related disease or not. However, nothing is certain, and this latest round of reserve strengthening marks only the beginning of the next stage of the asbestos dilemma.

Ultimate price

The two most widely accepted estimates of the ultimate cost of asbestos claims come from the actuarial firms Tillinghast-Towers Perrin and Milliman USA. Tillinghast puts the global asbestos price tag, on a combined basis for insurers and defendants, at $200bn, while Milliman's estimate is $275bn (see Table 2). For US insurers, the ultimate costs are estimated at $60bn and $70bn, respectively. Although both estimates were made in 2001, they remain unchanged for the time being.

"To our knowledge, nothing has fundamentally changed in the last few months or so to change our belief of what's happening," said Darren Michaels, a London-based consultant with Tillinghast.

However, it is the shortfall in funds available to meet those huge expected totals that has insurers reaching for their chequebooks. Credit ratings agency Fitch, in its July 2002 report Asbestos: Impact on the US Insurance Industry, estimated that at the end of 2001, cumulative loss payments for the industry were approximately $24bn, while its reserves were just under $15bn. This would place the unfunded future liability of the US insurance industry at $21bn, following Tillinghast's estimate, and $31bn, following Milliman's, though the picture could improve as more insurers up their asbestos reserves. Fitch estimates that current reserving shortfalls for the US p/c industry range from $10bn to $35bn, and that the bulk of asbestos payments will need to be made over the next 20 years. Such reserving shortfalls can be absorbed without the emergence of widespread solvency problems, according to Fitch.

Getting stronger

Several major players have made significant additions in the past six months to their funds set aside for the payment of asbestos claims. In early February this year, New Jersey-based p/c insurer Chubb upped its asbestos reserves by $75m. This amount is not in itself particularly large, but it surprised the insurance community coming so soon after a $625m reserve boost in October 2002. Chubb's reason for the addition was that it needed to cover asbestos payments that were due from reinsurers, but that it probably would not be able to collect - another potential problem that unsettled the market.

Indeed, that was one of the concerns raised after Bermudian p/c insurer ACE raised its asbestos reserves on 27 January. ACE, which was created in 1985 to meet the then high demand for excess liability coverage, increased its gross asbestos reserves by nearly $2.2bn, which works out at a cost of $354m after reinsurance recoveries and tax. It inherited the bulk of it asbestos liabilities from CIGNA, when it acquired CIGNA's p/c operations in 1999. Analysts and ratings agencies said many of the reinsurers that had exposure to ACE's asbestos liabilities were likely to dispute claims, while smaller reinsurers could even be forced out of business.

"The charge also increases ACE's already significant exposure to reinsurance recoverables.... uncollectible reinsurance could materially affect ACE's equity," said Fitch when it placed the company's ratings on rating watch negative. However, the agency did recognise that ACE had added $145m to its reserve for uncollectible reinsurance as part of the charge.

Earlier in January, Travelers, the Hartford, Connecticut-based p/c insurer, reported that it had strengthened its asbestos reserves to $3.4bn, after reinsurance recoverables, up from $950m at 30 September 2002. Travelers said this would amount to a $1.3bn after-tax charge in the fourth quarter of 2002.

Meanwhile, in the latter half of 2002, German giant Allianz said it would fund a $750m increase in the asbestos and environmental reserves of subsidiary Fireman's Fund. This followed asbestos reserve increases by The Hartford ($600m according to Standard & Poor's) and The St Paul where, in both cases, existing reserves for other lines of business were reclassified as asbestos reserves.

Each reserving action followed an actuarial review of each company's present and expected asbestos liabilities in the context of the asbestos claims rate, the size of payouts awarded to people exposed to asbestos, and the likelihood of tort reform. But that type of reform is not being taken for granted. For example, Brian Duperreault, the ACE Ltd chairman and chief executive, said: "While we believe that there are favourable trends in the judicial environment regarding our asbestos liabilities, the reserve strengthening reflects a more conservative view and assumes that there will be no such future improvements."

It is still too early to say whether these companies have reached an adequate level of reserving. If anything, their actions will spur other insurers to conduct their own reviews of their asbestos liabilities, not only because of the scale of the problem but also because of the positive response from investors after ACE and Travelers announced their reserve increases. The share prices in both companies rose significantly after their announcements.

"Because the markets have reacted favourably, at least initially, to their effort to try to quantify the loss, (and) put up enough money to cover their prospective losses ... other companies are under the same pressure now to do the same thing," said Carl Pernicone, a partner and specialist in insurance and reinsurance coverage disputes involving environmental and other long-tail injury claims in the New York office of law firm Wilson, Elser, Moskowitz, Edelman & Dicker.

Legalese

However, the reserve increases are the result of several changes to the asbestos litigation environment in the last two years. This is because of factors that include an increase in the number of asbestos-related claims, expanding theories of liability, the cost of major litigation and awards to asbestos sufferers, and inconsistent legal conclusions.

In addition, there has been an increase in the number of asbestos-related claims due to more intensive advertising by lawyers seeking claimants, coupled with a sharp rise in the number of companies seeking bankruptcy protection as a result of asbestos-related liabilities. There have been over 60 asbestos-related bankruptcies since 1976, with over 20 of these since January 2000.

"The bankruptcy law provides that asbestos defendants can cap their exposures by using a provision called 524G of the bankruptcy code, which basically allows them to set aside money in a trust fund - a compensation trust fund - that will be used to compensate asbestos plaintiffs. Typically the trust is funded by the stock of the bankrupt company, whatever cash, whatever assets it has on hand, plus, if there is a parent company in the picture that is concerned that (it) might be exposed because of the subsidiary's liabilities, the parent company will typically make a significant cash contribution," said Mr Pernicone. "So the parent wants to make a contribution because, by making the contribution, the parent gets the benefit of 524G. And the benefit is what is called a channelling injunction, which insulates the bankrupt company and any other contributing companies from any direct claims. Any claims that are filed have to be channelled by virtue of the injunction into the trust for processing. That's the advantage that 524G presents."

This has led to plaintiff lawyers broadening their range of possible defendants by focussing on previously peripheral defendants, such as asbestos installers, contractors or premises owners.

"What's driving it is very simple," said Mr Pernicone. "The traditional defendants are in bankruptcy, and/or their insurance assets are already exhausted. So the plaintiffs' bar is looking - because they've got this huge machine that they've created that they want to keep feeding to keep it going - for new sources of revenue, of money."

In turn, this has given rise to new classes of claims under the non-products liability coverage in policies, which is not subject to any aggregate limit, rather than products liability coverage.

Also, many insurers are being sued directly by asbestos claimants who are asserting that insurers had a duty to protect the public from the dangers of asbestos, according to the Hartford in its report for the third quarter of 2002.

Central to the rising number of claims and peripheral defendants is the growing number of `unimpaired' claimants: individuals who have been exposed to asbestos but who do not yet show any signs of illness.

Righting civil wrongs

The reserve strengthening is at once a sign that insurers are taking the problem seriously, but also a carrot to the group of lawyers representing unimpaired claimants. Whether the donkey ever gets the carrot has yet to be decided.

It is generally accepted within the insurance community that legislation is needed to rein in the size of the payouts that are being awarded to the plaintiffs in asbestos lawsuits - particularly unimpaired plaintiffs. But few within the industry expect anything soon.

Encouraging signs did emerge from President Bush's State of the Union address, when he called for legislative reform to protect physicians from frivolous lawsuits.

In early February, doctors in Florida, New Jersey, Mississippi and West Virginia staged walkouts in protest against rocketing medical malpractice insurance rates. The doctors said that sharp increases in malpractice insurance premiums were the result of excessive jury awards for the pain and suffering claims of patients.

Although this did not relate directly to asbestos cases, said Mr Pernicone, if the doctors got their way, it could provide a boost for the reforms being sought by asbestos defendants and their insurers.

He added that these two groups had an unexpected ally in the lawyers representing plaintiffs who were actually suffering from serious illnesses, such as asbestos-related lung cancer and mesothelioma, a rare cancer tied to asbestos exposure. These lawyers want to preserve any funds that are available for asbestos compensation for the truly ill, rather than let it be paid out to unimpaired claimants.

Lone star state

Indeed, in early February a coalition of Texas business groups said it was preparing legislation to keep people who were not showing signs of sickness from getting any money, even if they had been exposed to asbestos. According to one lobbyist, Ron Dipprey, who heads the Texas Asbestos Consumers Coalition's efforts, it was estimated that 80-90% of people who had received payments for asbestos-related damages had not yet developed a related illness.

However, Mr Pernicone was not optimistic that there would be any asbestos tort reform before the latter stages of a second Bush term, which, in turn, depends on President Bush being re-elected in 2004. Also, Mr Pernicone said that tort reform would not be a `silver bullet' solution that magically wiped out huge chunks of asbestos liability. "There is enough true sickness to wipe out current insurance assets and then some.